An annual client year-end review would not be complete without an appraisal of pension contribution and tax planning opportunities and this year is no exception.
With changes to the highest rate of income tax, the annual allowance and lifetime allowance all within sight, a strategic plan needs to be put in place for your higher net worth individuals.
Although pensions are quite often viewed with a negative bias, and these aforementioned reductions do not help, what is often overlooked is that following the abolishment of the annuity purchase requirements, with the exception of immediate purchasing power, an additional rate tax payer cannot lose by making a pension contribution (investment risk aside).
For these individuals a £10,000 gross pension contribution will cost only £5,000 net of tax relief. The subsequent receipt of the 25 per cent pension commencement lump sum reduces net outlay to £2,500 and even in the event of death immediately after vesting with no financial dependants, loved ones would receive the balance of the fund (after deduction of the 55 per cent tax charge) of £3,375 outside of the estate, with no further tax to pay on receipt.
Any growth on the fund (largely tax exempt) would make the return of capital more attractive still, and in reality, provided death was not immediate after vesting, any pension payments would be taxed at less than the 55 per cent charged on the remaining fund as is the case on death.
Armed with these facts advisers should be considering the following:
Currently the highest rate of income tax is 50 per cent and this will drop to 45 per cent from April this year. To maximise relief on income above £150,000 should be made before 5 April 2013 but care needs to be taken not to over contribute. If contributions reduce taxable income below £150,000 relief drops to 40 per cent. Thus it might be prudent in some circumstances to defer part of the contribution until the following year when the client’s additional rate income tax will be 45 per cent.
As long as the client has a suitable pension in place providing a bridge back to earlier tax years, it is possible for unused relief for the three tax years commencing 2009/10 to be carried forward to the current year. Failure to make good any shortfall from 2009/10 before the end of the 2012/13 tax year will see the opportunity lost for good.
If maximum funding in the current year remains appropriate and both the current year’s annual allowance and carry- forward have been fully utilised, it is possible with the permission of the pension provider to cut short the current pension input period and in doing so commence a new period, the final day of which will fall in the 2013/14 tax year. By doing this, the annual allowance for 2013/14 can be made at anytime within the new PIP and if done so before 5 April 2013, provided earnings permit will result in relief in the current tax year.
Client employees may be able to sacrifice a March bonus payment in lieu of a pension contribution. This still has the effect of reducing the client’s taxable income as well as saving both the employee and employer National Insurance contributions on the amount sacrificed.
Employer’s may wish to consider bringing forward pension contributions for staff in light of changes in corporation tax rates. Payments made in the company’s current financial year may attract higher rates of relief which will drop from 1 April 2013.
Other factors may also have an influence on final contributions in strategic planning. A client intending to utilise flexible drawdown in the tax year 2013/14 can do so only if no contributions have been made in that tax period. Their final opportunity to contribute would therefore be in the current tax year.
With an eye on the reduction of the lifetime allowance to £1.25m from April 2014, whether a client should opt for “fixed protection 2014” should be considered. If the intention is to lock in the current £1.5m lifetime allowance then contributions can only be made in the current and next tax year.
If protecting a higher lifetime allowance is not appropriate or achievable, then planning to get the client’s fund as close to the new lifetime of £1.25m may well be desirable.
The impact of the Government’s reduction of the lifetime allowance to £1.25m effective from April 2014 has not been well understood. This cutback is substantial in real money terms as compared to the original £1.5m lifetime allowance introduced in 2006.
In 2006 a male aged 60, who had accumulated the maximum lifetime allowance of £1.5m could have received a pension commencement lump sum of £375,000 and a residual pension, escalating at 3 per cent, with a 50 per cent spouses pension of £40,881 pa.
Taking inflation to the current date and projecting forward current inflation to 2014, the real purchasing power of the equivalent 2006 benefits in 2014 would be a PCLS of £493,875 with a like for like annuity of £53,840pa.
However what will be available is a PCLS of £312,500 and a residual pension of only £26,700pa. (The latter is based on annuity rates from Dec 2012). These figures represent a loss in real money terms of 36.7 per cent and close to 50 per cent respectively from the adjusted April 2006 figures.
More shockingly for some is simply the capital cost of indexed annuities and how little a fully funded pension will provide.
With the hard facts of what the new LTA will potentially permit, best use of the opportunities now available should be made.
Martin Tilley is director of technical services at Dentons Pension Management