While the plain vanilla stakeholder pension plan is poised to help society cope better with pension provision, can it provide effective tax-planning solutions as well?
Long before the Green Paper which launched the stakeholder consultation process, it was clear that here was a pension scheme that would cause a sea-change in attitudes to pensions. By creating a low-cost, simple and accessible pension, millions of people who currently can look forward to nothing in retirement but state benefits would begin to provide for themselves. Well, that's the theory anyway.
It has become fashionable to view the likely result with some scepticism. Many commentators are now predicting that if stakeholder becomes a success in terms of the number of subscribers, most will not be from the target audience. Rather, they suggest, success will result from the use of stakeholder by the better-off as a financial planning tool.
There are some opportunities but they are not extensive, and IFAs should think carefully before investing too much time in considering stakeholder as a tax-planning tool.
To consider those opportunities, we need to look at the tax treatment of personal pension schemes, including stake- holder. How does it differ from today?
One big change for the self-employed is that all contributions paid by individuals will be made net of basic-rate tax. Even if the individual is not liable to pay tax at all or only pays a modest amount at the lower rate of 10 per cent, the basic-rate tax credit will not be clawed back by the Inland Revenue. This brings the self-employed into line with the current treatment of contributions made by employees.
There must be thousands of low-paid self-employed individuals who could gain real tax advantage through stakeholder – a true 22 per cent discount on their pension contributions. Very tax-efficient this may be but it will probably not generate significant amounts of new pension contributions. Such people almost certainly have other priorities, such as where their next meal is coming from.
A second feature of the new regime concerns an individual's eligibility for stakeholder. No longer will it be necessary to have earnings, let alone net relevant earnings, in order to contribute. All under the age of 75 will be able to pay £3,600 (that is, £2,808 net of 22 per cent tax) into a stakeholder provided they are not a member of an occupational pension scheme earning more than £30,000 or a controlling director. Note there is no lower age restriction. Non-earners, such as carers and the unemployed, will be able to fund their retirement if only they can find the money. This must provide another large group of potential contributors.
A third change means that there may be some merit in tapping some non-earners. Under stakeholder it will be possible for a third party to pay contributions on behalf of the member. A spouse will be able to contribute to a stakeholder for his or her partner; a parent for his or her child or a grandparent for his or her grandchild.
There could be an inheritance tax issue around these third-party contributions since, strictly, the third party pays the individual (a gift) who in turn contributes to the plan.
Since payments are made net of tax, income tax relief effectively accrues although higher-rate relief will be dependant on the member being a higher-rate taxpayer, not the contributor.
In the future, a reasonably well-off household with only a single earner will be able to fund £7,000 (or whatever limit will apply in future) for both mum and dad into Isas, and £3,600 for the partner and for each child into a stakeholder pension with the earner having their own entitlement to fund a pension in their own right under the normal rules.
Two parents, with only one earning, with two children could between them enjoy £24,800 of tax-efficient investment in addition to the earner's own pension contri- bution entitlement.
All this is possible without the need to look at approved share schemes, VCTs and other tax-friendly investments. Perhaps the family should be considered to be the original affinity group.
Members of occupational pension schemes, who are not controlling directors and who earn less than £30,000, may also contribute up to £3,600 to a stakeholder pension. Contributions in these circumstances cannot exceed £3,600, even for older savers, because the age-related percentage calculation method is related to net relevant earnings. For a member of a company scheme, net relevant earnings are nil.
Stakeholder contributions may make more sense than paying AVCs because:
The stakeholder benefits are not aggregated with scheme benefits to test against the Inland Revenue maximum pension, unlike AVCs; There is no need to retire to take the stakeholder benefits. This is more straightforward than the “flexible AVCs” rules introduced last year; and Twenty-five per cent of the stakeholder fund can be taken as tax-free cash, in addition to the Inland Revenue tax-free cash from the occupational scheme.
For the really keen investor with “spare” income, they can also pay AVCs within normal limits in addition to stakeholder.
Once again, it is clear that the best opportunities for tax planning with stakeholder exist for those who are reasonably well-off.
Clearly then, there are opportunities for tax planning using stakeholder. However, the Government's own stakeholder target, the low-paid, are unlikely to be the major beneficiaries of the tax advantages. Perhaps the sceptical commentators are right and this is a product for better-off investors.
The best of the tax-planning opportunities appears to be the ability to pay contributions on behalf of a spouse or partner. Even with tax relief restricted to the basic rate, this will make sense for those who can afford it.
After enjoying tax-efficient growth, the benefits will emerge partly in the form of a tax-free cash sum.
The partner's income in retirement will attract its own personal allowance which means in many cases that the bulk of the income could be tax-free. Pension sharing without the need to divorce!
Martin Bracegirdle, Financial planning adviser,Clerical Medical