Well, this is the last installment of my consideration of unapproved pension schemes and how the rules for their taxation will change after A-Day. I have also touched on the fact that proper pension provision depends on a combination of:
Investment selection and management, taking due account of appropriate asset allocation, diversification and correlation principles.
Structure, incorporating the choice of tax wrapper.
Regarding the latter, the choice is endless. Of course, with the exception of venture capital trusts and enterprise investment schemes, approved (soon to be registered) pensions are the only investments that will give you tax relief on contributions.
But Isas, as well as pensions, offer tax freedom on capital gains and income on the underlying investments. Pensions will, as a quid pro quo for the front-end tax relief, deliver a tax charge on the emerging income.
Pensions also prevent access to the funds until the retirement/vesting date. It is these constraints and the earnings cap that fuelled the development of unapproved schemes.
As I have made clear over the past few weeks, existing Furbs, provided they are not added to after A-Day, will preserve in full their current tax status apart from the increased rates of tax applicable to income from April 6, 2006. The preserved freedom from inheritance tax will be particularly worth keeping. It may be that very few consider removing funds from pre-A-Day preserved Furbs.
Be that as it may, I will now consider the implications of such removal. First, under the structure and operation rules (anti-avoidance provisions not applied provided the structure and operation of the Furbs is as it would be for an approved scheme) there may be some doubt over whether benefits can be realised and paid to someone under retirement age. Some scheme rules, with this in mind, will be drafted so as to prevent such a payment being made. Even if the scheme permits the payment, would there be adverse tax implications?
Paying a lump sum to an individual under retirement age would certainly not be in line with the structure and operation of an approved scheme. What could the Inland Revenue do if such a payment were made? If it views the scheme, by virtue of the early payment, as other than a retirement benefits scheme, it may seek to apply the ordinary settlement provisions to tax past fund growth and income. Or it may be prepared to take a relaxed view in light of the circumstances. This is an issue which should be resolved as soon as possible.
Even if early removal of funds is possible, both legally and with no tax penalty, advisers ought to be able to justify that all parties will be better off by virtue of the move. This means, all other things being equal, the scheme's advisers ought to be confident that the funds/investments will be treated more favourably outside the Furbs than within it. This would seem to be hard to justify. IHT protection will have been lost to start with.
Income and gains on personally owned investments will for most Furbs members be assessed at the highest rates – just as high as those applying to assets held in trust. The only tax advantage, it would seem, in holding investments personally is that the member's annual CGT exemption could be available, assuming the member has not used the exemption in respect of other disposals.
When it comes to considering whether to establish an employer-financed retirement benefits scheme – the new name for a Furbs after A-Day – the attractiveness of this would have to be seriously questioned without the benefit of IHT freedom.
Apart from the loss of IHT protection and increase in rates of tax on income, there is also the shifting of the tax implications on contributions, resulting in deferment of employee liability until benefits are received but with employer deductibility also deferred until that time.
There is also a need to consider the overall tax position on investment gains and income under an EFRBS. Under preA-Day rules there would be no tax charged on benefits paid to the member if gains and income were brought into charge to tax. This is not so for an EFRBS. The whole payment emerging from the EFRBS would be taxed on the member, with no credit for tax borne on the funds. Of course, there would be more invested in the EFRBS as there would be no income tax or NI charge to deplete the funds available to invest, assuming the member's pre-contribution net income were being maintained. This would usually more than outweigh the loss of corporation tax relief.
For those who do start an EFRBS, it may be worth considering an offshore insurance bond as the underlying investment. There would be no tax on gains and income made in the underlying insurance fund and no tax on the employer (as settlor) when the bond is encashed, provided payment to the member is made in the same year. This is because of the tax charge on the member when payment is made. So at least a double charge can be avoided. This is a particular feature of the insurance-based investment.
In determining the attractiveness of an EFRBS, comparisons need to be carried out between:
Taking available funds, say, as dividends, assuming the member is a shareholder, or as salary and investing personally and taking benefits in a way to minimise/defer personal tax and Having a greater sum invested at outset (as is is only depleted by corporate rather than personal tax) suffering trust taxation (or not with any offshore bond investment) and being taxed wholly as a payment from employment on withdrawal of benefits. It would be possible to avoid NICs on payment of benefits if the benefits did not exceed what could have been received from a registered (approved) scheme and if the member's employment had ceased.
New unfunded schemes will be taxed in much the same way as they are now.