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There’s life in the old dog

An offshore life contract could be the adviser’s best friend when generating retirement benefits outside a pension, says Scottish Equitable International head of marketing Steven Whalley.

If it barks like a dog and wags its tail like a dog, it is a dog – right?

If it grows like a pension contract and allows the company to claim tax relief like a pension contract, it is a pension contract – also right? Not necessarily. It could be an offshore life contract.

In fact, there are times when an offshore life contract can not only offer benefits which are surprisingly like a pension but can reach parts of financial planning that a pension cannot reach.

This is good news for financial advisers as it means you are in a position to extend the service you offer in corporate retirement planning.

We have identified customer types for whom you could consider an offshore life contract. First, there are those scheme members whose employers would like to fund the equivalent of maximum benefits even if they have worked less than that.

It is estimated that only 5 per cent of scheme members reach maximum benefits out of 10 million in occupational pension schemes.

While employers are very unlikely to want to treat all employees in such a way, there are obviously a large number who could benefit.

There are also those who are salary capped, that is, individuals in post-1989 schemes who are earning over 105,600 from April 2005. According to the National Audit Office, there are around 170,000 employees in such schemes earning over 100,000 (source: the Government’s estimates of the impact of the pension lifetime allowance, National Audit Office, March 2004).

In addition, there are those who work abroad and who are not eligible to join their employer’s UK pension scheme. It is difficult to ascertain how many individuals this might affect but Alliance & Leicester International forecasted in June 2004 that there will be around two million people working abroad by 2014.

After pension simplification comes into force, there will also be those with pension funds over 1.5m who want to avoid the lifetime charge. The National Audit Office calculated (based on a 1.4m lifetime limit) that 10,000 people will be affected immediately.

The tax advantages of an offshore life contract are well known. The fund grows tax-free except for irrecoverable withholding tax on dividend income – just like a pension.

Five per cent of the original investment can be taken each year with no immediate tax to pay. This is cumulative. To many clients, a regular withdrawal could look like a regular pension income being paid. With a regular pension, the whole amount is taxable.

There is also no capital gains tax on switches – again, just like a pension.

It is important to note that income tax is payable at the highest rate when a chargeable event occurs (normally when benefits are taken over the 5 per cent allowance). However, for offshore bonds, only the growth is taxable, whereas all the benefit received in the form of income from a pension is subject to income tax.

Given that pension arrangements often have regular rather than single-premium payments, it is worth pointing out that there is no difference in the tax treatment between regular and single-premium offshore life contracts.

A suitable type of contract is one where the company can make flexible payments, such as being able to stop and start contributions easily. Given that many contracts will be set up on a regular-premium basis, so the initial amount may not be substantial enough to create a diversified portfolio over a range of sector funds, a contract with an attractive range of risk-rated managed funds could be an advantage.

There are very few plans designed for the UK market but they can be found.

In terms of how such a scheme works for the UK-resident employee, the process would be for he or she to take out the plan in their own name. The employer either pays the contribution direct into the plan or increases the employee’s salary, allowing them to make the contribution.

Assuming the employer pays the contribution, the company’s corporation tax liability will be reduced, the employee’s remuneration package will increase and so be subject to National Insurance and income tax and, as the employee’s overall remuneration package will increase, the employer will have to pay additional National Insurance contributions.

Where the employer increases the employee’s salary to enable them to pay the contribution, the company’s corporation tax liability will be reduced, the employer will need to pay additional National Insurance contributions, the employee’s additional salary will be subject to National Insurance and income tax in the usual way and the contribution will be paid out of taxed income.

For those who are working abroad, the process is for the employee to set up and own the plan and make contributions, perhaps by negotiating a salary increase instead of retirement contributions from their employer. There is the added advantage that, when it comes to taking benefits, the client can take them either in the last country they worked in or in the UK, depending on which offers the best tax advantages. The tax position for the company will depend on the exact employment status of the employee.

So far, we have looked at instances where offshore life contracts could offer a solution where traditional pensions cannot be used. It is worth noting that offshore life contracts can also be used alongside pensions as they are more flexible in how and when benefits can be taken. There is no limitation as to how much can be taken as cash and benefits can be taken at any age.

Adding offshore life contracts to your repertoire of retirement planning options will not prove to be a dog of an idea.

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