Graham Doubtfire, Private Client Tax Director at Scrutton Bland asks are pensions now more tax efficient than ever?
A lot has been said about the new pension rules and pensioners spending their retirement funds on a new car but very few people have looked at how the new rules can make pension investments very tax efficient.
What relief can I claim?
Pension investments allow an individual to claim tax relief at their highest marginal rate of income tax. This may mean that tax relief could be claimed of 40%, 45% or even in some cases 60%.
This could mean that, after tax relief, the net cost of getting £10,000 into your pension could be as low as £4,000, with the other £6,000 coming from tax relief.
How can this help with the new rules?
Whilst a tax deferral is great, it becomes of significant benefit when it enables you to make a permanent tax saving and this is what the new rules will allow you to do.
Taking the above example of £10,000 being invested into a pension, if this can be drawn as income when in retirement (presently any age from 55) then this can be taken as follows:
n £2,500 as a tax free lump sum
n £7,500 as income subject to income tax at your marginal tax rate
If the £7,500 is taxed at the basic rate then this will produce an income tax liability of £1,500 so the £10,000 pension withdrawal will suffer income tax of £1,500 leaving £8,500 to be spent as income.
Following these tax reliefs through from start to finish and taking the above example of the net costs and taxes applying on exit to a £10,000 gross contribution:
n For a 40% taxpayer the net cost is £6,000 which becomes £8,500 when drawn out of the pension (a more than 40% increase)
n For a 60% taxpayer the net cost is £4,000 which becomes £8,500 when drawn out of the pension (in effect more than doubling the amount available through tax relief).
The family company
A significant number of our clients will be family companies. The remuneration strategy selected will often be structured as low salary/high dividend as this limits the income tax and National Insurance on getting the income into the owner’s hands.
It is possible for the company to make contributions but in the context of a family business the difficulty is justifying a remuneration package of more than the level of the low salary, which will be set at around £8,000 for 2015/16, for the non working spouse. It is important that HM Revenue and Customs can be satisfied that the overall package of salary and pensions would be paid to a third party for the same level of work.
The problem with personal contributions is that to make personal pension contributions an individual needs “Net Relevant Earnings” (which is a technical term that defines salary, but not dividends, from a company or a profit share from an unincorporated business) of at least the level of contribution to be made, unless it is less than £3,600.
Taking a long term view, the new rules could be used to make pension contributions of around £8,000 and then taking more dividends, which may be a sensible strategy as a way of building up a pension pot so that a couple can both make full use of their Personal Allowances in retirement.
For many owners of family businesses and Private Clients this radically alters how their income and benefits should be structured to maximise the tax relief available and this along with other income tax changes that have occurred on 6 April 2015 makes a review of your remuneration package and pension planning essential.
To make sure your pension investments are tax efficient contact:
t: 01473 267000