Category: Higher Rate Pension Tax Relief Restricted

Lifetime Allowance Falls to £1m: Could you be caught?

Pension Lifetime Allowance (LTA) decreased to £1m on 6 April 2016. In combination with previous reductions, it has fallen almost by half from its 2012 high of £1.8m. High net worth professionals like solicitors, barristers and accountants often underestimate the risk of exceeding their LTA. That might become very costly in the future. Above LTA, pension income is subject to 25% tax and lump sum a whopping 55%.

Example
Consider George. He is an accountant and has his own accounting business. He is in his 40’s, approaching halftime of his career. His pension pot is worth about £400,000. George considers himself comfortable, but not particularly rich. He’s heard the news about the falling LTA, but £1m sounds like different world. He’s nowhere near a millionaire after all, so he doesn’t need to worry about LTA.

Truth is, if George continues to contribute to his pension plan at the same rate, or (more likely) increases his contributions a little bit in the later years of his career, he can easily get dangerously close to the £1m mark, or even exceed it. This does not mean that he should stop contributing, but the sooner he becomes aware of the issue and starts planning, the wider options he has.


What are the options for senior professionals at risk of exceeding the new LTA?

LTA Protection
First, if you are likely to exceed the new reduced LTA (£1m), or already have, you can apply for LTA Protection, which is a transitional scheme to protect taxpayers from the unexpected LTA reduction. Depending on your circumstances you have two main options:

  • Individual Protection for those with pension pots already worth over £1m. Your LTA will be set to the lower of 1) the current value of your pension 2) £1.25m (the old LTA).
  • Fixed Protection for those with pension pots below £1m at the moment, but likely to exceed it in the future. Your LTA will be $1.25m, but no further contributions are allowed.

Other conditions apply and many factors must be considered when deciding whether LTA Protection is worth it in your case. Also note that a similar LTA Protection scheme has been in place for the 2014 decrease in LTA (from £1.5m to £1.25) – you can still apply until 5 April 2017.

LTA Planning Options and Alternatives
If you have higher income and want to save more than the LTA allows, the first thing to look at is an ISA. It won’t help you reduce taxes now, because it’s always after-tax money coming in, but in retirement you’ll be able to draw from your ISA without having to pay any taxes – capital gains, interest and dividends are all tax-free within an ISA. There is no lifetime allowance on ISAs, only an annual allowance, currently at £15,240 and rising to £20,000 in April 2017. Furthermore, you don’t even have to wait for retirement – you can withdraw from your ISA at any time.

Another alternative is to invest in stocks, bonds or funds directly, outside a pension plan or ISA. Capital gains, interest and dividends are subject to tax in this case, but there are relatively generous annual allowances which you can take advantage of – the most important being the CGT allowance, currently at £11,100 (the first £11,100 of capital gains in a tax year is tax-free).

These two options alone provide a huge scope for tax-free investing when planned properly. Those on higher income may also want to consider more complex solutions, such as trusts, offshore pensions or offshore companies, although the use of these always depends on your unique circumstances and qualified advice is absolutely essential – otherwise you could do more harm than good.

Conclusion
LTA planning must be taken seriously even when it seems too distant to worry about at the moment. Pensions are the cornerstone of retirement planning, but not the only tool available. With careful planning, a combination of different investment vehicles and tax wrappers is often the most efficient, especially for higher net worth professionals.

Budget Statement 2016: Key Takeaways

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Budget Statement 2016: Key Takeaways

Chancellor George Osborne delivered his annual Budget speech yesterday. While there are winners and losers as usual, this year’s Budget can be considered quite favourable to middle income families and savers. The pension tax relief is safe (for now) and Capital Gains Tax goes down, among other things. Whilst the Budget contained a wide range of measure, our analysis concentrates on those aspects, which are most important to our clients, namely, taxes, pensions and investments. The full speech is available here.

Personal Allowance and Higher Rate Threshold Up

The Personal Allowance, which is the amount you can earn without having to pay Income Tax, will increase from the current £10,600 to £11,000 for the 2016-17 tax year and £11,500 for 2017-18 (up from the previously announced £11,200).

The higher rate threshold will rise from the current £42,385 to £43,000 for 2016-17 and £45,000 for 2017-18. It is estimated that about 585,000 taxpayers will fall out of the 40% tax bracket as a result.

Both of these are in line with the Government’s previous promises to increase the Personal Allowance to £12,500 and the higher rate threshold to £50,000 by April 2020.

Pension Tax Relief Remains

The fears of pension tax relief cuts or other radical changes to the existing pensions system have not materialised, at least for now. In light of the loud opposition to these plans, pointing out that such measures would discourage people from saving for retirement, the Chancellor has decided to not proceed at this point. The only reference in his speech was the following:

“Over the past year we’ve consulted widely on whether we should make compulsory changes to the pension tax system. But it was clear there is no consensus.”

Of course, this does not mean the issue is safely off the table forever. The Chancellor still needs to find ways to meet his goal of “surplus by 2019-20” and pensions certainly remain among the possible targets. For the 2016-17 tax year though, the allowance stays at £40,000 (for those earning under £150,000), with pension tax relief equal to your marginal tax rate. As previously announced, the Lifetime Allowance falls to £1m effective from April 2016.

ISA Allowance £20,000 and New Lifetime ISA

While pensions have been subject to shrinking allowances in the last years, the trend has been the opposite with ISAs, apparently one of the Government’s preferred ways for people to save for retirement. This time the Chancellor has announced that the annual ISA allowance would jump to £20,000, although only from April 2017. For the 2016-17 tax year the allowance remains at £15,240, same as this year, as previously indicated.

A completely new type of ISA will be introduced in April 2017, called Lifetime ISA. Young savers will be able to contribute up to £4,000 a year and receive a 25% bonus from the Government. That is extra £1 for every £4 saved, a maximum of £1,000 per year. You must be under 40 when opening the account; you will be entitled to the bonus every year up to the age of 50, but only if you have opened an account before 40 (therefore those reaching 40 before 6 April 2017 will miss out). Furthermore, to qualify for the bonus the money must only be used either to save for retirement or to buy a home. If you withdraw cash before the age of 60 and use it for purposes other than buying a home, you will lose the bonus (including any returns on it) and pay a 5% penalty.

The Lifetime ISA is intended as an alternative to pensions for young workers (“many of whom haven’t had such a good deal from the pension system”) and will most likely further develop in the next years. With its home ownership objective it will replace the previously announced Help to Buy ISA, which remains in place until 2019 and can be transferred to the new ISA after April 2017.

Capital Gains Tax Down (Excluding Property)

Shares and other investments sold outside an ISA or pension scheme are subject to Capital Gains Tax when the annual CGT allowance (currently £11,100) is exceeded. As another welcome change to investors, the rates of CGT will drop from 18% to 10% (basic rate) and from 28% to 20% (higher rate).

Importantly, these reductions won’t apply to capital gains from property sales, which will continue to be taxed at the existing rates. This is consistent with the Government’s recent actions against Buy to Let and intended to “ensure that CGT provides an incentive to invest in companies over property”.

Other Changes

The following are some of the other announcements from this year’s Budget speech.

  • From April 2017 there will be two new tax-free allowances (£1,000 each) to support micro-entrepreneurs and the “sharing economy”. The first will apply to property income (such as when renting out your home), the other to trading income (such as when occasionally selling goods and services online).
  • Corporation Tax will decrease further than previously announced, to 17% from April 2020.
  • Contrary to expectations, fuel duty will continue to be frozen for sixth year in a row.
  • From April 2018 there will be a new levy on soft drinks with high sugar content. The proceeds will help finance more PE and sport in schools.
  • Last but not least, Armed Forces veterans in need of social care will be able to keep their war pensions, rather than use them to pay for care.

Conclusion

For the time being, pensions remain the primary way to save for retirement and their tax and other advantages are hard to beat by the alternatives, even with the reduced CGT. Their major downsides are the reduced Lifetime Allowance and Annual Allowance for high earners, effective from 6 April. Of course, further changes may come in the next months and years.

With 25% bonus from the Government, the new Lifetime ISA offers attractive net returns, as long as you meet the conditions. It is only £4,000 per year, but that could add up and compound over time. Even if you are too old to qualify yourself, make sure your children know and take advantage of it when it starts to be available in April 2017.

Lastly, if you are likely to exceed the CGT allowance, consider deferring the sale until 6 April where possible. Not only you will have a new allowance to use, but also CGT rates will be lower by 8 percentage points if you exceed it.

10 good reasons to pay into a pension before April

There are less than three months to go before the new pension freedom becomes reality. With the legislation now in place, the run up to April is time to start planning in earnest to ensure you make the most of your pension savings.

To help, here are 10 reasons why you may wish to boost your pension pots before the tax year end.

1. Immediate access to savings for the over 55s

The new flexibility from April will mean that those over 55 will have the same access to their pension savings as they do to any other investments. And with the combination of tax relief and tax free cash, pensions will outperform ISAs on a like for like basis for the vast majority of savers. So people at or over this age should consider maximising their pension contributions ahead of saving through other investments.

2. Boost SIPP funds now before accessing the new flexibility

Anyone looking to take advantage of the new income flexibility may want to consider boosting their fund before April. Anyone accessing the new flexibility from the 6 April will find their annual allowance slashed to £10,000.
But remember that the reduced £10,000 annual allowance only applies for those who have accessed the new flexibility. Anyone in capped drawdown before April, or who only takes their tax free cash after April, will retain a £40,000 annual allowance.

3. IHT sheltering

The new death benefit rules will make pensions an extremely tax efficient way of passing on wealth to family members – there’s typically no IHT payable and the possibility of passing on funds to any family members free of tax for deaths before age 75.
You may want to consider moving savings which would otherwise be subject to IHT into your pension to shelter funds from IHT and benefit from tax free investment returns. And provided you are not in serious ill-health at the time, any savings will be immediately outside your estate, with no need to wait 7 years to be free of IHT.

4. Get personal tax relief at top rates

For those who are higher or additional rate tax payers this year, but are uncertain of their income levels next year, a pension contribution now will secure tax relief at their higher marginal rates.

Typically, this may affect employees whose remuneration fluctuates with profit related bonuses, or self-employed individuals who have perhaps had a good year this year, but aren’t confident of repeating it in the next. Flexing the carry forward and PIP rules* gives scope for some to pay up to £230,000 tax efficiently in 2014/15.
For example, an additional rate taxpayer this year, who feared their income may dip to below £150,000 next year, could potentially save up to an extra £5,000 on their tax bill if they had scope to pay £100,000 now.

* Contact me if you don’t know what this is.

5. Pay employer contributions before corporation tax relief drops further

Corporation tax rates are set to fall to 20% in 2015. Companies may want to consider bringing forward pension funding plans to benefit from tax relief at the higher rate. Payments should be made before the end of the current business year, while rates are at their highest. For the current financial year, the main rate is 21%. This drops to 20% for the financial year starting 1st April 2015.

6. Don’t miss out on £50,000 allowances from 2011/12 & 2012/13

Carry forward for 2011/12 & 2012/13 will still be based on a £50,000 allowance. But as each year passes, the £40,000 allowance dilutes what can be paid. Up to £190,000 can be paid to pensions for this tax year without triggering an annual allowance tax charge. By 2017/18, this will drop to £160,000 – if the allowance stays at £40,000. And don’t ignore the risk of further cuts.

7. Use next year’s allowance now

Some may be willing and able to pay more than their 2014/15 allowance in the current tax year – even after using up all their unused allowance from the three carry forward years. To achieve this, they can maximise payments against their 2014/15 annual allowance, close their 14/15 PIP early, and pay an extra £40,000 in this tax year (in respect of the 2015/16 PIP). This might be good advice for a individuals with particularly high income for 2014/15 who want to make the biggest contribution they can with 45% tax relief. Or perhaps the payment could come from a company who has had a particularly good year and wants to reward directors and senior employees, reducing their corporation tax bill.

8. Recover personal allowances

Pension contributions reduce an individual’s taxable income. So they’re a great way to reinstate the personal allowance. For a higher rate taxpayer with taxable income of between £100,000 and £120,000, an individual contribution that reduces taxable income to £100,000 would achieve an effective rate of tax relief at 60%. For higher incomes, or larger contributions, the effective rate will fall somewhere between 40% and 60%.

9. Avoid the child benefit tax charge

An individual pension contribution can ensure that the value of child benefit is saved for the family, rather than being lost to the child benefit tax charge. And it might be as simple as redirecting existing pension saving from the lower earning partner to the other. The child benefit, worth £2,475 to a family with three kids, is cancelled out by the tax charge if the taxable income of the highest earner exceeds £60,000. There’s no tax charge if the highest earner has income of £50,000 or less. As a pension contribution reduces income for this purpose, the tax charge can be avoided. The combination of higher rate tax relief on the contribution plus the child benefit tax charge saved can lead to effective rates of tax relief as high as 64% for a family with three children.

10. Sacrifice bonus for employer pension contribution

March and April is typically the time of year when many companies pay annual bonuses. Sacrificing a bonus for an employer pension contribution before the tax year end can bring several positive outcomes.
The employer and employee NI savings made could be used to boost pension funding, giving more in the pension pot for every £1 lost from take-home pay. And the employee’s taxable income is reduced, potentially recovering personal allowance or avoiding the child benefit tax charge.

ISA inheritability makes ‘allowance’ for your spouse

Details have begun to emerge on how the new inheritable ISA rules will operate. And the good news is that it will be achieved by an increased ISA allowance for the surviving spouse rather than the actual ISA assets themselves. This means clients won’t have to revisit their wills.

How the rules will work.

If an ISA holder dies after 3 December, their spouse or civil partner will be allowed to invest an amount equivalent to the deceased’s ISA into their own ISA via an additional allowance. This is in addition to their normal annual ISA limit for the tax year and will be claimable from 6 April 2015. This means the surviving spouse can continue to enjoy tax free investment returns on savings equal to the deceased ISA fund. But it doesn’t have to be the same assets which came from the deceased’s ISA which are paid into their spouses new or existing ISA. The surviving spouse can make contributions up to their increased allowance from any assets.

What it means for estate planning

By not linking the transferability to the actual ISA assets, it provides greater flexibility and doesn’t have an adverse impact on estate planning that your client may have already put in place. For example, had it been the ISA itself which had to pass to the spouse to benefit from the continued tax privileged status, it could have meant many thousands of ISA holders having to amend their existing Wills. Where the spouse was not the intended beneficiary under the Will or where assets would have been held on trust for the spouse – a common scenario – the spouse would miss out on the tax savings on offer. Instead it’s the allowance which is inherited, not the asset. This means that, even in the scenarios described above, the spouse can benefit by paying her own assets into her ISA and claiming the higher allowance. And the deceased’s assets can be distributed in accordance with their wishes, as set out in their Will.

The tax implications

The tax benefits of an ISA are well documented. Funds remain free of income tax and capital gains when held within the ISA wrapper. And it’s the continuity of this tax free growth for the surviving spouse where the new benefit lies. It’s an opportunity to keep savings in a tax free environment. But the new rules don’t provide any additional inheritance tax benefits. The rules just entitle the survivor to an increased ISA allowance for a limited period after death. The actual ISA assets will be distributed in line with the terms of the Will (or the intestacy rules) and remain within the estate for IHT. Where they pass to the spouse or civil partner, they’ll be covered by the spousal exemption. Even then, ultimately the combined ISA funds may be subject to 40% IHT on the second death.

With ISA rules and pension rules getting ever closer, it may be worth some clients even considering whether to take up their increased ISA allowance if the same amount could be paid into their SIPP. This would achieve the same tax free investment returns as the ISA and the same access for client’s over 55. But the benefit would be that the SIPP will be free of IHT and potentially tax free in the hands of the beneficiaries if death is before 75.

What’s next?

The new allowance will be available from 6 April 2015 for deaths on or after 3 December. Draft legislation is expected before the end of the year and the final position will become clear after a short period of consultation. The new inherited allowance will complement the new pension death rules – a welcome addition to the whole new world of tax planning opportunities for advisers and their clients from next April.

Government Restricts Higher Rate Relief on Pension Contributions

In today’s Budget the Chancellor has restricted higher rate tax relief on employee contributions to pensions where the employee earns £150,000 or more and makes annual contributions of £20,000 or more.
For further details see this

Chris Wicks CFP
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