Your tax-free savings plan – it’s called a pension fund!
For business owners a pension fund should not be viewed as an insurance type financial product, instead, it should be seen as a tax-free savings fund you can use to scrape profits into and avoid paying corporation tax on that profit.
It is an essential part of your financial planning and should not be underutilised as almost every other way of getting money out of your business is taxable. At the same time, the growth in value of the pensions funds investments is tax-free, as you only pay tax when you start to draw money from your fund. (At the earliest age of 55). The first 25% of your pot is tax-free and you pay income tax on the rest at your marginal rate of tax.
Hopefully you can structure your income to make sure you only draw money from your pension fund whilst in the 20% band (depending on your other source of income) but if you don’t need the money you should consider leaving it to grow in your fund as this money will not form part of your estate for Inheritance tax purposes. If you never need to access this 75% then it can be passed tax-free to your beneficiaries on your death.
A SIPP is the most flexible form of pension fund a good Independent Financial Adviser (IFA) can recommend a good fund administrator/trustee who will look after all the regulatory compliance issues. Ultimately the returns on the investments within the fund will depend on where you invest the funds. A lot of the bad press over poor pension fund performance over the years has been the result of poor fund investment management but your IFA will advise you which fund managers to use.
As well as investing in the stock market your pension fund can also acquire commercial property (but not residential) and although the capital value does not increase as quickly as residential property, it does tend to pay higher rates of rent, which your pension fund doesn’t pay tax on, unlike holding property in a company or individually. Investing in commercial property for your business to operate from has been a favourite use for many years. There are various caps that limit the amount of tax relief that is available which we will cover below.
100% of earnings
The first limit on tax relievable pension contributions is your annual earnings. Subject to having sufficient annual allowances available, you can make tax relieved contributions to a pension scheme of upto 100% of your earnings. If you do not have any earnings or if your earnings are less than £3,600 a year, you can make gross contributions to a registered scheme of up to £3,600 a year (or someone can contribute on your behalf).
This limit is not the case where your employer (including owner-directors of their own companies) make ‘employer’s contributions’. The company pays into your pension scheme gross but deducts this from your company’s profits as an expense, thereby reducing it’s corporation tax liability for the year and effectively you get untaxed income channelled into your pension fund. Annual allowance The annual allowance places a limit on the amount of tax-relievable pension contributions. The allowance is set for each year and any unused allowances can be carried forward for three years. The annual allowance for 2018/19 is set at £40,000.
So in effect up to £160,000 can be contributed in one year if nothing has been paid in the previous 3 years, but to do this you do need to have had a pensions fund set up in your name over that period, even if nothing has been paid into it. This £160,000 could be doubled if your spouse is also a director! These employer contributions do count towards the £40,000 allowance. When you do start to draw your pension in the future, this annual allowance (of how much you’re allowed to put into another pension scheme is reduced to £10,000 pa.
Relief given at marginal rate
Tax relief for pension contributions is given at your marginal rate of tax. Where contributions are made privately out of your own funds, (not by your employer), the contribution is paid net of basic rate tax. Thus an £8,000 actual contribution is the equivalent to a gross contribution of £10,000 paid net of basic rate tax of £2,000. Higher and additional rate relief is reclaimed through your self-assessment tax return. Thus, a gross pension contribution of £10,000 actually costs a 20% basic rate payer £8,000, a 40% higher rate taxpayer £6,000 and a 45% additional rate taxpayer £5,500. A person with no or low earnings can make a contribution of up to £3,600 into a scheme. This will cost £2,880 net of basic rate tax.
Reduced annual allowance for high earners from 2016/17
From 2016/17 the annual allowance for those with EARNINGS above £150,000 was reduced by £1 for every £2 by which income exceeds £150,000 until it reaches £10,000 (for persons earning £210,000 and above). Thus, for 2018/19, a person with earnings of £180,000 will be entitled to an annual allowance of £25,000 (£40,000 – (50% (£180,000 - £150,000)).
The above does not affect the amount your company can contribute on your behalf but may trigger a special tax charge on you so take advice here!
The lifetime allowance places a lifetime cap of £1m on tax-relieved pension savings. The lifetime allowance was reduced to £1 million on 6 April 2016. A 55% tax charge applies if tax-relieved pension savings exceed this lifetime allowance (although protections are available where this is only the case as a result of a reduction in the lifetime allowance).
It is likely that the pension tax relief landscape will change radically. The Government is always looking for ways to raise more tax and reducing the relief on pension funds is regularly tipped for attack.
So, maximise the use of your pension fund now as it may be a case of making the most of the existing rules while they remain available. Contact us for assistance.