Pensions: more exciting than you thought?

Tax year-end not far off

You may be a long way off retirement but the end of the tax year is only a couple of months away, on 5 April. Investing in a pension remains one of the single most effective and legitimate ways of saving yourself tax and investing for the future and should be a serious consideration for any business owners with surplus profits or cash in their business.

If you withdraw the money from the business as salary or dividends, you will be taxed at your marginal rate of income tax, potentially a punitive amount if you are already a high-rate or additional rate tax payer.

Where to invest surplus cash

Clearly, there are alternatives – for example, if there are assets you could invest in that would help develop the growth or profitability of your business in the future, there are attractive tax reliefs available on purchases of assets that qualify, such as plan and machinery or IT equipment, where the cost can be offset in the same year by a tax deduction.

Another scenario – if you are looking to sell your business in the near future, it may make sense to leave it well capitalised and you may well be able to increase the sale value and receive this in a tax-efficient manner through the use of Entrepreneurs’ Relief, if certain conditions are met, where you only pay 10% on the profit you make on the sale.

However, if neither of the above situations applies to you and whilst you should always leave a buffer cash in the business to cover unforeseen circumstances, investing in a pension via your company may be a wise choice – it will certainly be a tax-efficient one – and pensions are more flexible than they used to be and are about to become even more so.

Tax-free benefits

If you invest money from your company in a pension, there will be no tax charge on this, at the point it is invested. If you are a higher rate tax payer (i.e. with income in excess of £41,865) and you withdraw the money from your own company as salary, you will incur a tax and NI charge of 55.8%, leaving you with less than half. This is because whilst your tax and national insurance bill as the employee is 42%, the business will pay another 13.8% in employer’s national insurance. So, by putting the money into a pension, of which you are the sole beneficiary, you are effectively more than doubling your money.

Even if you take the money out as a dividend, you will incur a 25% tax bill and if your income is over £150,000 you’ll incur over 30% on any dividends above this amount.

Flexibility

Using something called a SIPP, you can now invest pension funds in a wider range of assets, as opposed to just the standard fund, for example commercial property. So, you could, for example, purchase premises for your business using your pension fund. Your business would pay rent into the fund and both this income and the capital value of  the property would be tax-free.

A SIPP fund can even borrow money to further enhance the effectiveness of the investment over time.

The great escape – even more flexibility

Due to measures announced last year by the government, which will come into force from 2015, yo now have more flexibility on what to do with your pension when it comes to drawing down the money on retirement, or even if you continue working.

Under previous rules, you could take 25% of your pension pot as tax free lump sum on retirement and in the majority of cases, the remainder had to be invested by buying an annuity – a guaranteed payment per year for life.

Under the new rules, you can now access as much of the fund, in cash, as you wish, whenever you want, from the age of 55. You will still be able to take the first 25% tax-free. Any amounts you take out after the initial 25% will be taxed at your marginal rate of income tax, in that tax year – for 2015/16 this will be 0% for earnings up to £10,600; 20% on income up to £42,385; and 45% in income above £150,000.

If you prefer at the time, you are still able to purchase an annuity with the fund.

Some options include:

  • Taking the 25% tax-free amount and then withdrawing the rest over a period of years to reduce the tax you pay on it
  • Taking the 25% tax-free amount and buying an annuity with the rest
  • Taking the 25% tax-free amount and leaving the rest in the pension fund to grow – it can be taken later or an annuity purchased later
  • Withdrawing the whole amount and investing it yourself – though the tax on this is likely to be punitive in many cases
  • A mixture of the above

If you choose to take the cash, some options for investment include:

  • Buy-to-let property
  • An investment fund – typically a range of stocks and shares, bonds and property investments, managed by a financial expert. Funds are available in a range of risk profiles, from ones with a high proportion of low risk government gilts bonds, through corporate bonds, to higher risk stocks and shares investments in a variety of markets. The risk can be tailored to your appetite and the amount you have to invest.
  • Peer-to-peer lending where you can lend to, or invest in, a variety of different businesses via an online system. The latter of  these is relatively new and likely to be fairly high-risk, so should not be used for a large proportion of your funds.

It is also worth noting that further changes by the government mean that you can leave your pension pot as an inheritance for your children and no tax will be payable at the point they inherit it (as long as you are over 55 when you die). They will, of course, pay tax when they withdraw the funds, at their marginal rate but at least inheritance tax is negated, n a situation where your overall assets are likely to exceed the inheritance tax threshold of £325,000.

Whatever you decide, there is greater flexibility that ever, which is always attractive and, as long as you have enough to cover your retirement, you should be able to access some of your hard-earned savings to use as bit of a treat – the holiday of a lifetime, a classic car, or even some art or wine that you’ve never been able to afford, the latter two of which may even prove to be a wise investment.

Posted by John Hoskin