SIPP answer to £10,000 annual allowance pension limit
Increasing company funded pension provision can help high rate tax payers save more for their future, says Martin Tilley, director of Technical Services, Dentons Pension Management
The introduction of the tapered annual allowance has brought a new lease of life to a long standing case study used by us and originally created to reduce a higher rate tax payer’s annual tax bill.
The requirement to include not just salary and benefits but other income such as interest, dividends, corporate or net pay pension contributions and, in particular, rent in the definition of ‘adjusted’ annual income means more clients will now be above the critical £150,000 threshold and have some reduction in their pension annual allowance.
For those older clients who have left pension funding late in their lives, it means the chance of amassing a meaningful pension if restricted to the minimum annual allowance of £10,000pa is slim.
The study below details how a rearrangement of assets can lead to an enhanced company injection of capital of over £30,000 into a pension, irrespective of the client’s initial high earnings.
The individual in question owns an SME that he has built up over the previous two decades. There have been good times and lean and during that time he has accumulated £460,000 of pension assets, having made maximum provision of carry forward in previous years. The business is doing well and whether through salary or dividend payment, his earnings, which include £30,000pa rental from the commercial property he owns and from which his business trades, will be £210,000 restricting future company contributions to £10,000pa.
He approaches his adviser in December, having been preparing his tax return and is worried about his excessive tax bill for future years. His initial enquiries about reducing his tax liability by pension contributions are scuppered by the tapered annual allowance.
Instead, the adviser creates a plan whereby the client’s commercial property is acquired by a newly created full self invested personal pension (SIPP).
It is not unreasonable for the process, which includes the advice, due diligence of a suitable property specialist SIPP provider, transfer and the transaction itself to take 8-10 weeks, so the effects will likely not take place until the following year.
The process first requires an arm’s length opinion of value to be sought from a suitably qualified professional valuer, such as FRICS/MRICS. Future rent will also need to be evidenced as being on a commercial basis.
The client should then be able to select their own conveyancing solicitor.
The adviser can then go about creating the SIPP and arranging the transfer of existing funds to the new arrangement.
With the conveyance complete we have a number of outcomes and considerations.
Firstly, the transfer of the property into the pension fund will result in the rental income being received free of any tax within the pension environment and any increase in value on the building will be free of capital gains tax.
The pension scheme, all the while the tenant is in place, has a good secure income. This £30,000pa rental received from the company is a deductible expense for them, which is being used to augment the clients pension but as investment income to the scheme and not a contribution.
The individual, having transferred the right to receive future rent to the pension scheme, has reduced his higher rate tax burden by the amount he would have paid on £30,000 of rental income. He has also reduced his income, which is now £180,000, meaning that a company pension contribution of £16,650 can be made. Although this increases his adjusted annual income it is still permitted within his tapered annual allowance.
The total company tax relievable, in addition to the client’s pension, is therefore £46,650 as opposed to the £10,000 pre-transaction. The advantage being that the client is then building their pension, part of which will be distributable tax free when vesting age is attained.
Considerations from the individual’s perspective are that the transfer of ownership would trigger a capital gain and thus tax payable on it, albeit probably at the lower 20% level announced in the March 2016 Budget. It might also be possible to stagger the purchase across two tax years, meaning the capital gain on the property is also split over the tax allowance periods but any saving would need to be considered against the clients other capital gains and the cost of the staggered transaction.
Other costs associated with the transaction include a property valuation fee, stamp duty and conveyancing fees, all of which should be payable by the new SIPP as an expense of investment.
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