There have been so many changes in the taxation of pensions in recent years that tax advisers are in danger of not seeing the wood for the trees.
Back in 2002 the then Labour Government proposed the reform of pensions, how they worked and how they were taxed with a view to simplifying the rules and bringing them up to date to suit modern life.
For many reasons, the Government suggested that the complexity of the rules was a major factor (and they were indeed complex) in deterring people from saving. No doubt stock market crashes, mis-selling of insurance products, high commissions and, above all, the fall out from the Maxwell and Equitable Life situations also weighed with the public. Whatever the reason, the country was facing a major pension savings crisis.
Meanwhile, life expectancy was rising, as it continues to do. While the latest figures show that increases in life expectation have slowed, it is significantly higher now than when the then pensions rules were first framed in the 1960s. Between 1991 and 2011, life expectancy increased for both men, from 77.9 to 82.6, and women, from 81.5 to 85.6. However, on the downside, over this time, the proportion of years that an adult aged 65 could expect to live independently declined from 73.6 per cent to 63.5 per cent for men, and from 58 per cent to 47.3 per cent for women. So while we are living longer, we will need greater funds to do this.
So we were in a perfect storm – complex inflexible tax rules requiring increasingly poor annuities to be taken on retirement, falling savings rates, increasing life expectancy but longer periods of dependency.
Something had to change. The process started in 2002, then made tremendous progress when the ‘A-Day’ reforms were introduced in April 2006 and culminated in the Pension Freedoms rules in 2015. I would suggest that over this period the rules surrounding pensions have been turned upside down but have we tax advisers moved with the times and fully realised the ramifications? Let us explore this further.
Prior to 2006, we had contribution limits of 17.5 per cent of NRE (net relevant earnings) and caps on earnings over around £100,000; the A-Day rules swept these aside initially with contribution rates of up to 100 per cent of NRE on earnings up to about a quarter of a million. While subsequently the revenue cost of this became unsustainable, flexibility remains (especially for those not in final salary schemes) subject to the Annual Allowance (varying between £40,000 and £10,000 depending on income, unused relief from previous periods, and anti-avoidance rules).
Clearly, more and more clients have to be advised to keep an eye on the lifetime limit which has been progressively reduced to its current level of £1 million. For a final salary scheme member, this is problematic (a pension of more than £50,000 pa will exceed the £1 million value and lead to a potential 55 per cent tax charge on the excess) – however for many in money purchase schemes who have children (children and pensions being mutually exclusive in my experience), the limit is more of an aspiration – I will certainly never get to the limit!
One could say that after a good decade we are nearly back to where we were pre A-Day on contributions – indeed worse for some. So what is new and why do I think that pensions are a vital part of the tax adviser’s armoury?
Well, they are almost completely non-contentious. The sorts of things I talk about here do not approach even the edge of aggressive tax planning and broaden the range of things advisers can talk to clients about (obviously not forgetting that we are covered by Financial Services Rules – but we can still give loads of tax advice) with the advent of Making Tax Digital and all that will do to compliance margins.
In my view, it is the freedom not to vest or take a pension at all which is the biggest change. Let us explore the consequences of this in just a moment but there are another couple of developments which, as tax advisers, we should bear in mind:
• What is happening to inheritance tax (IHT) yields and what might happen to Business Property Relief (BPR)? Well, yields from IHT were up four per cent in 2016/17 over the previous year and we know that government is reviewing the extent of BPR from the surveys being undertaken.
• Where is entrepreneurs’ relief (ER) heading? The Public Accounts Committee highlighted this as an over generous relief and we know from meetings between the CIOT and HMRC that cash rich companies could find ER restricted at some point in the future.
So let us return to the big point.
From 2015 when the final pension freedoms came in, you no longer need to vest a pension at 65 or even 75. You can keep drawing down until you die and then nominate a beneficiary (or beneficiaries) to receive the undrawn funds. The rules are well known but if you can manage to die before reaching 75, the undrawn funds can be taken either as income or as a tax free lump sum by the beneficiary. If you can survive post 75, then the funds can be drawn either as lump sum or income but in both cases will be subjected to income tax at the beneficiary’s margin rate.
Undrawn funds should not be part of your IHT estate and will not be part of the beneficiary’s either. Further, as the last tax charge for lifetime allowances was on the earlier of 75 or your death, the undrawn funds do not form part of a beneficiary’s pot for lifetime allowances and it remains in a tax efficient wrapper, which is also generally commercially beneficial. Why would clients generally spend their pension if they still have ISA investments (subject to all the normal caveats)? The unused pension outstrips the ISA by being outside the scope of IHT. Why would they keep surplus cash in a company where BPR and ER (Entrepreneurs’ Relief) could be restricted - instead of the company making an employer contribution (subject to the annual allowance limits and it being wholly and exclusively for the company’s trade)?
So the benefits mount up… holding a considerable range of permitted assets which the family would wish to retain longer term and that may have growth potential so long as they do not trigger a lifetime allowance charge on death or at 75 through your pension pot? why not?
In summary, the pension reforms really have turned the world upside down, drawing estate planning, will drafters, IFAs, business planners and of course tax advisers ever closer in their endeavours to provide their clients with a complete one stop or at least joined up service!
(The views expressed by the author are his own and do not necessarily represent the views of MHA MacIntyre Hudson, MacIntyre Hudson Advisory Services or the CIOT)