Putting SIPPs to work

Tax efficiency

Given that change often presents opportunities, and without the expected pension changes this year, are there any new opportunities to explore regarding the use of pensions in efficient tax planning? As there is no change to the rules on claiming income tax relief at an individual’s highest marginal tax rate on personal pension contributions, it is still possible for those paying income tax at the additional rate of 50% on income above the £150,000 threshold to benefit from 50% pension contribution tax relief.

However, it was announced in this year’s Budget that the additional rate will reduce from 50% to 45% in the 2013/14 tax year. While not a direct change to pensions legislation, this change in tax rates presents a window of opportunity for high earners in the current tax year.

Assuming an individual has earnings of at least £50,000 above the additional rate threshold of £150,000 then a personal contribution of up to the annual allowance of £50,000 should attract 50% tax relief. Under the relief at source mechanism applicable to personal contributions made to Self-Invested Personal Pensions (SIPPs), this would manifest itself by the individual making a net contribution of £40,000, with the pension provider adding in the 20% basic rate tax relief it collects from HMRC of £10,000, making a gross contribution of £50,000.

Then the individual should be able to claim the balance of the tax relief due of £15,000 via their tax return, equating to total tax relief of £25,000. Assuming the basic rate of income tax remains at 20% and the annual allowance remains at £50,000 for the 2013/14 tax year, but recognising that the additional rate reduces to 45%, then delaying the above exercise until the next tax year would cost £2,500 in lost tax relief. Not to mention the lost opportunity through the delay in investing within the tax-advantaged investment growth environment of a SIPP.

Carry-forward facility

It will also be possible to take advantage of the higher additional rate of income tax for the current tax year by utilising the carry-forward facility. This allows any unused annual allowances from the previous three tax years, to be used in the current tax year providing the individual has been a member of a registered pension scheme for the tax years concerned.

Potentially, therefore, a tax relievable gross contribution of up to £200,000 could be made in the current tax year and, pushing the example to the extreme, providing the individual had at least £200,000 of income above the additional rate threshold, this should attract the full 50% tax relief of £100,000.

It may even be possible to contribute £250,000 in a tax year and potentially attract tax relief of up to £125,000 by electing to end the SIPP’s first Pension Input Period early.

Tax relief cap

At the time of writing there is much debate about the government’s stated policy objective to limit the amount of tax relief that wealthy individuals can legitimately take advantage of. This has particularly caused a stir with regard to uncapped tax relief relating to charitable giving.

It is worth noting that as part of this policy objective it has been stated that any cap on tax reliefs would not extend to those reliefs that are already capped, such as relief given on pension contributions. As part of the drive towards ’a fairer, more efficient and simpler tax system’ it was also announced that the government would look at introducing a General Anti-Abuse Rule (GAAR) to tackle abusive tax avoidance.

Few would disagree with the sentiment that all parts of society should pay a fair amount of tax, but a GAAR may create a higher degree of uncertainty as to what is legitimate tax planning, what is tax avoidance and what is tax evasion. As it stands, utilising pension tax reliefs would appear to fall firmly in the sphere of legitimate tax planning.

Estate planning

Returning to the subject of charitable giving and possible tax restrictions that may apply, a charity lump sum death benefit facility exists within pension legislation. Ordinarily, where a member dies while drawing retirement income via income drawdown, or is over age 75 and has not yet drawn income from their retirement fund, then the payment of the remaining fund as a lump sum would suffer a 55% tax charge.

However, where the member has no dependants on death, their remaining pension fund can be paid out to a charity that has been chosen by the member as a charity lump sum death benefit. This is payable tax-free and not taxable on receipt by the charity, providing it is used for charitable purposes. The same option applies where a deceased member’s dependant dies while in income drawdown.

Where an individual wishes to pass on their estate and pension fund on death to beneficiaries, but also wishes to pass some money on to a chosen charity, it is worth considering the tax efficiency of making the charitable payment from the pension fund instead of the estate, as it saves the 55% pension tax charge rather than the potential 40% inheritance tax charge.

Admittedly, for the philanthropically minded there may not be the feel-good factor of seeing the benefit of their charitable donation, but there again not everyone can afford to give away money during their lifetime. The primary aim of contributing to a pension arrangement should be the provision of retirement benefits but the secondary benefits of legitimate tax planning should not be ignored.

Author

Robert Graves, head of pensions technical services, Rowanmoor Pensions