For a pension that’s future proof
Investment rule changes mean new approaches are needed for nest-egg maximisation, says Tony Harrington
ON April 6 next year the Government’s plan to reduce the amount any individual can invest in their pension comes into ef f ect. From t hat date t he annual tax-deductable allowance that can be paid into a pension will be cut from £50,000 to £40,000.
This is part of the UK Government’s aim to restrict the amount of tax relief given to individuals, thereby increasing tax revenues and helping it to pay down the UK’s huge public sector debt.
To many readers this reduction in the size of the tax-free allowance will sound like something with which only the relatively rich need to concern themselves.
However, as Turcan Connell Asset Management’s financial planning director Derek Blaik explains, even those on relatively modest salaries could find themselves caught by the change. If they are, they could be looking at punitive additional tax bills.
“When an individual gets a significant salary increase and they are a member of a ‘final salary’ pension scheme, this will usually also mean an increase in pension benefits by a proportionate amount.
“What you have to realise is that the Inland Revenue works out what the equivalent sum as a oneoff lump-sum payment would be, by multiplying the additional pension sum by a factor of 16,” Blaik points out.
Under this rule if the sum accruing in a pension was increased by £2500 a year (after inflation is considered), then the x16 factor automatically puts the individual at the £40,000 limit. Anything accrued over that would attract tax at up to their highest tax rate.
For this reason Blaik says that mid-tier and higher-paid employees need to be aware of the changing pensions landscape, and it may well be that they need to consider working out an arrangement with their employer in which they are given cash in lieu of an additional pension contribution. This change also coincides with a reduction in the Lifetime Allowance on pension funding from £1.5m to £1.25m from April 2014. The higher personal income tax rate of 40% (45% for those earning more than £150,000 per annum) is actually substantially lower than the 55% tax one would have to pay on any sum in excess of £1.25m built up in one’s pension fund, leading to a potential tax saving of up to 15%.
What we are seeing are higher earners and high net-worth individuals increasingly looking for alternative, tax-efficient ways of saving. The traditional habit of pushing as much as possible into the pension plan has given way to looking at other investments. These include diversified investment portfolios and offshore investment bonds. Offshore bonds offer the opportunity to defer any liability to income tax for a potentially long period.
For the investor willing to take a high level of risk, there are enterprise investment schemes (EIS), which have been around since 1994, and where investments in qualifying companies offer valuable tax breaks. Venture capital trusts (VCTs) also offer attractive tax breaks, including income tax relief on qualifying investments. However, Blaik says that individuals need to take professional advice. “We have seen several instances where, although the investor gained tax relief through an EIS or VCT scheme, the company itself lost substantially so that the investment as a whole created a significant loss for the investor.”
“Individuals really do need to take care and seek professional advice when considering these pension rule changes and any alternative investment strategies,” he adds.
Derek Blaik of Turcan Connell Asset Management says the right advice is crucial to an alternative investment strategy