Insight Out Magazine | Cash in on planning

Every year a number of important changes take place that require a ‘use it or lose it’ approach to financial planning. This year it’s the turn of pensions where new carry forward rules will allow you to ‘mop up’ unused relief from previous years and make significant contributions to your retirement pot.

It’s an opportunity that can not only reduce your tax bill in the current year, but may also reduce your payments on account for the following year. To qualify you need to make any pension contributions by 6 April 2012 to gain relief in 2011/2012. If you fail to deal with any unused relief from the 2008/2009 tax year by 6 April 2012, you will lose that relief forever.

Similarly, if you want to protect your pension lifetime allowance, which this year sees the maximum pension fund you can accumulate without incurring a tax charge reduced from £1.8m to £1.5m, you need to apply for transitional protection by 6 April 2012 or lose out.

Ian Pickford, Financial Planning Director at Mazars Financial Planning in London, says such ‘use it or lose it’ oversights see thousands of pounds worth of ‘free’ money wasted annually. And business owners are particularly at risk as they tend to concentrate on business planning, at the expense of their own personal finances.

The key, according to Pickford, is to conduct a ‘personal business plan’. He describes this as a way of aligning business plans with personal financial goals.

“Most owners are used to conducting a financial plan for their business, but tend to forget a personal financial plan for themselves. So this idea of personal business planning is simply about how to tie the two together to maximise investment strategies,” he explains.

Neither need it be a complicated exercise. It’s all about applying a common sense strategy, according to Pickford. “If you're a 50 per cent taxpayer, then you’ve got to earn 50 per cent more if you want to be better off. So you need to think about strategies that reduce debt and use up tax free investment allowances first and foremost to give you a head start,” he says.

Cash management is another area where owners can easily improve returns. This is particularly important in a low interest rate environment as it offers the opportunity to lock into the best rates to improve cash flow.

Forward planning is also an effective tool. For example, giving some thought to an exit strategy at the outset of a company’s life – rather than towards the end – allows owners to construct a more stable retirement plan for themselves.

This offers a more secure route to retirement than relying solely on, say, a sucessful sale. “The old adage of ‘my business is my pension’ is great if you can find a buyer or if you get the timing right and you secure a good price. But it’s not an outcome you should rely on. Any business owner who is coming up to retirement now and looking to sell their business is probably wishing they had put a bit more aside,” explains Pickford.

Indeed, contributing towards a pension is a ‘no-brainer’ that every company director should make use of, according to Pickford, as it offers a tax efficient way to extract profits from a business. Although with the amount individuals can contribute to a pension each year and still receive tax relief now restricted to £50,000, higher earners should also be looking for additional tax efficient vehicles.

Apart from using up annual allowances, such as ISA investments, Pickford suggests high earners should give some thought to Venture Capital Trusts (VCT) and Enterprise Investment Schemes (EIS) as good options to consider. EIS in particular are worth investigating as from April this year the maximum allowable investment into these schemes rises to £1m. Other benefits include 30 per cent upfront income tax relief, 100 per cent capital gains tax deferral for the life of the investment and 100 per cent inheritance tax relief after two years, provided the investments are held at time of death.

The extension of the Business Premises Renovation Allowance (BPRA) for a further five years also offers opportunities. Investors using BPRA are entitled to 100 per cent tax relief on the proportion of their investment that is used for ‘qualifying expenditure’ on renovating or converting an unused commercial property into, say, a hotel.

The relief is typically calculated at between 70-95 per cent of the gross investment. Investors can then elect to offset this against their marginal rate of income tax. For example, if the qualifying expenditure is 90 per cent, then a 50 per cent taxpayer making an investment of £100,000 would receive income tax relief of £45,000.

“It’s all about making the most of opportunities, while keeping a close eye on the threats,” concludes Pickford.

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Threat or Opportunity?

Mark Brownridge, of Mazars Financial Planning, analyses the threats and opportunities posed by new tax legislation and outlines some key financial planning strategies.

1.Personal income tax allowance to rise to £8,105 in April, but still reduces where income exceeds £100,000

Personal allowance will rise from £7,475 to £8,105 with effect from April 2012 – good news for basic rate taxpayers. But a fall in the higher rate income tax threshold will mean higher rate taxpayers will see little or no benefit. Additionally, for those earning over £100,000 per annum, the personal allowance is reduced by £1 for every £2 of excess income over £100,000 and will disappear completely for those with income in excess of £116,210 from April 2012. This results in an effective 60 per cent tax rate for the affected band of income.

Threat - In real terms, this equates to a 20 per cent increase in tax on earnings in excess of £116,210. Higher earners therefore face additional tax of £3,242 per annum. Contributions to a pension plan are treated as a deduction for the purposes of calculating whether income is in excess of £100,000, and therefore can be used to preserve the personal allowance.

Through the receipt of pension tax relief at 40 per cent in addition to the reclaimed personal allowance, the effective tax relief equates to 60 per cent. Clearly, the advantages for a 50 per cent taxpayer are even greater.

2. From April 2012, the maximum allowable investment into an Enterprise Investment Scheme (EIS) will rise to £1m.

In 2011, the government raised the income tax relief for Enterprise Investment Schemes (EIS) from 20 per cent to 30 per cent. From April this year, the maximum allowable investment into an EIS will rise to £1 Million. The Government has also announced the extension of the Business Premises Renovation Allowance (BPRA) for a further five years. Qualifying BPRA schemes allow income tax relief up to an individual’s marginal rate.

Opportunity – With the amount individuals can contribute to a pension each year – and still receive tax relief – now restricted to £50,000, higher earners will be looking for tax efficient alternatives. These investments, although higher risk, represent an opportunity to further reduce an individual’s tax bill.

For individuals with significant tax liabilities, up to £150,000 (£300,000 from 2012/2013) income tax relief can be obtained via an EIS. Additionally, EIS shares are free from Inheritance Tax after two years.
A BPRA investor is entitled to 100 per cent tax relief on the proportion of their investment that is used for “qualifying expenditure” on renovating/converting an unused commercial property, commonly into a hotel. This is typically calculated at between 70-95 per cent of the gross investment. Investors can then elect to offset this against their marginal rate of income tax. For example, if the qualifying expenditure is 90 per cent, a 50 per cent taxpayer who invested £100,000 would receive income tax relief of £45,000.
For both investments, the income tax relief is easy to claim, via an adjustment to your tax code, making it a very simple and effective way to access the income tax relief available.

3. New carry forward pension rules allow higher levels of contributions

Although the annual allowance (the maximum you can pay into a pension plan each year and still receive tax relief) is set at £50,000 per year, new carry forward rules allow higher levels of contribution to be made. Additional contributions may also be possible based on unused relief from the previous three tax years (2008/09, 2009/10 and 2010/11). In addition, certain pension schemes allow contributions in excess of £50,000.

Opportunity – For the past couple of years, many individuals have been restricted to a maximum pension contribution of £20,000. The new rules allow you to “mop up” unused relief from previous years and make significant contributions to your pension planning.

Pension contributions made before 6 April 2012 can reduce your tax bill for the 2011/2012 tax year. It may also reduce your payments on account for the following tax year. It is vital to make such payments by that date if you want relief in 2011/2012.
Most people can make pension contributions of up to £3,600 gross each year and obtain basic rate tax relief. This is true even if they are not paying any tax. So, for example, consider making payments for your partner, children or grandchildren. High earners are able to receive 50 per cent tax relief on pension contributions up to the new limit.
Unless you use any unused relief from the 2008/2009 tax year before 6 April 2012, you will lose that relief forever.

4. Top income tax rate of 50 per cent for income above £150,000

This already affects high earners and trusts.

Threat – And a very clear one for high earners!

There are many planning ideas that can be considered to reduce taxable income to below the £150,000 threshold.
Investment bonds are a particularly attractive option as they can provide a tax deferred income of up to five per cent of the initial investment amount. However, this income is not included in an individual’s taxable income calculation, as investment bonds are classed as non-income producing. Income tax may arise on full surrender, but if this is at a time when an individual is no longer a higher rate taxpayer, or because the policy has been assigned to a lower rate taxpayer prior to a chargeable event, then higher rate income tax charges may be avoided altogether.

5. Pension Lifetime Allowance reduces to £1.5m

From 6 April 2012, the maximum pension fund you can accumulate without incurring a tax charge will be reduced from £1.8m to £1.5m.

Threat – Clearly, this will affect those with significant pension pots. To help those affected by the reduction, the government has introduced transitional protection. However, individuals will not automatically receive this protection and must instead apply before 6 April 2012, so prompt action is required.

Anyone with pension funds exceeding the new limit will be liable to a 55 per cent tax charge. However, it is possible to elect for “fixed protection” on an amount of up to £1.8m as long as no further pension contributions are made.
An alternative is to transfer pension funds to a Qualifying Recognised Overseas Pensions Scheme (QROPS). Assuming the lifetime allowance is not exceeded on the transfer to a QROPS, any subsequent growth in value will not be subject to the lifetime allowance charge and therefore the 55 per cent tax charge will not apply. There is also an income tax benefit when drawing down the pension income.

6. Rate of capital gains tax (CGT) remains the same

CGT of 28 per cent continues to apply to higher rate taxpayers and trustees while the rate remains at 18 per cent for basic rate taxpayers..

Threat - Again, higher rate taxpayers are clearly in the firing line. The personal annual exemption remains at £10,600 but for many individuals with significant portfolios, the amount they ultimately receive upon disposal of their assets is significantly impacted by the amount of tax they pay.

Individuals should therefore consider investments which are not subject to CGT upon disposal. These include Venture Capital Trusts (VCT) and Enterprise Investment Schemes (EIS). For EIS there is a minimum holding period of three years to qualify. Both invest in small, fledgling companies and are therefore considered higher risk investments, but as well as being free from CGT upon disposal, they also carry other attractive income tax reliefs, which could also help reduce income tax liabilities.

7. Pension flexibility

Last year, the government introduced a raft of measures that gave anyone aged 55 or over more options when considering their retirement income. Anyone approaching retirement now has far greater flexibility around how they receive their pension income.

Opportunity – And a big one! Over 600,000 people are expected to retire in 2012 alone and while a lifetime annuity will remain a popular choice for many, it will be important to consider which other options are more appropriate.

Individuals are no longer forced to purchase an annuity at age 75. They can therefore continue to draw an income and keep their pension fund invested, if they wish. This gives individuals the opportunity to delay making irreversible decisions about pension income. If you wish to take a tax-free cash lump sum, you must do so by this age.
Under the new flexible drawdown rules, it is also now possible to take all of your pension fund in one go, subject to meeting certain criteria.
Be careful with death benefits. If you have not started to access your pension funds before you die, the fund is available as a lump sum, tax-free to your beneficiaries. However, once you start taking benefits, while the fund can still be taken as a lump sum upon your death, it is hit with a 55 per cent tax charge.

8. Individual Saving Account (ISA) contribution limits will rise to £11,280 per annum per individual

The limit will rise annually in line with inflation.

Opportunity - Maximum use of an individual’s £11,280 per annum ISA allowance should be considered a priority.

ISAs represent one of the most tax efficient forms for investment as they provide a shelter from both income tax and capital gains tax.

Key points

Threat or Opportunity?