Pension quandary for high earners
For entrepreneurs, many of whom have a fluctuating income the Government’s 2006 rules on pension funding were fortuitous. It meant one off contributions of more than £215,000 (£245,000 in 2009/10) could be made into ‘approved’ pension schemes and potentially benefit from higher rate tax relief at 40%.
Tax relief slash for high earners
Though the death knell sounded for high earners last year when it was announced that from April 2011 those earning more than £150,000 (who from April 2010 will also pay 50 per cent income tax on any income above that) will have tax relief on pensions cut – on a tapering scale that will see those earning £180,000 or more receive just the basic rate of tax relief at 20 per cent.
It gets worse. To ensure those (who the new rule applies to) don’t stash the maximum possible into tax relievedpension schemes in the interim, the Treasury introduced a cap on the amount of tax relieved contributions that canbe made by those earning more than £130,000.
Those in that bracket can now only receive higher rate tax relief on £20,000 or their normal level of regular contributions – whichever is the higher. In certain circumstances where contributions have been made less frequently than quarterly this limit may be increased up to £30,000. Any contributions above that level will now besubject to a tax clawback, effectively reducing relief to 20 per cent.
Are dividend payments the answer?
Will paying yourself dividends help avoid the new rules either post 2011 or during the transitional period? No chance. The Treasury includes these along with savings interest in its definition of ‘income’.
Tax relievable pension contributions were already limited in 2009/10 to the lower of £245,000 or your earnings for the year; so reducing your earnings to a modest sum and paying yourself a handsome dividend was never going to be the answer to making a hefty pension contribution.
Case study: An entrepreneur’s solution to pension planning
Rob Davenport is the managing director and controlling share holder of Shawston Piping Solutions. He has no conventional pension scheme because he always paid himself in dividends.
That’s not to say he isn’t making financial provision for his retirement. After receiving a substantial lump sum when he made a partial earn out from the business in 2008 in advance of the capital gains tax changes in April 2008, he parted with the ‘one size fits all’ wealth manager provided by his bank and appointed Xentum to manage his portfolio.
Investment portfolio
The investment portfolio mainly consists of mostly UK listed equities and a couple of residential properties. Rob says the equity fund “Is very dynamic – there’s lots of buying and selling. So when the cost of oil came down, wegot into the transport sector, then got out again at the top, and have recently moved into mining. Our equity fund has out performed the market by 18 per cent, so I’m quite please with it.”
These investments do not benefit from the tax relief available to approved pension schemes. He has, however, built up retirement provision in another, unexpected way.
Stakeholder pensions
Acting on Xentum’s advice he has set up stakeholder pensions for his two young children into which he pays a couple of hundred pounds each month and which, he says, “When they are older they will be able to self invest and use it to purchase a commercial property or whatever. It’s also a good way of passing money down the generations without liability to inheritance tax.”
Rob is able to make these contributions to his children thanks to changes intended mainly to help stay-at-home mums keep making pension contributions. Under this measure basic rate tax relief is added on to the contributions made on behalf of non-tax payers even children – on pension contributions of up to £2,880 net per year.
Rob doesn’t rule out investing in a pension scheme if in future his method of remuneration means he starts paying enough income tax to make it worthwhile. Currently, Rob isn’t motivated by paying into a scheme that only gives 20 per cent tax relief on contributions when it’s likely the income taken from it will be taxed at 40 per cent.
Source: Edited version of retirement planning feature EN Magazine October 2009.
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