Pensions are they still worth it?

In recent times there have been a number of tax increases that impact on owners of trading businesses. The change that has obtained the most attention has been the increase in the rates of Employers National Insurance. But at and around the same time we have also seen the reduction in the level of Business Property Relief (BPR) available on qualifying assets (with effect from April 2026) which is important for IHT purposes. In addition it has also been announced that private pension pots have been brought within the charge to Inheritance Tax (with effect from April 2027). If this isn’t bad enough for business owners who have simply “had enough” they will now face higher amounts of Capital Gains Tax as and when they come to sell their business. 

As a consequence of these changes it is important that the “strategies” that tax payers have used for any number of years should be revisited 

Ever since the rules “Pension Freedoms” were introduced in 2015 wealthy individuals have been encouraged to consider their pensions as “monies of last resort”. Tax Payers have been encouraged to perhaps spend other wealth (which is subject to IHT). As a consequence, with pensions being proposed to be within the remit of IHT from 2027 this strategy needs to be revisited. 

Tax payers are now going to have to consider whether alternative strategies should be considered. Such strategies might include:

A. Taking the Pension Commencement Lump Sum (more commonly known as “tax free cash”) and simply “gifting it away” sooner rather than later; 

B. Withdrawing the tax-free cash and using it to buy assets qualifying for BPR so as to utilise the £1m BPR allowance if it is not otherwise utilised; 

C. Withdrawing the taxable element of the pension so as to reduce the level of the pension in the longer term; and 

D. Choosing an annuity over “drawdown”. 

What is clear is that these rules are a game changer for how pensions should be dealt with. Clearly it is going to be necessary for an individual’s overall “strategy” to be revisited. 

Historically many businesses have purchased their premises in their pensions. Often a Self-Invested Pension Plan is used in these kind of situations. The pension would then receive rent from the limited company as a form of “investment return”. What should be noted is that:

A. As a result of the 2027 changes the Pension (including any value associated with the business premises) are going to be within the scope of IHT; and 

B. The Pension Scheme will not be able to claim any Business Property Relief (BPR) in respect of the bricks and mortar that might be contained within the pension “environment”. 

Individuals who have this kind of arrangement should therefore be considering whether such a “structure” remains “fit for purpose”. There will be some taxpayers where it might be preferable for the business to effectively “buy back” the Business Premises from the pension so as to increase the amount of BPR available looking at the wider position. Of course, as is always the case with situations such as this, there are other tax considerations that will need to be considered. These will include, but will not be limited to Stamp Duty Land Tax, VAT, capital allowances etc. 

Again the message to tax payers is clear - the “rules have changed” and therefore it might be the case that structures might need to be changed as a consequence. 

Since Pension Freedoms were introduced in 2015 the making of pension contributions has been the “go to advice” when deciding how to extract wealth from owner managed businesses. Pension contributions have been attractive as they have provided corporation tax relief, they have been free of National Insurance Contributions and they have been paid to an environment (the pension) which has itself been free of Inheritance Tax. 

However with effect from April 2027 Pensions are going to be within the remit of IHT. As such shareholders in Owner Managed Businesses might think that pension contributions are “no longer worthwhile”; instead business owners might decide to let the cash build up in the company and to simply extract any cash available on a disposal claiming Business Asset Disposal Relief along the way. Of course, in recent times the Chancellor has also increased the rate of Capital Gains Tax by reducing the level of Business Asset Disposal Relief available. Rates of BADR that now apply are:-

• 14% on the first £1million of gains up to 5 April 2026
• 18% on the first £1million of gains thereafter. 

For tax payers who are looking to “fund their retirement” there is a need to consider the “tax cost” of making pension contributions (and withdrawing funds at a later date) versus the tax cost of extracting sums on a sale. 

Let us consider A Limited. A limited has had a good trading year and has made profits in excess of budget of £60,000. The owner of A Limited (Mr A) is 62 years old. He has only modest pensions and is conscious that at some point in the not too distant future he will look to sell his business. He has been advised that if structured correctly any cash in the company might become available to him on a future sale. Mr A is considering what approach he should take with respect to the £60,000 of profits that have been made in recent times. 

1. Tax Position of a Pension Contribution 

If the Company makes a pension contribution Mr A’s pension will be “boosted” by £60,000. At some point in the future he will be able to take 25% of the sum involved (£15,000) tax free as part of his tax free lump sum. He will be able to withdraw the remaining £45,000 as he wishes. He has other income but any withdrawals from his pension should remain with the basic rate band if those withdrawals are “managed” correctly. As such he will suffer (£9,000 i.e. 20% of £45,000) on these withdrawals. 

Of the original £60,000 Mr A receives £51,000 being the £15,000 “tax free cash” together with the net amount of £36,000 of taxable withdrawals. 

1. Tax Position of extracting on Sale 

If the monies are left in the company then the company will not be able to claim corporation tax relief. As such the sum available will be reduced by corporation tax. The amount “in the company” will be reduced by between 19% and 25% depending on the overall level of profit in point. However if we assume that the rate that applies is 20% (i.e. towards the lower end of the spectrum) then the cash held in the company will be £48,000. 

If this sum is extracted on a sale then, if the company is sold subsequent to 5 April 2026, then a CGT rate of 18% will arise. As such the £48,000 amount will be reduced to £39,360. Clearly this is somewhat less than the £51,000 available to Mr A were he to make a pension contribution. The tax saving of making the pension contribution would be higher still if the company paid corporation tax at the highest rate of 25%. 

Once again however the above is very much a “simplification” of the points that need to be considered. However what is clear is that notwithstanding the removal of the IHT advantages associated with a pension they should remain at the forefront of an individuals mind when considering how they should they should extract monies from their business. 

Clearly with such dramatic change to the rules it is clear that up to date professional advice from tax advisors, independent financial advisors and private client lawyers is required more than ever before.

If you would like to discuss any of the above in more detail please do not hesitate to contact us.