At some point most business owners and directors will face the prospect of having to pass on their business to the next generation, oversee a trade sale, or in some cases sadly having to simply ‘close the doors’.
Whichever outcome, the ability to replace the income previously generated by their business as tax efficiently as possible will be foremost in their minds.
With business sale proceeds no longer benefitting from Business Property Relief (BPR) for Inheritance Tax purposes and with interest rates at their lowest level in living memory, increasingly the focus is turning back to pensions, as the preferred method of ‘profit extraction’.
The Taxation of Pensions Act 2014 will herald the most significant changes to UK private sector pensions in a generation.
- From 5 April 2015 there will be no restrictions on the level or frequency of withdrawals from a (money purchase) pension scheme.
- On death before the age of 75, regardless of whether or not benefits have been taken, any unused pension fund can pass to any named beneficiary entirely tax free.
- Where death is after age 75, any unused pension fund can pass to any named beneficiary subject to an income tax charge at the individual’s marginal tax rate.
- In cases where the beneficiary is a non-taxpayer (e.g. grandchildren) and benefits are taken over a number of tax years the income tax charge could be avoided all together.
These changes effectively mean that the over 55s will have full access to their pension pots and the discretion to do whatever they wish with them. They will also be able to pass on any unused pension savings to their beneficiaries, potentially tax free.
The legislation will provide for the setting up of individual policies for each beneficiary and those beneficiaries can take income immediately, regardless of their age when they inherit. As a result, pensions will become a useful tool for paying school and university fees tax efficiently.
However, greater freedom gives greater choice and this can be rather bewildering, with most decisions made being irrevocable. Also, hidden amongst the small print are some very real ‘dangers’.
For example, any individual taking just £1 of pension income for the first time after 5 April 2015 will lose the ability to ‘carry forward’ any unused pension contribution relief and will in future only be allowed to contribute £10,000 per year (forever) into their pension scheme, compared to up £40,000 per year.
For an individual intending to maximise their pension contribution, say for ten years, this could cost them up to £190,000 in lost tax relief. This situation can be avoided with careful planning and it will be important to review existing pension policies to ensure they are fit for the new legislation and that they can cope with the new flexibility.