BEST PRACTICE
Pension Planning and the Family Owned Business
by Maybeth Shaw , BDO Northern Ireland
s the dreaded 31 January tax return deadline approaches and upcoming tax
Apayments dominate our thoughts , it is a good time to start considering ways to reduce our future tax liabilities – and perhaps help to alleviate the pain of writing those cheques to HM Revenue & Customs !
The end of the 2016 / 17 tax year is almost upon us , so now is the time to start planning for unused tax reliefs , exemptions and allowances ; not only for the year about to end , but also for the year about to begin . An important planning point for taxpayers relates to pension contributions that are not only tax free , but can also benefit from a taxable relief or deduction depending on who makes the contribution .
For family owned businesses , pension planning should form an important part of their succession planning strategy . Family business owners are often overly reliant on future cash flow from the business as a source of income for retirement , which can put pressure on the business over the long term and make the transition to the next generation much more difficult . This is particularly the case for husband and wife shareholders retiring around the same time .
Pension planning should therefore be considered as early as possible to help avoid unnecessary demands on the business from former owner managers . With people living longer and state pension age getting further away , there will continue to be more reliance on post retirement sources of income and a greater pension pot is a good option to supplement any value expected to be extracted during retirement from the family owned business .
This will not only hedge the risk of business underperformance post retirement , but will also reduce the financial burden on the business to fund retirement for the current generation , allowing the next generation to concentrate on strategic growth plans and opportunities that will arise in the future .
Contributions
UK taxpayers can make tax relievable pension contributions to the greater limit of 100 per cent of their relevant earnings or £ 3,600 . Contributions for basic rate taxpayers have an extra 20 per cent claimed by the pension provider which is added to the taxpayer ’ s pot . Higher and additional rate taxpayers can claim to have their basic rate band extended via self assessment .
An alternative to a taxpayer making contributions to a pension is to make contributions via their personal trading company . These contributions are a tax free benefit for the individual and are not limited by the relevant earnings or £ 3,600 caps . The company can also receive a corporation tax deduction in the accounting period in which the contributions are made provided they are of a reasonable level compared to the actual involvement in the day to day operations of the taxpayer in the company .
Annual Allowances
The amount of tax free contributions available in the 2016 / 17 tax year is £ 40,000 . If there is any unused allowance left before 5 April 2017 , it will be beneficial to utilise these allowances if the funds are available . A taxpayer ’ s unused personal allowance of the previous three tax years can be carried forward to the current year . The annual allowance was £ 50,000 in 2013 / 14 and has been £ 40,000 since 2014 / 15 .
From 6 April 2016 , the annual allowance of £ 40,000 will be tapered by £ 1 for every additional £ 2 of adjusted income ( gross taxable income , plus employer contributions , before deductions ) the taxpayer has over £ 150,000 . As the prior three years of annual allowances are not affected by this rule , any taxpayers with substantial income and unused 2013 / 14 annual allowance should consider making contributions individually or via their trading company before 5 April 2017 or the £ 50,000 2013 / 14 annual allowance will be wasted .
Flexible drawdown
From 6 April 2015 , taxpayers over the age of 55 can draw down up to 100 per cent of their defined pension schemes giving them more flexibility in how they withdraw from their pension pot . The first 25 % of the pot is still tax free though the balance is taxed at their marginal rates of tax in the year of withdrawal .
The 25 per cent lump sum can be drawn down in increments , so it is important to bear in mind that it is the percentage that is withdrawn , not 25 per cent of the pot from the first withdrawal . This means that part of the 25 per cent lump sum not withdrawn can be retained in the pot to grow further , and still be taken tax free .
Once money is taken from a defined contribution pension , a money purchase annual allowance ( MPAA ) of £ 10,000 is triggered and replaces the standard annual allowances . The MPAA cannot be carried forward like the standard annual allowance .
This reduced allowance is to discourage taxpayers from abusing the flexible pension rules by recycling tax free withdrawals back into the pot as tax relievable contributions . In his first Autumn Statement the new Chancellor , Philip Hammond , has announced plans to reduce the MPAA to £ 4,000 . This effectively cuts the annual allowance by 90 per cent from £ 40,000 to £ 4,000 once a taxpayer starts to draw down from their pension . The move to reduce the MPAA is in the consultation stage at the date of writing and if it comes into effect on 6 April 2017 , taxpayers may wish to revisit their contribution plans and take action before that date .
Lifetime allowance
Higher earners with large pension pots will have to be mindful of exceeding the Lifetime allowance ( LTA ). The LTA decreased from £ 1.25m to £ 1.0m on 6 April 2016 though is expected to increase with the consumer price index from April 2018 . Any taxpayer with a pot in excess of the LTA will suffer a tax charge when they start to benefit from their pension . The amount in excess of the LTA is taxed at 25 per cent if paid as an annual pension or 55 per cent if taken as a lump sum .
Conclusion
Over dependence on the family business to fund retirement can fall fowl of business risks such as poor growth in the industry , foreign exchange rate , funding risk or other factors which may produce insufficient income depending on remuneration requirements . Even if there are sufficient funds being produced by the family owned business to fund the current generation ’ s retirement , this can restrict the ability of the next generation to take advantage of opportunities that may arise in the future .
A healthy pension can not only provide long term financial security for the current generation and help free the next generation to develop the business , it can also provide significant tax efficiencies on making contributions if careful planning is implemented before further restrictions on pension contributions arise .
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