We highlight two examples where advice paid of in light of the pension freedoms.
The pension freedoms introduced in April 2015 saw a dramatic change in how we save for and fund our retirement. The key change was around unrestricted access to pension funds, handing individuals the opportunity to put themselves in the pensions driving seat. But navigating these new opportunities is easier said than done: below are two examples that spring to mind.
The treatment of pensions after death
Client A made contact with us in early 2016. In her early 70s, she had recently lost her husband, with whom she had spent a lifetime building a business and a residential property portfolio. With a complicated estate and a business to wind down, Client A found herself with short-term cashflow issues, both personally and in terms of maintaining her property portfolio.
As a couple, they had been diligent pension savers, both holding self-invested personal pensions (Sipps), which had not been accessed yet (she immediately inherited her husband’s Sipp upon his death). Both pensions were significant and could have met the required shortfall independently during this difficult period. Client A wanted advice on which pension to use.
Our advice was to take advantage of one of the more beneficial changes in pension legislation relating to the tax treatment of inherited pension funds. Client A’s husband had died prior to age 75, meaning that she could access his Sipp entirely free of tax. This contrasted with her Sipp, where she could take a proportion of tax-free cash but any residual withdrawals would be subject to income tax. Our advice was therefore to use her husband’s Sipp to meet the income shortfall.
Not only was withdrawing from the inherited Sipp immediately more tax-efficient, but it also helped with her personal inheritance tax (IHT) situation. Pensions do not form part of your estate for inheritance tax purposes and therefore are a very efficient vehicle for passing on wealth to the next generation. Overall, Client A was able to meet her income requirements (now and in the future) free of tax, whilst retaining her Sipp to potentially pass onto the next generation free of IHT.
Maximising contributions and using business assets
Client B (in his mid-60s) contacted us with a regularly recurring problem for business owners. A fisherman for 20 years, he had recently sold his fishing rights for a considerable sum. The business was still a going concern, which Client B ran in partnership with his son.
The cash from the fishing rights sale was now sitting in cash within the business, earning minimal interest. As there were no capital requirements for the business, Client B was looking for efficient ways to utilise the cash. Client B was reluctant to withdraw the cash as salary or dividend, as he recognised there would be significant income tax to pay by doing so.
After sitting down with the client and conducting a detailed audit of his affairs, we recognised that his (and his son’s) pension savings were limited. Our advice was to use the cash within the business to make a contribution to their pensions. Employer pension contributions are an extremely tax-efficient way of withdrawing excess cash from a company. The contribution is treated as a trading receipt for the company (reducing the corporation tax bill) and would also enhance their pension savings.
Further to tax-efficiency of the employer pension contribution, we were also able to maximise the amount contributed. Client B was aware of the annual limit of pension contributions eligible for tax relief – £40,000 for those earning less than £150,000. However, we were also able to highlight that unused allowances from the previous three tax years can be carried forward. This meant a maximum of £160,000 could be paid in.
Client B and his son had not contributed to a pension for many years. This meant that they were in a unique position to maximise their pension contributions, whilst saving tax both personally (as they had not taken the cash as dividend or salary) and for the business (through corporation tax relief).
A final point to note; much of the commentary on investing for the long-term tends to focus on the nuts and bolts of portfolio construction. This is crucial, but only part of the story. In a crowded funds universe, a robust financial plan can have a significant impact on your wealth. A good financial plan is all about getting on the right road. There’s no point driving a fast car if you’re heading in the wrong direction, and equally, a good portfolio of funds can be let down by poor financial planning.
Paul Gillen is a financial planner at Seven Investment Management.