Save content
Have you found this content useful? Use the button above to save it to your profile.
money funds pension
iStock_CatLane_money funds pension

Maximise company owner pension savings

by
4th Jan 2017
Save content
Have you found this content useful? Use the button above to save it to your profile.

Richard Service explores how a defined benefit pension scheme can be used to maximise pension funds of directors of private companies.

In my article How to value final salary pension benefits I highlighted the disparity in the taxation of members of defined benefit (DB) as compared with defined contribution (DC) pension schemes. 

Opportunity

While the factors used to measure inputs to DB schemes for tax purposes are unchanged, and the current ultra-low rates of interest (and all the consequences of that such as annuity rates) remain, there may be an opportunity to maximise pension funds of directors of private companies. I have in mind someone who hasn’t made any (or perhaps minimal) provision towards their pension.

With retirement looming, and being aware of the huge tax advantages of pension funds, the individual would like to take advantage of the tax benefits of pension tax relief. Making contributions to a DC scheme at £40,000 a year – even picking up unused annual allowances from the three preceding years – will not get the individual anywhere near a pension pot valued at £1m.

Use a SSAS

The tax adviser and pension adviser should explore the possibility of the employing company setting up a DB scheme for the individual, as a small self-administered pension scheme (SSAS). The costs of such schemes are surprisingly low; I’ve found providers who will offer an administration service for around £1,000 per year.

The SSAS commits to provide the maximum permitted level of benefits – for example maximum inflation proofing of pension in payment, maximum dependant’s pension and benefits from age 60.  By reference to these as-generous-as-possible benefits, the administrator of the SSAS advises the company of the premium required to secure the required level of pension.

Set the premium

One approach is base the premium on the individual’s available annual allowances. Divide the total of the current year and all previous years unused annual allowances by 16. Fund up the SSAS for that level of pension. On this basis, the individual should not be taxed on the premium passing to the SSAS. As regards corporation tax relief, if one individual is involved it’s unlikely that spreading  provision in FA 2004, s 197 will be triggered, but even if it is triggered that’s merely a delay to the company’s CT relief.

For as long as the director is in post, premiums can continue to be paid to the SSAS. 

Higher contributions

If the individual wants the company to pay in a greater amount, it may still be tax efficient even if an annual allowance charge is triggered. For a DB scheme the annual allowance charge is not based on the premium paid by the company to the SSAS. It’s based on this measure of 16 times the increase in pension secured over the SSAS scheme year. If the scheme rules provide the most generous benefits possible to the individual, in effect a proportion of the premium passes tax free despite triggering the annual allowance charge.

Draw benefits

The SSAS rules should be drafted to permit members to make use of all the pension freedoms. Thus, in the fullness of time when it comes time to draw benefits the director will be entitled to ask the scheme to make a transfer to a DC scheme, allowing him to access the funds, or bequeath the funds in the new DC scheme free of inheritance tax.   

Potential challenge

I believe that it could be very problematic for HMRC to question this strategy. The key reason causing the benefit of boosting annual allowance is the factor of 16 used to value DB scheme benefits. As explained in the previous article, this factor has not been updated to reflect the current market environment. 

Were HMRC to challenge this planning it would throw a very bright spotlight on what to me seems a bias in favour of DB schemes. And the biggest DB scheme in existence is for civil servants.

I put this forward merely as a suggestion, not as fully comprehensive planning.

Tags:

Replies (11)

Please login or register to join the discussion.

Paul Johnson Owner Books and Figures
By PJ30
05th Jan 2017 23:09

"what to me seems a basis in favour of DB schemes" - the auto-correct may have got you Richard, you meant "bias", yes?

Thanks (0)
Replying to PJ30:
Head of woman
By Rebecca Cave
06th Jan 2017 09:05

Thanks for spotting that typo. I have corrected it.

Thanks (0)
avatar
By zebaa
06th Jan 2017 10:50

But no mention of section 75 and the problems this may bring.

Thanks (0)
avatar
By AndrewV12
06th Jan 2017 11:52

Its funny Pensions went out of fashion a few years ago (reduced final payouts ect, miss selling), but now they are back on the radar.

Mainly in the above context (getting money out of a Limited Company).

Thanks (0)
avatar
By [email protected]
06th Jan 2017 11:57

For this to work, the SSAS must be established either as a DB SSAS or a SSAS with both DC and DB sections. The legislation makes it clear that the only benefits that can be provided from a DB is in the form of a scheme pension, (section 165(1) FA 2004) to the rules can't permit the member to access benefits flexibly. However, that can easily be got around by transferring out from the DB scheme/arrangement to a DC one when it becomes time to crystallise.

There are risks. The sponsoring employer takes on the funding liability to provide the promised pensions. Therefore, one would only wish to invest in assets that had the exact opposite correlation to the potential DB liabilities. This tends to make the exercise only really ideal for relatively short funding time-scales, two to four years.

This is not a new idea by any means and has been discussed at technical conferences since before A-Day. (Even with the proposed AA of over £200,000, although for different reasons than they would be used currently) HMRC are aware of this planning as they shared the platform when the concept was being explained by a SSAS administrator.

The costs referred to, would be the annual running costs, I would expect the one-off set-up costs to be in the order of £2,000 to £3,000 and there may well be additional costs in appointing a scheme actuary to crunch the funding calculations. Even before the falls in Gilt yields a DB SSAS would often facilitate funding at over double the level permitted under a DC arrangement.

Lastly, it is important to remember that carry forward is only available to an individual in respect of a tax year in which they were a member of a UK registered pension scheme, see section 228A(4).

Thanks (0)
7om
By Tom 7000
06th Jan 2017 14:56

Can the defined benefit be anything. If the annual salary is £8k...can we set the pension at £100k for example? and pop in £1m to fund it?

Thanks (0)
Replying to Tom 7000:
avatar
By [email protected]
09th Jan 2017 14:16

Yes, but no but.

The Pension Input Amount (PIA), the figure assessed against the member's available annual allowance, is based upon a multiple of 16 times the indexed increase in their DB accrual.

This means that in the first year of a DB scheme, their opening value is £0 and so is the indexed opening value. If they are promised an indexed linked DB pension at age 55 of £5,000 p.a. with a 100% dependant's pension increasing at 5% p.a. or RPI if higher, then this would equate to a PIA of £80,000.

Clearly, this would be more than the client's available annual allowance, but provided they had sufficient annual allowance carry forward to cover the excess there would be no annual allowance excess charge.

One would need an actuary to calculate the cost of "guaranteeing" this promise, and it will depend upon a number of factors and assumptions. However, it could well be in excess of £200,000.

Thanks (0)
Replying to [email protected]:
7om
By Tom 7000
09th Jan 2017 18:08

but if you have nothing to bring forward the most you can pop in is £2.5k increase a year x 16 = 40k..so you are still stuck at the £40k a year max figure to pop in..
So this isnt really a mechanism for getting more in than £40k a year? And under a sip you can draw it out when you want...so I seem to have lost what the benefit is...or am i being slow again

or do I visit an actuary who says to guarantee £2.5k a year sir for you and your spouse run off you need to put in 30x this = 75k so you can really

Thanks (0)
Replying to Tom 7000:
avatar
By [email protected]
10th Jan 2017 08:56

Yes, it is all down to what an actuary says is required in an employer pension contribution to "guarantee" the promised pension.

Thanks (0)
avatar
By lme
09th Jan 2017 14:06

I would appreciate thoughts on how this squares with the new PCRT?

Thanks (0)
Replying to lme:
avatar
By [email protected]
10th Jan 2017 09:01

Making contributions into a DB registered pension as opposed to a DC scheme should not be offensive, after all, individuals employed by HMRC are in a DB registered pension scheme!

Don't get me wrong, setting up a DB SSAS by a company needs to be looked into carefully and it is not for everyone by any means. Remember, the April 2015 pension flexibilities do not apply to DB schemes. It is important that anyone thinking of this gets advice from one of the few advisers that understand the pros and cons of such planning and that there is a clear game plan and exit strategy in place from day one.

Thanks (0)