Case Study - Director's Pensions & Tax Planning

Our clients run a successful family business as well as having significant personal and pension assets within a Small Self-Administered Scheme (SSAS). The clients are in their late fifties and were considering taking the maximum tax-free cash sum from the SSAS and to start drawing an income under Unsecured Pension (USP).

They had no intention of retiring from or selling the business and did not need any more capital or income. The SSAS’ main assets were properties worth in excess of £2m and around £750,000 in the SSAS bank account. The clients did not want to have to sell any of the properties if possible. Their main priority was overall tax planning, particularly Inheritance Tax. We discussed the main options in detail, being either to take the pension benefits immediately or to leave the pension funds alone, possibly until age 75.

There were advantages of taking pension benefits immediately, such as the likelihood of the maximum amount of monies being able to be extracted from the scheme over their lifetime (although this may have resulted at least one of the properties having to be sold to meet the income requirements of the scheme). The tax-free cash and/or other personal assets could then be gifted (either directly to beneficiaries or into Trusts) to reduce their potential IHT liability, as they would have sufficient income from the pension to last for the rest of their lives.

However, the possible drawbacks included an immediate increase to their potential Inheritance Tax liability, as the tax-free cash (which they did not need) could add to their taxable estate and any pension benefits remaining under USP on death would suffer a 35% tax charge on any lump sum that passed to dependents. Our clients in this case were comfortable with the risks associated with USP i.e. investment risk, annuity rate risk and longevity risk.

Deferring taking any pension benefits could allow the clients to deliberately erode their personal assets first (knowing they could take tax-free cash from the scheme in the future), therefore reducing their overall potential Inheritance Tax liability - the business was eligible for Business Property Relief and therefore could be passed on to beneficiaries on death without any IHT liability. If the clients died without taking any benefits from the SSAS, the whole of the fund could also potentially pass on free of IHT or other tax charges, subject to certain conditions being met.

The pension scheme assets could then continue to benefit from the tax advantages offered by the SSAS i.e. tax efficient fund growth and no Income Tax on the rental income received on the properties held. However, if the clients died prematurely, they may have had little or no financial benefit personally from their own pension fund, although any residual funds could still be used to benefit their dependents.

Before being able to advise our clients we needed to consider their capital and income requirements, their income and expenditure, tax position, attitude to risk and their state of health and whether any of these factors were likely to change in the future. The first priority had to be to ensure the clients had sufficient capital and income for the rest of their lives.

We made calculations based on assumptions regarding life expectancy (which is often underestimated), tax position, potential investment growth and annuity rates that showed the clients the financial effect of taking either of the two courses of action outlined above. The objective was to establish how the clients could extract the maximum overall value from all of their assets (business, personal and pension), in a manner that was as tax efficient as possible and these calculations proved invaluable in allowing our clients to make an informed decision.

 

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