techtalk TECHTALK JANUARY 2018 ISSUE 1 VOLUME 17

Transcription

1 techtalk 1 TECHTALK JANUARY 2018 ISSUE 1 VOLUME 17

2 2 techtalk WELCOME TO THE JANUARY EDITION OF TECHTALK EDITOR Paul Rutkowski Paul is a senior manager within Scottish Widows, having joined the Group in He has over 20 years of experience across a broad spectrum of financial services roles including workplace pensions, individual pensions, proposition management and business development. In this edition of Techtalk, I m delighted to introduce the Financial Planning team s response to the Autumn Budget, incorporating planning ideas to take you through the end of the current tax year and on into 2018/2019. If you have a look across at the contents page, you ll find a full list of the articles and authors for this edition, including a brief summary of each topic. In a relatively quiet Budget, the Chancellor, Philip Hammond, didn t make any significant new announcements affecting financial planning. However, a surprising number of recent and forthcoming changes, announced in earlier Budgets and throughout 2017, will have an impact in the coming months: the dividend allowance falls from 5,000 to 2,000 from April 2018 the lifetime allowance increases from 1 million to 1.03 million for 2018/2019 transitional provisions end on 5th April 2018 for many benefits in kind caught by the optional remuneration arrangements rules planned National Insurance changes for the self-employed and in respect of redundancy payments have been deferred to April 2019 the tapered annual allowance and reduced money purchase annual allowance continue to complicate pension planning LISAs are now established and offer an alternative to pension savings along with ISAs and the usual end of tax year planning considerations apply. See also our Autumn Budget summary: The Financial Planning team isn t just responsible for bringing you Techtalk. Advisers and paraplanners can access a wide range of supporting material produced by the same team. Just visit the Scottish Widows Adviser Extranet and go to the Financial Planning page. Enjoy the read. Paul Rutkowski

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4 4 techtalk LOWERING THE BAR: THE REDUCED DIVIDEND ALLOWANCE From 6th April 2018, the recently introduced dividend allowance will reduce from 5,000 to 2,000. The implications for business owners and investors are looked at in detail. THOMAS COUGHLAN Tom has spent over 15 years in technical roles. He has wide experience including the provision of technical support to financial advisers covering life, pensions and investment compliance. He currently specialises in pension planning. Owners of small companies are in the enviable position of being able to choose the most taxefficient method of remunerating themselves from salary, dividends and employer pension contributions. The right mix depends on a variety of factors including profit level, other income, age and the state of existing retirement funds. Recent changes to dividends have reframed this debate, but no black and white answer has emerged. Salary and dividends usually form the backbone of the remuneration strategy and with good reason but pension contributions should not be overlooked as they are often the most tax-efficient. Before looking at different remuneration strategies, I will recap on recent changes to the dividend tax rules. THE POST APRIL 2016 DIVIDEND RULES The headline change to dividends in April 2016 was the introduction of the 5,000 dividend allowance, which currently exempts the first 5,000 of dividends from income tax. It is an allowance rather than an exemption, which means it still uses up part of the tax band that it falls in. The other change was an increase in the effective rates of tax. The previous dividend tax rates were 10%, 32.5% and 37.5% for Pension contributions should not be overlooked as they are often the most tax-efficient.

5 techtalk 5 From 6th April 2018, the dividend allowance will reduce to 2,000 2,000 basic, higher and additional rate taxpayers, respectively, however because dividends were paid net of a 10% non-reclaimable tax credit, it was the effective rates of tax that were important. The equivalent effective rates were 0%, 25% and 30.6% in each case. The new rates of tax that apply to dividends from April 2016 onwards are 7.5%, 32.5% and 38.1% a 7.5% increase in each band over the old effective rate. This change also removed the tax credit, taking with it any distinction between net and gross dividends. THE POST APRIL 2018 REDUCED DIVIDEND ALLOWANCE From 6th April 2018, the dividend allowance will reduce to 2,000. Whilst this is a reduction to the current allowance, it is perhaps best viewed as a comparison alongside the original rules which were in force less than two years ago. When the 2016 reformed dividend rules came in, it was noted that higher rate taxpayers receiving less than 21,667 in dividends would be better off. The equivalent critical threshold for additional rate taxpayers was 25,400. The reason for a critical threshold was that low levels of dividends became tax free, but above the allowance dividends were taxed at a higher rate. The reduction in the dividend allowance from April 2018 will, therefore, change the critical thresholds, which will become 8,667 for higher rate taxpayers, and 10,100 for additional rate taxpayers. WHAT ARE THE IMPLICATIONS FOR INVESTORS AND OWNER MANAGED BUSINESSES? In the main, investors benefitted significantly from the original tax-free dividend allowance of 5,000. No tax on dividends up to this amount took many out of dividend taxation altogether. From April 2018 when the allowance reduces to 2,000, investors with dividends between that level and 5,000 will become liable to tax, but in many cases that will be less than what they would have paid before April The reformed rules won t matter very much for those with dividends less than the allowance that fall within the basic rate income tax band, because their liability was previously covered by the tax credit. Basic rate taxpayers with dividends in excess of the allowance will be worse off, but few taxpayers fall into this category. Higher and additional rate taxpayers with dividends within the allowance benefit significantly as previously they would have been taxable on all dividends received. And even those with dividends above the allowance but below the critical thresholds will benefit but to a smaller extent compared to their pre-april 2016 position. Anyone receiving dividends in excess of the critical thresholds will be worse off. Director shareholders paying themselves dividends as part of their remuneration strategy would in many cases be receiving dividends well above 5,000 / 2,000 so fewer in this category will be happy with the reforms and soon to be reduced dividend allowance. As these critical thresholds from 2016/2017 and 2018/2019 were/are relatively low, it is straightforward to conclude that many director shareholders would suffer an increased dividend tax liability as a result of the new rules. The amount of extra tax depends on the actual level of dividend and non-dividend income received in the tax year, so relies on a personal tax calculation. But despite this increase in tax against higher levels of dividends, many will still be better off compared with a remuneration strategy based wholly on salary. And many will benefit significantly by adding some pension contributions to their remuneration mix. COMPARING REMUNERATION STRATEGIES Whilst it is helpful to consider the changes to dividends in recent years, a more meaningful comparison for director shareholders is between their current remuneration strategy and the alternatives available to them in the same tax year. As the owners of small private companies can exercise control over the type of remuneration they receive, they will want to ensure they have the most tax-efficient mix of salary, dividend and employer pension contributions. This will involve a discussion with their accountant to establish: how much salary they should pay themselves, ensuring entitlement to valuable social security benefits; the level of dividends available to them, within the constraints imposed by HM Revenue & Customs and the amount of distributable profit within the company; their ability to fund their personal pension within the available annual allowance plus carry forward.

6 6 techtalk Let s look at an example for the 2018/2019 tax year, taking into account that the personal allowance and basic rate income tax band will have increased to 11,850 and 34,500 by then. EXAMPLE Walter is aged 54, runs his own limited company, remunerates himself using salary and dividends, and has his full annual allowance available in this tax year plus 35,000 carry forward. In 2018/2019 he wants to distribute 100,000 out of his company to remunerate himself. After a discussion with his accountant around the level of dividends he can receive, he decides to pay himself a salary of 8,424 (the national insurance primary threshold) and the rest in dividends. As there will be no employer national insurance liability in relation to the payment of salary, the remainder - 91,576 - can be paid as a dividend. The remuneration package is, therefore: Salary: 8,424 Dividend: 91,576 The total tax liability is as follows: 2018/2019 Salary 8,424 Dividends 91,576 Total income 100,000 Full personal allowance available: 11,850 Earned Income: Salary 8,424 Deduct PA ( 8,424) Taxable 0 Dividends: Dividend 91,576 Deduct PA ( 3,426) Taxable 88,150 Dividend allowance: 2,000 x 0% = 0 Basic rate tax: 32,500 x 7.5% = 2, Higher rate tax: 53,650 x 32.5% = 17, Total tax 19, What is important here is the overall extraction rate. As the dividend itself is a distribution of post-tax profits, the corporation tax bill has to be accounted for. The profit before tax was 113,056.79, which is found by grossing up the dividend by 100%/81%. The extraction rate, then, is the monetary amount received by the shareholder director as a percentage of the total cost to the company: Amount received after all taxes: 100,000-19, = 65.96% Cost to the company: 113, ,424

7 techtalk 7 WHAT ALTERNATIVE REMUNERATION STRATEGY IS AVAILABLE? Following a discussion with his financial adviser, Walter is aware that he is able to swap some of his remuneration for an employer pension contribution to improve his overall tax position. As he is close to his 55th birthday he knows that he will be able to access these funds very shortly under the Freedom & Choice regime. Walter looks at swapping some of his dividend for the maximum contribution he can make to a personal pension. EXAMPLE Walter considers his potential tax bill if he swaps 75,000 of the dividend for an employer pension contribution, thereby maximising his annual allowance plus carry forward in 2018/2019. To compare the overall tax position it is necessary to take all tax liabilities into account. The remuneration package would, therefore, be: Salary: 8,424 Dividend: 30,826 Employer pension contribution: 75,000 The total tax liability is as follows: 2018/2019 Salary 8,424 Dividends 30,826 Total income 39,250 Full personal allowance available: 11,850 Salary: Salary 8,424 Deduct PA ( 8,424) Taxable 0 Dividends: Dividend 30,826 Deduct PA ( 3,426) Taxable 27,400 Pensions: Pension 75,000 Deduct provision for retirement tax (assume basic rate taxpayer): Dividend allowance: 2,000 x 0% = 0 Basic rate tax: 25,400 x 7.5% = 1,905 Tax-free cash: 18,750 x 0 = 0 Taxable pension: 56,250 x 20% = 11,250 Total tax 13,155 Again, as the dividend itself is a distribution of post-tax profits, the corporation tax bill has to be accounted for. The profit before tax was: 38, ( 30,826 x 100%/81%). The extraction rate is: Amount received after all taxes: 101,095 = 83.22% Cost to the company: 121,480.79

8 8 techtalk Director shareholders will be able to improve their overall tax position by considering whether they are receiving the right mix of salary, dividends and pension contributions. Walter should be motivated by this to change his remuneration strategy. Switching some of the dividends to an employer pension contribution can save a significant amount of tax in 2018/2019. There is no need to have salary of a certain level to be able to receive employer pension contributions, and as Walter is the driving force that generates the company s profits there should be no issue deducting the employer pension contribution from profit. In other words, it is likely to be incurred wholly and exclusively for the purposes of trade and is, therefore, a deductible expense. Looking further forward, Walter will not be able to utilise this strategy each year (he would have exhausted all of his carry forward), so he will have to revert to a higher level of salary and/or dividends in later years. He can, however, pay up to a maximum of 40,000 in employer pension contributions depending on the annual allowance available to him and any other contributions he makes to registered pension schemes. Many director shareholders will be able to improve their overall tax position by considering whether they are receiving the right mix of salary, dividends and pension contributions. Any such discussion will involve the client s accountant, but ensuring pension contributions which are sometimes overlooked by director shareholders are maximised within the annual allowance can help to better the extraction of profits, in addition to the usual retirement benefits that are available. To carry out your own comparisons please use Salary, Dividend and Pension calculator. This can be found in the Tools section of the Scottish Widows Adviser Extranet. Note: Scottish resident taxpayers will have their own income tax rates and bands from 2018/2019 which may affect the tax outcomes in our examples.

9 techtalk 9 LIFETIME ALLOWANCE: A SMALL INCREASE BUT A WELCOME CHANGE OF DIRECTION The Budget confirmed the LTA is increasing to 1.03m from April 2018, offering some relief for pension savers after years of drastic cuts. CHRIS JONES Chris joined the group in He s worked in a number of technical roles in marketing, product development and technical support. His recent focus has been on pensions taxation and the new pension reforms. The Budget confirmed the Lifetime Allowance will increase in line with inflation to 1.03m from April Although it may seem insignificant, after many years of drastic cuts it does offer some relief for pension savers. The Lifetime Allowance (LTA) was introduced in April 2006 as part of the A-day pension reforms. It was originally set at 1.5m with the intention to increase in line with inflation. This happened for the first few years with it rising as high as 1.8m in April Since then there have been significant reductions with the Government looking for ways to save funds, eventually falling to what pension savers will hope is the lowest point of 1m in April The increase to 1.03m from April 2018 will be the first increase in eight years. In simple monetary terms, the 30,000 increase will allow clients to take up to 7,500 more tax-free cash and save up to 16,500 in LTA charges. The increase to 1.03m from April 2018 will be the first increase in eight years. However, whilst the increase is small it sends the signal that the Government doesn t intend to reduce it any further and perhaps confirms they will continue to uplift it in line with inflation as was originally intended. This may give more wealthy clients the confidence to continue to save into their pensions, knowing that at least some of their growth will be covered by the inflationary increases. Although this provides some positive news, the substantial reduction in the LTA means it now affects many more clients than originally intended and has become a key planning consideration.

10 10 techtalk This combined with more clients accessing their benefits flexibly via drawdown also adds further complications due to the second LTA test at age 75. Whenever benefits are taken from a pension they are tested against the LTA at that time. In addition, where clients move into drawdown they face a second LTA test at age 75 or whenever they buy an annuity, if sooner. Even if benefits are not taken, they are still subject to the LTA test when the client reaches age 75. Most death benefits are also subject to an LTA test if the pension fund hasn t already been tested against the LTA. Each time benefits are taken they use up a percentage of the LTA. For example if 500,000 is taken in 2017/2018 it would use up 50% of the LTA. This would leave a further 50% available for future crystallisations. In 2018/2019 this would mean up to a further 515,000 could be taken. If, for example, the LTA rose to 1.1m in April 2021, the 50% becomes worth 550,000. For advisers and clients used to planning around a falling LTA, this now means a different outlook and having to consider increases in the value of benefits against inflationary increases in the LTA. CRYSTALLISING EARLY V CRYSTALLISING LATER For those close to or above the LTA, crystallising sooner rather than later has been a popular strategy in recent years as the LTA has reduced significantly. This aims to cap the growth on the value of the fund and protect future growth against LTA charges. It works well if the client needs to take an income from the fund and so can use that to control the value of the remaining fund at the point of the second LTA test. This option remains valid in this type of situation. However, delaying the crystallisation may now lead to greater tax-free cash and so this needs to be considered. The likely fund growth along with the income requirements, versus inflation will be key. Where income isn t required, the same strategy of crystallising up to the LTA has also been used and again this is a good option whilst the LTA has been falling. Now the LTA is increasing this may no longer be the best option. If the inflationary increases to the LTA remain, they will offset at least some of the growth in the funds. If very cautious funds are selected and inflation remains relatively high, they could offset all the growth. EXAMPLE Sophie has just turned 65 and has a fund worth 1,030,000 as at May If we assume 4% growth and 2% inflation, let s take a look at the difference between crystallising now or leaving the funds uncrystallised. With the first option, there will be second LTA charge at age 75. With the second option, the uncrystallised funds will be subject to the age 75 test. Crystallise May 2018 Fund uses 100% of LTA and 0 LTA charge Value in drawdown = 772,500 May 2028 second LTA test applies Drawdown value at age 75 = 1,143,489 Second LTA test = 1,143, ,500 = 370,989 LTA charge = 370,989 X 25% = 92,747 Leave the funds uncrystallised Fund value at age 75 = 1,524,652 LTA at age 75 = 1,255,564 LTA excess at age 75 = 269,088 LTA charge = 269,088 X 25% = 67,272 Although the growth takes the fund over the LTA, some of that is offset by the inflationary increases leading to a lower LTA charge. If Sophie takes her benefits earlier, none of the funds placed into drawdown will benefit from the inflationary increases. EXISTING INDIVIDUAL AND FIXED PROTECTION Unfortunately, the indexation doesn t apply to those who have previously obtained Individual Protection (IP) or Fixed Protection (FP). Their protection amounts remain in place until the standard LTA increases to a higher amount than their protected LTA. Assuming the LTA continues to rise with inflation and inflation averages around 2%, it will take another 10 years before the standard LTA even returned to the level of FP16 ie 1.25m. This means that most existing protection will remain very valuable for many years and clients should ensure they do not inadvertently lose it, for example by being automatically enrolled into a new employer s scheme and not opting out during the opt out period.

11 techtalk 11 APPLICATIONS FOR INDIVIDUAL AND FIXED PROTECTION 2016 Applications remain open for those that are still eligible for either FP16 or IP16. To be eligible for FP16 clients can t have made any contributions or received any benefit accrual since April They also could not have joined any new arrangement since April 2016, which would include any group life plans set up under a registered pension scheme basis. To be eligible for IP16 clients need to have accrued pension benefits worth at least 1m as at 5th April If so, the value could be protected up to a maximum of 1.25m. For clients whose value was greater than 1m but less than 1.03m there is no longer any value in IP16. Whilst there is no deadline in applying for either FP16 or IP16, pension schemes only have a statutory duty to provide values as at 5th April 2016 up to 5th April This may create an effective deadline for applying for IP16 for many clients. PROTECTED TAX-FREE CASH The formula for calculating protected tax-free cash (TFC) contains an anomaly whereby as the standard LTA reduced below 1.5m, the level of protected TFC increased. With the small increase in the LTA the position reverses, but this will only make very small differences to the valuations.

12 12 techtalk REACH YOUR LIMIT: TAX YEAR END PENSION PLANNING Your employed clients can maximise their pension funding before the tax year ends. We explain the details here. THOMAS COUGHLAN Tom has spent over 15 years in technical roles. He has wide experience including the provision of technical support to financial advisers covering life, pensions and investment compliance. He currently specialises in pension planning. We provide everything you need to know to help your employee clients maximise their pension funding in a single article. As the end of the tax year comes into sight, clients who can afford further contributions should consider making a single contribution, or a series of regular contributions, to their pension plan to get the maximum benefit out of the current pension tax system. A number of recent changes and additional restrictions have made this more complicated so to help you we have summarised the factors you ll need to consider. RELEVANT UK EARNINGS If your client can only make personal contributions, they will be limited by the higher of their relevant UK earnings or 3,600. This is the maximum tax-relieved personal contribution allowed in a tax year. For administrative reasons, most pension providers only accept personal contributions paid net of tax relief. The effect of this is to prohibit contributions that are not eligible for tax relief, such as those in excess of earnings (or 3,600 if higher for personal pensions) or those paid by the over 75s who are not entitled to tax relief. If your client can only make personal contributions, they will be limited by the higher of their relevant UK earnings or 3,600.

13 techtalk 13 The earnings limit is separate from the annual allowance, which means personal contributions in excess of 40,000 can be made in a tax year and receive tax relief. However, if the annual allowance including carry forward is exceeded, a separate annual allowance tax charge operates to reclaim some of the tax relief which was given initially. A, B & C earn the amounts detailed in the table below. They are contributing to a personal pension that can only accept contributions that receive tax relief. They have not paid or benefitted from any contributions or accrued final salary benefits in the current tax year. The maximum amount they can pay before the end of tax year is: Relevant UK earnings Maximum contribution A 1,600 3,600 B 16,000 16,000 C 160, ,000 Clients A and B are well within their annual allowance, assuming neither of the restricted annual allowances apply. C, however, will exceed their annual allowance (unless full carry forward is available) and so will suffer an annual allowance tax charge. This has the effect of recovering the excess tax relief. THE ANNUAL ALLOWANCE AND CARRY FORWARD The earnings limit only applies to personal contributions, but the annual allowance limits the total of all contributions personal, employer and third party as well as benefits built up within defined benefit schemes. Since pension input periods (PIPs) were aligned with the tax year from 6th April 2016, only contributions actually paid within the tax year and benefits built up over that period are aggregated together and tested against the annual allowance. This is a much simplified process, however PIPs still need to be understood if carry forward from 2015/16 and/or 2014/15 is being used. As a reminder, carry forward allows the unused annual allowances of the three previous years to be swept up and added to this year s annual allowance. Your client must have been a member of a registered pension scheme in the tax year they wish to carry forward from. The current year is used first, then the earliest of the three previous years, then the subsequent year and then the most recent year. There is often confusion about what carry forward relates to, but the rules are straightforward: it is only the unused annual allowance from each eligible year that can be brought forward. Earnings from previous years cannot be carried forward; nor can the 3,600 de minimis limit. A consequence of this is that relevant UK earnings must be at least as high as the personal contributions the client wishes to make to utilise carry forward. For example, a client who wishes to make a 160,000 personal contribution (the maximum contribution within the annual allowance plus carry forward), must have relevant UK earnings of at least 160,000. Their earnings in previous years are not relevant. END OF TAX YEAR TIPS Clients can pay up to 100% of their relevant UK earnings into a pension, however this should not be done without also considering the impact of the annual allowance. Carry forward allows the unused annual allowances of the three previous years to be swept up and added to this year s annual allowance. Clients should make contributions that benefit from the top rates of tax: 40% and 45% for higher and additional rate taxpayers, and 60% for those with income between 100,000 and 123,000.

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15 techtalk 15 WHAT ABOUT PENSION INPUT PERIODS? When using carry forward, you will have to determine how much annual allowance remained unused in each of the previous three tax years. 2014/15 and 2015/16 are more complicated than 2016/17 because the PIPs were not necessarily aligned with the tax year. PIPs were the period of time over which pension input was measured for testing against the annual allowance. The tax year the end date of the PIP fell into determined which year s annual allowance the pension input was set against. For instance, if the end date of the PIP was 31st December 2014 all pension inputs for that period (which most likely ran from 1st January 2014 to 31st December 2014) were set against the 2014/15 annual allowance. In 2014/15, therefore, for each scheme your client is/was a member of you must determine which PIPs ended between 6th April 2014 and 5th April All contributions paid and benefits accrued during these periods are totalled and deducted from the standard 40,000 annual allowance that applied in that year. 2014/15: 40,000 less total pension input during PIPs that ended between 6th April 2014 to 5th April /16 pre-alignment period: 80,000 (but carry forward capped at 40,000) less total pension input during PIPs that ended between 6th April 2015 and 8th July The PIP for the post-alignment period was a fixed period from 9th July 2015 to 5th April All contributions paid and benefits accrued during this period were set against the remainder of the annual allowance from the pre-alignment period, which was capped at a maximum of 40, /16 post-alignment period: Maximum 40,000 of the unused 80,000 annual allowance from the pre-alignment period less total pension input from 9th July 2015 to 5th April For 2016/17, thankfully, the calculation is straightforward: reduce the standard 40,000 annual allowance (or tapered annual allowance) by the pension input amount, which is the total of all contributions paid and benefits accrued from 6th April 2016 to 5th April /16 was the tax year in which the changes to PIPs were announced, and predictably it is the most complex. On the day of the Summer Budget th July all open PIPs were automatically closed. A further PIP covered the remainder of the tax year from 9th July 2015 to 5th April PIPs were fully aligned with the tax year thereafter. The first part of the tax year from 6th April 2015 to 8th July 2015 was termed the pre-alignment period ; the latter part, the post-alignment period. The annual allowance in the pre-alignment period was 80,000; there was no annual allowance in the post-alignment period, but a maximum of 40,000 of the unused annual allowance of the pre-alignment period could be used in the post-alignment period. This was in preference to carry forward from earlier years. The PIPs that ended between 6th April 2015 and 8th July 2015 were tested against the 80,000 annual allowance of the pre-alignment period, and there could have been more than one for each scheme. Again, all contributions paid and benefits accrued during PIPs that ended between these dates are set against the annual allowance that applied in that period. 2016/17: 40,000 or the tapered annual allowance less total pension input between 6th April 2016 to 5th April Once you have worked out the available annual allowance in the current tax year and each of the previous three tax years, the maximum contribution without incurring a tax charge can be worked out: 1) 2017/18; the current year s unused annual allowance, plus 2) 2014/15: the unused annual allowance of the earliest year, plus 3) 2015/16: the unused annual allowance of the pre-alignment tax year, capped at 40,000, less the pension input amount in the post-alignment period, plus 4) 2016/17: the unused annual allowance of the previous year. Total

16 16 techtalk To calculate the tapered annual allowance for your client, use the Tapered Annual Allowance Calculator on the Scottish Widows Adviser Extranet. WHAT ABOUT THE ANNUAL ALLOWANCE TAX CHARGE? If the total pension input in a given tax year exceeds the annual allowance plus carry forward, the excess is added to the member s income and taxed according to the tax band that it falls in. E.g. if an additional rate taxpayer has total pension input of 130,000 and an available annual allowance plus carry forward of 120,000, they will be subject to a 4,500 tax charge - which is 45% against the 10,000 excess pension input. WHAT IF THE ANNUAL ALLOWANCE IS RESTRICTED? If the tapered annual allowance applies in either 2016/17 or 2017/18, the process followed above applies in the same way, but with the reduced allowance substituted for the standard 40,000 allowance. To calculate the tapered annual allowance for your client, use the Tapered Annual Allowance Calculator on the Scottish Widows Adviser Extranet. If the money purchase annual allowance applies, contributions to defined contribution schemes are restricted to 4,000 in the tax year without carry forward. It is triggered by flexible access to pensions after 5th April Defined benefit accrual can continue and will be tested against the remainder ( 36,000) of the standard annual allowance with carry forward available. END OF TAX YEAR TIPS Carry forward relates to the unused annual allowances of the three previous tax years. Unused earnings or the 3,600 de minimis limit cannot be carried forward. The use of personal contributions to utilise carry forward requires sufficient relevant earnings in the current tax year. E.g. a 160,000 gross personal contribution utilising full carry forward would require relevant UK earnings of 160,000. The tapered annual allowance and the money purchase annual allowance are covered in more detail in Bernadette s article, also in this edition. Note: Scottish resident taxpayers will have their own income tax rates and bands from 2018/2019 which may affect the tax outcomes in our examples.

17 techtalk 17 IN 2017/2018 GRAEME EARNED FROM 31st DECEMBER 2010 TO 31st DECEMBER 2016 HIS PREVIOUS CONTRIBUTIONS PER MONTH WERE CARRY FORWARD TOTAL 65,000 3,000 70, /15 total contribution 36,000 Monthly contributions of 3,000 per month were paid during the PIP that ran from 1st January 2014 to 31st December /16 Total pension input 18,000 Pre-alignment period monthly contributions of 3,000 per month were paid during the PIP that ran from 1st January 2015 to 8th July /16 Total pension input 27,000 Post-alignment period monthly contributions of 3,000 per month were paid during the PIP that ran from 9th July 2015 to 5th April /17 Total pension input 27,000 Monthly contributions of 3,000 per month were paid during the PIP that ran from 6th April 2016 to 5th April EXAMPLE Graeme earns 65,000 in 2017/2018 and has not made any contributions in the current tax year. His previous contributions were 3,000 per month running from 31st December 2010 to 31st December His adviser has recommended that he pay the maximum contribution he can to his personal pension before 6th April His unused annual allowances from 2014/15 onwards are as follows: 2014/15 monthly contributions of 3,000 per month were paid during the PIP that ran from 1st January 2014 to 31st December Total contribution = 36, /16 pre-alignment period monthly contributions of 3,000 per month were paid during the PIP that ran from 1st January 2015 to 8th July Total pension input = 18, /16 post-alignment period monthly contributions of 3,000 per month were paid during the PIP that ran from 9th July 2015 to 5th April Total pension input = 27, /17 monthly contributions of 3,000 per month were paid during the PIP that ran from 6th April 2016 to 5th April Total pension input = 27,000 Carry forward calculation: 2017/18: 40, , /15: 40,000-36,000 4,000 Pre-alignment: 40,000-27,000 13,000* 2016/17: 40,000-27,000 13,000 Total 70,000 *carry forward was from the pre-alignment period but reduced by the post-alignment contributions. The total annual allowance plus carry forward is more than Graeme s relevant UK earnings, so he will only be able to pay 65,000 in personal contributions. He must be able to benefit from an employer contribution of 5,000 to be able to maximise his carried forward allowance. Tax-relieved third party contributions are not an option once his relevant UK earnings have been exhausted.

18 18 techtalk NATIONAL INSURANCE REFORM A ROUND-UP OF THE KEY CHANGES A useful reminder for advisers of changes in place from April 2017, together with further measures yet to be introduced. JEREMY BRANTON Jeremy has over 30 years experience in the financial services industry covering a number of technical and marketing roles. He joined the group in 2006 as a tax and trusts specialist and also offers technical support on pension and protection planning. A reminder of the changes introduced in April 2017 which limit the tax and National Insurance contributions (NICs) advantages where benefits in kind are provided via salary sacrifice. And a summary of proposed changes to the NICs regime for the self-employed and treatment of termination payments. OPTIONAL REMUNERATION ARRANGEMENTS New rules introduced from 6th April 2017 mean that the tax and NICs advantages previously applying where an employee sacrifices an amount of earnings in return for a non-cash benefit are largely withdrawn. Where benefits in kind are provided through salary sacrifice, they will be chargeable to income tax and employer Class 1A NICs, at the higher of: the amount of salary sacrificed the cash equivalent of the benefit in kind otherwise due under the legislation. If the normal taxable value of the benefit in kind is greater than the amount of salary sacrificed, it will be subject to tax and Class 1A NICs in the normal way. The legislation refers to optional remuneration arrangements these are arrangements provided by an employer where: The employee gives up the right, or future right, to receive an amount of earnings for example salary which would be chargeable to tax in return for the benefit. These are known as Type A arrangements. The employee agrees to be provided with a benefit instead of an amount of earnings for example the option of a cash allowance. These are known as Type B arrangements. EXAMPLE In January 2018 Bob starts a new job and is given the option of a cash allowance of 4,500 as an alternative to a company car. Bob opts for a car with a list price of 21,140 and an appropriate percentage based on emissions of 20%, resulting in a taxable benefit of 4,228. As the cash allowance is higher at 4,500, this is the value of the benefit for these purposes. The new rules don t apply to flexible benefit arrangements that provide employees with a choice of benefits in kind, without offering a cash alternative. Nor do they apply to a benefit in kind not linked to salary sacrifice.

19 techtalk 19 EXEMPTIONS There are a small number of benefits provided in connection with salary sacrifice arrangements that are excluded from the new rules, including employer pension contributions. This type of pension funding can provide some very worthwhile benefits: a 13.8% saving in employer NICs where post exchange earnings exceed the secondary threshold 8,164 pa in 2017/2018 ( 8,424 in 2018/2019) a 12% NICs saving for an employee sacrificing salary that remains above the primary threshold 8,164 in 2017/2018 ( 8,424 in 2018/2019) a 2% NICs saving for high earners sacrificing salary above the upper earnings limit 45,000 in 2017/2018 ( 46,350 in 2018/2019). Scottish Widows offers a calculator and guidance to help advisers illustrate the savings to employers whether as a requirement to save costs or to offer additional employee benefits: corporate-pensions/wp-supporting-clients/salary-exchange While it s good news that there s been no change to the treatment of salary sacrifice for pension contributions, establishing a new salary sacrifice arrangement won t be effective in reducing salary for threshold income purposes for high earners affected by the tapered annual allowance. Arrangements already in place before 9th July 2015 are unaffected unless an amendment is subsequently made to the arrangement. The other benefits excluded from the new rules are: employer-provided pension advice (up to 500) employer-supported childcare and provision of workplace nurseries cycle to work scheme cycles and cyclist s safety equipment ultra-low emission cars (CO2 emissions below 75g/km). There are a small number of benefits provided in connection with salary sacrifice arrangements that are excluded from the new rules, including employer pension contributions. TRANSITIONAL PROVISIONS Grandfathering provisions mean that most salary sacrifice arrangements in place before 6th April 2017 continue to be subject to the previous rules until the earlier of: the variation, renewal or modification of the arrangement 6th April 2018 so most of the transitional protections cease at the end of the current 2017/2018 tax year. Salary sacrifice arrangements in place before 6th April 2017 for cars with emissions of more than 75g CO2/km, accommodation and school fees are protected until April THE ABOLITION OF CLASS 2 NICS Self-employed individuals can currently build entitlement to contributory benefits such as the state pension via Class 2 NICs. They also pay Class 4 NICs subject to the level of their profits. Class 2 NICs are flat-rate weekly contributions 2.85 p/w in 2017/18 ( 2.95 p/w in 2018/2019) payable where profits exceed the Small Profits Threshold 6,025 in 2017/2018 ( 6,205 in 2018/2019). Class 4 NICs are paid on net profits that are subject to income tax. Class 4 contributions are payable at a rate of 9% on profits between the Lower Profits Limit 8,164 in 2017/2018 ( 8,424 in 2018/2019) and Upper Profits Limit (UPL) 45,000 in 2016/2017 ( 46,350 in 2018/2019) and 2% on profits above the UPL. The previously announced increase to the Class 4 main rate from 9% to 10% in April 2018 and to 11% in April 2019 was dropped shortly after the March 2017 Budget. The Government has announced that its proposal to abolish Class 2 NICs has been delayed by one year to April It has also proposed reform of Class 4 NICs to enable the self-employed to build up entitlement to contributory benefits. A new zero rate Class 4 band based on profits between the point at which Class 2 and Class 4 NICs are currently payable is proposed to facilitate this.

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21 techtalk 21 TERMINATION PAYMENTS The Government previously announced it would align the rules for tax and employer NICs on termination payments such that employers would be liable to NICs on any part of a termination payment exceeding the 30,000 tax-free threshold. Originally due to be effective from April 2018, this measure has also been postponed until April Termination payments will remain exempt from employee NICs and free from income tax up to 30,000. Termination payments can comprise minimum statutory amounts together with compensation paid by the employer for loss of employment. STATUTORY RIGHTS TO REDUNDANCY PAYMENT Employees selected for redundancy must receive at least one week s notice for each year of service up to a maximum of 12 weeks. An employee who has accrued at least two years service is entitled to a minimum level of compensation by means of as statutory redundancy payment (SRP) calculated as follows: ½ a week s pay for each year s service before age 22; plus 1 week s pay for each year s service between ages 22 and 40; plus 1 ½ week s pay for each year of service from age 41 While no upper age limit applies, the maximum length of service for these purposes is capped at 20 years and with weekly pay currently capped at 489, the maximum SRP is 14,670 for those made redundant on or after 6th April Many employees will be entitled to a termination package considerably better than the statutory minimum and favourable tax treatment applies to payments made in consideration of the termination of a person s employment. We illustrate the current income tax and National Insurance treatment for these payments together with the revised position affecting employers from April EXAMPLE An employee receives notice from their employer that they are being made redundant. They are required to work the minimum statutory notice period of 12 weeks during which they continue to receive their salary of 26,000 pa amounting to 6,000 over this period. They are entitled to SRP of 12,000. In addition, their employer pays them 24,000 compensation for loss of office upon leaving service, making a total termination payment of 36,000. Current position up to April 2019 Total payment 42,000 Income Tax Employee NICs Employer NICs Salary received during notice period 6,000 Yes Yes Yes Termination payment (above tax-free sum of 30,000) 6,000 Yes No No Position from April 2019 Total payment 42,000 Income Tax Employee NICs Employer NICs Salary received during notice period 6,000 Yes Yes Yes Termination payment (above tax-free sum of 30,000) 6,000 Yes No Yes A further change due to be implemented from April 2019 seeks to treat all payments in lieu of notice (PILONs) as earnings and therefore subject to tax and NICs. This is a complex area and one which the Government believe is open to manipulation. Currently PILONs that are contractual are subject to income tax and Class 1 NICs, but non-contractual PILONs are not. This measure will require the employer to identify the amount of basic pay the employee would have received had they worked their notice period and to treat this as earnings for tax and NICs purposes.

22 22 techtalk TAPERED AND MONEY PURCHASE ANNUAL ALLOWANCES: POST-BUDGET PLANNING OPPORTUNITIES There were no annual allowance changes in the Budget, but the tapered and money purchase annual allowances continue to affect pension planning. BERNADETTE LEWIS Bernadette joined the group in She has over 35 years experience in Financial Services with both intermediaries and providers. She has broad and deep technical experience across pensions, protection, tax and trusts. There were no annual allowance announcements in the Autumn 2017 Budget, but recent changes continue to affect pension planning. We summarise the main tapered annual allowance (TAA) and money purchase annual allowance (MPAA) rules. And consider some planning opportunities. ANNUAL ALLOWANCE LIMITS 2017/2018 & 2018/2019 Standard annual allowance: 40,000 TAPERED ANNUAL ALLOWANCE The TAA was introduced in 2016/2017. Carry forward is available, but carry forward from any tax years where the TAA applies is restricted to any unused TAA. Along with earnings increases, it s becoming more likely that affected clients will face annual allowance charges in 2017/2018 and 2018/2019, having already used up any carry forward. The TAA applies if: adjusted income is more than 150,000 and threshold income is more than 110,000. Tapered annual allowance: Money purchase annual allowance: 10,000 to 40,000 depending on adjusted income 4,000 If someone exceeds both limits, the 40,000 annual allowance reduces by 1 for every 2 of adjusted income over 150,000, to a minimum of 10,000 once adjusted income is 210,000 or more.

23 techtalk 23 The MPAA was introduced in 2015/2016 at 10,000. It reduced to 4,000 with effect from 6th April ADJUSTED INCOME (KEY ELEMENTS) net taxable earnings including bonuses, benefits in kind etc* net taxable self-employed profits* other taxable income such as pensions, rent, interest, dividends* gross member contributions benefitting from net pay tax relief / relief on making a claim employer pension contributions for defined benefit schemes, the pension input amount minus employee contributions. THRESHOLD INCOME net taxable earnings, net taxable self-employed profits, other taxable income* add back any new salary sacrifice arranged in connection with pension contributions after 8th July 2015 deduct gross member contributions benefitting from tax relief at source. * Total of all components of net income at step 2 in the section 23 Income Tax Act 2007 calculation. For money purchase schemes, pension input from 2016/2017 onwards is the total of all contributions paid during the same tax year. For defined benefit (DB) schemes it s safest to obtain a pension savings statement from the administrator, but there can be significant delays. If it s necessary to rely on an estimate, clients should explain this on their self-assessment tax return. TAA CARRY FORWARD PLANNING OPPORTUNITY Some clients with adjusted income over 150,000 will still find that using carry forward to make a relief at source member contribution reduces their threshold income below 110,000 and takes them out of scope for the TAA. EXAMPLE Sidonie s caught by the TAA for the first time in 2017/2018. Before any planning, her salary, adjusted and threshold income are all 180,000, making her TAA 25,000. However, she has 52,000 of carry forward available and makes a relief at source member pension contribution of 70,000 gross. This reduces her threshold income to 110,000. Sidonie benefits from the full 40,000 annual allowance for 2017/2018 and uses just 30,000 of carry forward. MONEY PURCHASE ANNUAL ALLOWANCE The MPAA was introduced in 2015/2016 at 10,000. It reduced to 4,000 with effect from 6th April 2017 as confirmed by Finance (No 2) Act The 4,000 limit applies to anyone who s already triggered the MPAA or who does so in future. The June 2017 General Election delayed the legislation implementing the reduction, which might have caught out some clients. MPAA TRIGGERS Usefully, setting up flexi-access drawdown and taking just the associated tax-free cash won t automatically trigger the MPAA. Nor will using the small pots rules. If someone does trigger the MPAA, their provider must notify them. The MPAA triggers are: taking an uncrystallised funds pension lump sum (UFPLS) taking income from member flexi-access drawdown converting member capped drawdown to flexi-access drawdown and taking income using member flexible drawdown before 6th April 2015 receiving income from a post-pension freedoms flexible annuity receiving income from a scheme pension set up from 6th April 2015 where the scheme has fewer than 12 members receiving some payments from overseas pension schemes receiving some stand-alone lump sums. Clients who were in flexible drawdown on 5th April 2015 automatically triggered the MPAA on 6th April Otherwise, the MPAA takes effect the day after a trigger event. It then applies to all their money purchase pensions for the rest of that tax year, and for every subsequent tax year. Once someone s triggered the MPAA, they face a tax charge if subsequent employer, member and/or third party contributions to all their money purchase pensions total more than 4,000 in a tax year. In addition, they can t use carry forward in respect of any money purchase pensions.

24 24 techtalk EXAMPLE River is a member of a group personal pension (GPP) with an employer only contribution of 600 paid on the 15th monthly. He s a higher rate taxpayer, isn t affected by the TAA and has plenty of lifetime allowance headroom. River took a UFPLS on 1st August 2017 from an old money purchase scheme. He discovered his employer offered no cash alternative to pension contributions only after triggering the MPAA. River let the contributions continue. In addition to something being better than nothing, his pension fund grows free from tax, provides 25% tax free cash, and falls outside his inheritance tax (IHT) estate. River s pension input of 7,200 for 2017/2018 is within the standard 40,000 annual allowance. However, he triggered the MPAA on 2nd August His employer will pay 8 x 600 contributions between 15th August 2017 and 15th March 2018 totalling 4,800. That creates an excess of 800 over the 4,000 MPAA. River s liable for a 40% annual allowance charge of 320 for 2017/2018. So his net benefit from this year s employer contributions is 6,880. If his circumstances remain the same in 2018/2019, the excess of over the MPAA will be 3,200, generating a 1,280 annual allowance charge.

25 techtalk 25 MPAA AND DB ACCRUAL Because the MPAA only applies to money purchase schemes, the normal annual allowance or TAA rules apply to any DB pension accrual. The member can also use carry forward in respect of their DB accrual. Dual active membership of money purchase and DB schemes is relatively unusual, but if required, see HMRC s Pension Tax Manual starting at PTM ANNUAL ALLOWANCE CHARGE A client faces an annual allowance charge if: the pension input amount for the tax year exceeds the standard annual allowance plus available carry forward the pension input amount for the tax year exceeds their personal TAA plus their available carry forward money purchase pension contributions that must be tested against the MPAA exceed 4,000 a client exceeds both the MPAA and either the standard annual allowance or the TAA (see HMRC s Pension Tax Manual starting at PTM056510). The annual allowance charge is at the taxpayer s marginal rate of income tax, making the excess contributions effectively non-tax relievable. The taxpayer declares their liability to the charge on their selfassessment tax return. Scheme pays might be an option, but it s only obligatory for a scheme if contributions to it exceed the standard annual allowance and the charge exceeds 2,000. TAA, MPAA AND AUTOMATIC ENROLMENT The fact that an employee is caught by the TAA or the MPAA doesn t change their employer s automatic enrolment duties. Contributions to automatic enrolment schemes established on a qualifying earnings basis should fall within these restricted annual allowances. However, many employers offer more generous contributions, certifying the scheme on a set 1, 2 or 3 basis. If automatic enrolment contributions cause an employee to exceed the TAA or MPAA, they can make their own choice to opt out, cease active membership, or possibly reduce their contributions below the scheme s automatic enrolment minimum. If so, they normally join the three-year automatic re-enrolment pool. However, some employers may be willing to switch affected employees to a qualifying earnings basis, or apply an entitlement check. To pass an entitlement check, the overall and employer contributions must be least as good as those required on a qualifying earnings basis. Ceasing active membership or opting out normally means the employee loses the benefit of an employer contribution. Their employer might agree to use its saving to pay additional salary plus the associated employer national insurance (NI) contributions. EXAMPLE Hassan earns 275,000 a year, has a 10,000 TAA and used up all his carry forward in 2016/2017. His employer contributes 8% of earnings 22,000 a year to a GPP. Hassan s facing an annual allowance charge on the 12,000 excess in 2017/2018. Scheme pays isn t available. With a 22,000 pension contribution, there d be a 45% annual allowance charge on the 12,000 excess over the TAA. 12,000 would be invested in Hassan s pension and he d be liable for a 45% annual allowance charge of 5,400 payable via self-assessment. Ignoring investment growth and assuming the whole 12,000 falls within the lifetime allowance, Hassan might take 3,000 tax free cash from age 55 plus 9,000 taxable income. If he s still an additional rate taxpayer, he d pay a further 4,050 income tax. So the total tax on the excess contribution could be 9,450 giving a net effective benefit of 2,550. If the employer agrees to reduce Hassan s pension contribution to 10,000, it could use the remaining 12,000 to increase his salary by 10, after allowing for employer NI of 1, Hassan would pay tax at 45% and employee NI at 2%. The effective net benefit could be 5, The TAA or the MPAA doesn t change their employer s automatic enrolment duties.

26 26 techtalk HIGHER EARNERS FUNDING A SPOUSE OR COHABITEE S PENSION Tighter annual allowances plus lifetime allowance restrictions might make funding spouses, civil partners and cohabitees pensions more attractive. As these are third party contributions, the member benefits from tax relief of up to the greater of 100% of their relevant UK earnings or 3,600. Third party contributions are gifts for IHT purposes, but the interspouse or 3,000 annual exemptions are often available. HMRC can treat non-exempt third-party contributions paid directly to providers as chargeable lifetime transfers. Where this is a risk, gifting cash so the member can pay their own contributions creates potentially exempt transfers. For the over 55s, it s possible to make a money purchase pension contribution and immediately withdraw a higher amount. The MPAA reduction made this less attractive as a remuneration strategy. However, it can still work for third party contributions. EXAMPLE Diana is 66. Her only taxable income in 2017/2018 is 6,360 basic state pension, so she has no relevant UK earnings. Her wife, Ingrid, has 33,000 taxable income and makes a 2,880 net pension contribution on Diana s behalf an exempt IHT transfer which the provider grosses up to 3,600. Diana can withdraw the whole fund immediately, taking 25% tax free, with the rest taxable: State pension: 6,360 Pension fund withdrawn (net of tax free cash): 2,700 Total taxable income: 9,060 The 2017/2018 personal allowance is 11,500, so Diana doesn t pay any tax. It also leaves her enough unused personal allowance to transfer 1,150 to Ingrid (a basic rate taxpayer) under the marriage allowance provisions. The contribution costs Ingrid 2,880 and creates an immediate 3,600 benefit for Diana. Similar planning can also work for the under 55s. EXAMPLE Min is 45, with a 310,000 salary and significant money purchase pension savings. He s been advised to limit his own plus employer contributions to 10,000 for 2017/2018, given the 1 million lifetime allowance and the TAA. His cohabitee Louisa is 46. She works part-time earning 15,000 a year and pays 300 gross/ 240 net a year into an automatic enrolment GPP. Min gifts 11,760 cash to Louisa to ensure it s treated as a potentially exempt transfer. She makes a pension contribution, which the provider grosses up to 14,700, her maximum tax relievable amount. As Louisa is under 55, she can t draw on her pension fund yet, but Min can continue to help her top up her contributions to 100% of her relevant UK earnings each year. From age 55, even if Louisa s still working, she could draw the whole fund, taking 25% tax free cash with the rest taxable. This triggers the MPAA, restricting any future contributions. Alternatively, once she s retired she may be able to take withdrawals within her personal allowance, providing an ongoing tax free income. Note: Scottish resident taxpayers will have their own income tax rates and bands from 2018/2019 which may affect the tax outcomes in our examples.

27 techtalk 27 TECHTALK ANSWERS ISA, LISA OR PENSION? We compare the main features and benefits of ISAs, LISAs and pensions. LUCINDA CHOW Lucinda is a graduate trainee in the Financial Planning team, with a law degree from the University of Nottingham. She is currently working towards her CII Diploma in Insurance and seeks to simplify complex legislation and engage people on planning for the future. When it comes to retirement savings, which route is best to take? On top of the traditional choice of a pension, your clients can also put their money into an Individual Savings Account (ISA), and since 6th April 2017, a Lifetime ISA (LISA). There has been a range of commentary on the advantages and disadvantages of each option, so we are here to bring it together and present you with a comprehensive view. THE BASICS THE ISA What it offers: The ISA is an account to shelter savings and investments from tax; there is no capital gains tax and no UK tax on income within an ISA. Eligibility: Anyone aged 18+, but 16+ for Cash ISAs. Conditions: In the 2017/2018 and 2018/2019 tax years, the maximum amount clients can save into ISAs is 20,000. This includes contributions to cash ISAs, stocks and shares ISAs and innovative finance ISAs. THE LISA What it offers: The LISA offers a 25% tax-free Government bonus on savings up to 4,000 (maximum bonus of 1,000) per year. Eligibility: Between the ages of 18 and 40. Conditions: The bonus only applies up to age 50 (this means a maximum of 33,000 of bonuses). Savers can withdraw their own contributions for retirement purposes at age 60. The amount put into the LISA counts towards their 20,000 ISA limit. It is also designed to help savers buy their first home. PENSION What it offers: A tax-efficient long-term savings plan specifically for retirement. Eligibility: No age restrictions, although tax relief on personal pension contributions are not available for those aged 75+. Conditions: Most personal pensions are unable to be accessed before age 55 (57 from April 2028). There is an annual allowance of 40,000; however, you can carry forward unused allowances from the previous three years. There is also a lifetime allowance of 1,000,000 in 2017/18 ( 1,030,000 in 2018/19). If the value of all a client s pension benefits exceeds this, any excess will result in a tax charge of 25% if it is withdrawn as an income (e.g. annuity or flexi-access drawdown) or 55% if taken as a cash lump sum.