Welcome to the November 2017 newsletter from Chamberlains –
Well, that was fairly unspectacular, wasn’t it? There were various dogs that didn’t bark – pensions, VAT registration limit reduction and tuition fees, for example. I’d suggest the only real point of interest (apart from the depressing comments about continuing low growth for the next few years) was the removal of Stamp Duty for first time home buyers for completions on or after 22 November 2017, the day of the Budget. This is for properties up to £300,000 or for the first £300,000 of properties up to £500,000. Note: if one of a pair of joint buyers has previously had an interest in a property, this disqualifies them both.
A few other brief points:
The tax-free personal allowance will increase to £11,850 from 6 April 2018, up from £11,500, and the higher rate tax threshold, when you start to pay 40% income tax, rises from £45,000 to £46,350
The capital gains tax annual exempt allowance is going up from £11,300 to £11,700, also from 6 April 2018.
Income tax rates remain at 20%, 40% and 45%, and corporation tax stays at 19% until 2020 when it is due to fall to 17%.
Capital gains in companies will, from 1 January 2018, no longer be calculated after an inflation allowance for gains after that date. Personal CGT lost indexation years ago (1998), but we benefit from lower rates, whereas companies kept the “indexation allowance” but are taxed within general corporation tax. This will affect buy-to-let investors who have started to invest through companies.
The VAT registration threshold is frozen at £85,000 (it normally goes up each year)
The Lifetime Allowance for pensions rose from £1,000,000 to £1,030,000. This is the top-value for people’s pensions, after which punitive taxes apply unless they’ve made special arrangements. (It’s a complicated area – not possible to summarise here.)
EIS investment limits have been doubled to £2,000,000 – not that this is likely to affect many people, and of this, at least the second £1,000,000 needs to be in “knowledge-intensive” companies. (The idea of EISs is to encourage people to invest in smallish companies. If they invest £100,000 they get an immediate tax deduction of £30,000. Not relevant for most people, but this year I’ve had a couple of clients who’ve benefited from them.)
And there are other bits and pieces, but nothing major for most of us, so I’ll leave it at that. If there was anything that caught your eye that you’d like to know more about, please let me know and I’ll apologise for not mentioning it! (And I’ll try to follow it through for you.)
In the meantime, I can’t resist talking about…
They were one of the dogs that didn’t bark – a lot of people were expecting the Budget to remove higher rate tax relief from pensions, but no, nothing happened. As a reminder, personal pensions work like this: you pay £80 to a pension fund for yourself, and the government tops up your pension pot to £100. In addition, if you’re a higher rate taxpayer you reclaim another £20 via your tax return. So the £100 in your pension pot has cost you only £60 – which gives you a £40 profit immediately to cover any falls in the stock market. But if you’re worried about stocks and shares, you can leave the pension pot as just cash – or ask your financial advisor for things considered to be safe.
There’s also a very useful tax-planning element – the amount left in the fund can pass on without tax when you die. (See the last section – some would say that I’m saving the best for last!)
Of course, there are conditions. You are only allowed to pay in as much as you’ve earned in that tax year, and it’s the gross figure that counts. In other words, if you want to pay in £20,000, this will be topped up to £25,000, which is the “gross” figure, so you need to earn £25,000 in that tax year. Relevant earnings are your salary (including taxable benefits), plus any trading income, profits from furnished holiday lettings and patent income from inventions (if you should be so lucky.)
The maximum gross contribution allowed is £40,000 each year, but you can bring forward unused allowances from the previous three years, even if you didn’t earn as much as that in those years. You also need to have had a pension scheme in existence in those years, even if you didn’t contribute to it.
For example, last year you had earnings of £30,000 and this year you earn £50,000. For simplicity we’ll say that you had no earnings in earlier years – perhaps an extended round-the-world trip? You also have dividends of £100,000 so you’d be due to pay a lot of tax. You decide to pay as much as you can into a pension scheme for yourself.
Your allowances are £40,000 for last year and £40,000 for the current year (NOT £30,000 and £40,000!) so you could make gross contributions of £80,000 if your current year’s earned income were high enough. But it’s not – it’s only £50,000. This means that you can pay £40,000 net, which is topped up to £50,000 gross by HMRC. When this goes onto your tax return your tax liability is reduced by £10,000, ie. 20% of the £50,000. So the £50,000 in your tax pot has cost you just £30,000.
So far, so good. However, there’s a plus and a minus to remember. The plus is the concession that even if you have no earnings you can pay £3,600 gross into a pension scheme each year, ie. £2,880 as an actual payment. The minus is the restriction that if you’ve “entered drawdown” (what’s that? – see below…) you can only contribute £4,000 gross, and you can’t bring forward allowances from earlier years,
SO WHAT HAPPENS WHEN YOU’VE BUILT UP A PENSION FUND?
An obvious thing to do beforehand is to see what you’re likely to get from the State when you reach the relevant age. To do this, you need to go to this website: www.yourpension.gov.uk , but you’ll need to have a Government Gateway login.
There are various things you can do, once you’re 55. The first is often to take out 25% of the value as a tax-free lump sum. Maybe you’ll pay off the mortgage, pay for celebrations, reinvest it, etc. Could you put it back into the pension fund to benefit from another top-up from HMRC?! Unsurprisingly, the taxman doesn’t like this sort of recycling so, if the tax-free lump is more than £7,500 in any one year period you can’t put in more than 30% of the lump sum. If you do, the lump sum will be taxed at at least 40%. However, you could put more in the next year, if your earnings allowed.
The traditional treatment for the remaining fund was to buy an annuity (not necessarily from your pension fund provider), and this may still be the right thing to do for some people. You’re effectively buying the right to an income for the rest of your life, but there are various extra options.
If you want the income to increase with inflation, or you want your surviving spouse to continue to receive the annuity, these will cost more. Effectively, the annuity provider gives you a lower starting amount. If you’re not healthy or you’re a smoker, they’ll give you more, because they expect you to die sooner! There are plenty of websites to work out what you might get. However, a healthy 65 year old male might get an annuity of £2,700 for a £50,000 pension pot, but this would fall to £1,700 if he wanted it to be index-linked. If he delays until 70, he could get £3,100 or nearly £2,000 for the index-linked version.
However, since April 2015 things have been much more flexible. You can even cash in the whole of the pension immediately (some politicians were fearful that we’d all go out and buy Ferraris!), in which case the first 25% will be tax free and the rest will be counted as income – so there’s a danger that it will be taxed largely at 40% or even more.
There are two more sensible options – “flexi-access drawdown” and a series of “uncrystallised fund pension lump sums” (UFPLS).
In flexi-access drawdown, up to 25% will be taken at the start and varying amounts, taken at times to suit the pensioner, will be treated as income and taxed as such. They’ll have 20% tax deducted by the pension provider, and it may be worth putting this on a tax return if personal allowances are not used by other income. The alternative is to complete a form P55, kindly provided by HMRC for you to reclaim tax in the tax year without waiting for a tax return.
Under the alternative UFPLS method, with a series of receipts from the fund, the first 25% of each draw will be tax free, with the remainder taxed as income. Tax will be deducted at 20% on the other 75%, but, depending on the size of the withdrawal, higher rate tax may be due. Again, a tax return or form P55 reclaim may be appropriate.
TAX PLANNING – WHAT HAPPENS TO THE FUND WHEN YOU DIE?
If you’ve invested everything in an annuity, it’s lost when you die – unless you’ve arranged for your surviving spouse to continue to receive it. It’s quite common for them to receive half of the original amount – but this is something you can choose when you buy the annuity. As I said above, this reduces the amount paid for your own pension, because the pension fund needs to allow for payments over what’s expected to be a longer period, as calculated by their actuaries.
However, if your pension pot still has assets when you die, these can pass free of inheritance tax to nominated beneficiaries – which can be anyone you’ve chosen. From the point of view of IHT planning, this can be very powerful: you put money into your pension fund, it receives a top-up from HMRC, you die (yes, that’s the downside…) and then your delighted heir receives the fund without any deductions for inheritance tax.
But it can be even better than that. After your initial tax-free 25%, you were taxed on pension income in the same way as normal income. If you’re unfortunate enough to die before 75, your heir may be slightly consoled by receiving not only the tax-free inheritance of the pension fund, but also the ability to take a lump sum or regular withdrawals for it tax-free too! It seems amazing – but that’s the situation. If you die aged over 75, the lump sum and subsequent withdrawals will be subject to normal income tax, which is probably more what you’d expect.
So far I’ve talked mainly about personal contributions, but it can often be better for an employer to pay. It saves National Insurance, but it can be complicated in other ways. Something for another occasion, perhaps next newsletter if anyone’s interested!