Revolution in pensions rules (FT Advisor)
by David Kaye
With the changes to pensions on the horizon, what can investors expect?
Much ink has been spilt analysing the likely impact of the recent changes to the Taxation of Pensions Bill, published on October 14 2014.
This requirement is being removed from April 2015 and anyone aged 55 or more will have almost complete flexibility on how they would like to receive their pension benefits.
The added flexibility means that individuals can take more of these benefits up front, although this is likely to come with a significant income tax bill as withdrawals from pensions beyond the PCLS are taxable.
Venture capital trusts (VCTs) and enterprise investment schemes (EISs) can be an attractive solution in this instance as there is a flat income tax relief of 30 per cent of the initial investment available to both.
These have the added advantage that there is no concept of pensionable or earned income on VCTs and EISs, so pension income can be offset. It is also a flat 30 per cent relief rate regardless of an investor’s marginal tax rate. However, upfront tax relief is not the only consideration.
As ever, advisers must help clients match their particular requirements to the available products. It is very much a case of picking the right product in order to achieve not only tax efficiency upfront but also inheritance tax (IHT) mitigation.
For example, does the investor require income? In taking advantage of the increased flexibility and not choosing an annuity, an investor may still have a requirement for income.
VCTs have the advantage of being able to pay out tax-free dividends, allowing for a tax-free income into retirement. EISs do not offer tax-free dividends, so they will typically roll up their profits and make one distribution at the end of their investment life, which is tax-free.
In order to retain the tax benefits, the minimum holding period for a VCT is five years and for an EIS it is three years. However, many VCT shares trade at a significant discount, which makes them more suitable for horizons in excess of five years. An exception is the limited-life VCT sector, which seeks to wind up following a shareholder vote after five years.
Many EIS investments will typically qualify for business property relief, which exempts from IHT assets that are held for two years and are trading at the point of death.
IHT is often a consideration for individuals of an age where they can draw down from a pension, so the combined income tax and IHT benefits may make EIS investments an attractive proposition.
However, it ought to be noted that for those aged under 75, the 55 per cent charge on any crystallised pension assets inherited on death is also to be abolished with the most recent pension reforms.
In the new system, a number of advisers will be recommending that their clients who do not need access to the money should keep their assets within their pension until they are 75.
An EIS investment is still a viable IHT-efficient option for clients who reach 75 and are taking benefits, because the drawdown from the pension will still incur income tax that can potentially be offset by the EIS’s initial 30 per cent income tax relief.
As soon as an individual has reached their annual pension cap and their Isa allowance for the tax year, then VCTs and EISs arguably ought to be the next major investment option.
David Kaye is chief executive of Puma Investments
See the article here on the FT Advisor wesbite.