The decision by the UK Government to cap tax relief on pension contributions could have a major impact on the retirement plans of wealthy individuals. From 6 April 2011, the Annual Allowance will be reduced to ￡50,000, and from 6 April 2012, the Lifetime Allowance will be reduced to ￡1.5 million. This will force many individuals to consider alternative investment structures to fund their retirement.
The Annual Allowance is a cap on the amount of tax relief an individual can claim per tax year.
Any excess contributions are subject to tax. The Lifetime Allowance is a cap on the total value of an individual’s pension savings they can build up. Any funds exceeding this cap will trigger tax charges of 25% or 55% depending on how benefits are taken. Increasing numbers of individuals are likely to be affected by these rules following salary rises because the allowances will no longer be increased with inflation. People will also be seeking new homes for ad hoc monies such as bonuses or any inheritance they may receive.
It is estimated this legislation change will affect 100,000 individuals, of whom 80% earn in excess of ￡100,000 per year (Deloitte, February 2011). The current marketplace offers various long-term investment vehicles that may be suitable for retirement planning, one of which is a single (or regular) premium offshore bond.
Case Study
Robert is a successful businessman, aged 45 and from Southampton. He pays ￡150,000 per annum to his Self Invested Personal Pension and receives full tax relief. Upon hearing about the reduction in tax relief, Robert visits his IFA to investigate alternative investments that may work alongside his existing pension. Robert wants to retire in 10 years and then sail around the world for 5 years before settling in Cornwall.
Robert is already contributing the maximum to his stocks and shares ISA, and wishes to continue funding his pension up to the Annual Allowance in order to obtain maximum tax relief.
His IFA suggests Robert considers an offshore bond for the following reasons:
- There are no limits to the investment amounts or fund size.
- The underlying fund does not suffer income or capital gains tax, apart from any withholding tax that may be deducted at source on income arising from investments held in some countries that cannot be reclaimed by us.
- Robert could withdraw up to 5% per policy year of total premiums paid without triggering an immediate income tax liability. If unused, the allowance rolls forward on a cumulative basis.
- Since Robert is planning to be non-UK resident for a few years, any future gain could benefit from Time Apportionment Relief (TAR). TAR reduces the amount of the gain liable to income tax by virtue of non-UK residency.
- Assuming the 5% allowance is not exceeded, Income Tax will not be payable until Robert either encashes the bond or a segment/s of the bond, or until the death of the last life assured. By this time Robert may be paying a lower rate of income tax.
- Robert will not be restricted to a 25% tax-free lump sum. Robert can make withdrawals as and when he wishes (subject to taking into account any income tax liabilities). Robert could always surrender a segment or segments, if capital in excess of the cumulative 5% allowance was required.
- Top-slicing can be used to reduce the effective rate of tax on a gain unless Robert is a higher rate tax payer at the time.
- A wide range of funds may be accessed, often with institutional discounts.
- An active investment strategy may be pursued if required since switching the underlying funds does not trigger a Capital Gains Tax (CGT) liability.
- It is possible to appoint a Discretionary Manager to oversee the underlying investments and make the necessary investment decisions on Robert’s behalf.
- When Robert gets older, he could assign his policy into a trust to benefit his son. The trust could be used to help mitigate any future UK Inheritance Tax liabilities.
Robert is impressed with the tax planning opportunities and the flexibility offered by the offshore bond. He particularly likes the idea of gross roll-up and TAR, and the way segments of the policy can be assigned to individuals who are 18 years of age or older. He believes this will be useful when his son starts university and requires financial assistance.
This case study should demonstrate how an offshore bond could be of benefit to an individual retirement and UK IHT planning.
Anyone living in outside the UK should also consider this as the best way to wrap up your assets before becoming tax resident back in the UK!
