To shamelessly misquote the old proverb (the one about planting trees):
“The very best time to have “planted” contributions into your pension scheme was 20 years ago. The second-best time … is right now.”
I dare say that we all know of director clients who have spent their working lifetime building a successful, profitable business, focusing all their efforts on just that, whilst confidently anticipating that there will be time enough to fund their pension provision when they get closer to retirement….
That was a sound enough plan if it was formulated, say, back in 2010 when the potential for pension contributions stood at £255,000 per year - no ifs, no buts - and when the Annual Allowance had been increasing every year since inception by a government desperate for people to embrace the exciting post A-Day world.
Jump forward to 2022 and the picture looks altogether different, though. Not only has the Annual Allowance been regularly and significantly reduced to its present £40,000 but not every client is entitled to benefit even from that much more modest amount.
The introduction of the Tapered Annual Allowance from 6 April 2016 didn’t lead to many headlines outside of the pension industry but it, more than any other introduced mechanism, has scuppered those successful Directors with plans to put large sums into pension provision later on in life.
If they have successful companies from which they are taking decent drawings, that is.
A Defined Benefit SSAS (DB SSAS) can allow, dependent on the client’s income level, a financial adviser (and their accountant) to reduce or even remove completely the impact of the tapering rule.
The Dry Bit….
The Tapered Annual Allowance, introduced in the tax year 2016/17, further restricts the potential for pension contributions for those clients who earn in total (e.g., salary, dividends, bonus) more than a certain amount. In doing so, it gives us two new terms to contend with – Threshold and Adjusted Income.
Since 6 April 2021, if anyone earns in total £200,000 or less (the Threshold Income line in the sand) then, happy days, they have £40,000 of Annual Allowance to play with (assuming that they are not a victim of the Money Purchase Allowance, another sneaky beast for a different conversation).
If, however, their Threshold Income is over £200,000 then the value of any contributions paid on their behalf by their company has to be added to the total and if all of that lot together (the Adjusted Income) produces a number over £240,000, then the £40,000 Annual Allowance starts to reduce on a £1 for £2 basis. This reduction continues until it bottoms out at £4,000 (for those lucky enough to have earnings of £312,000 or more).
The important word in the section above comes towards the start of the final paragraph – “value”.
It is the value of the employer pension contribution that needs to be added to the total earnings of someone whose Threshold Income is over £200,000 to determine the effect, if any, of tapering. In a Money Purchase environment, this value is the pounds and pence contribution amount but for a DB scheme, such as our DB SSAS, it is instead sixteen times the target pension created actuarially by the contribution, regardless of the cost to the employer of providing that target pension.
Let’s look at an example:
Let’s assume that the client’s Threshold Income is just over the all-important £200,000 – let’s say £220,000. His company would ideally like to contribute £100,000 for him to a pension scheme but that level of contribution to a money purchase arrangement would take his Adjusted Income (including the employer pension contribution) to £320,000 so his Annual Allowance would reduce to just £4,000.
In practical terms, it would make a contribution of that level from the company prohibitively expensive from the member’s income tax perspective.
Instead, if the same £100,000 employer contribution went to a DB SSAS, it might actuarially produce a target pension for the member of around £1,500pa or so and it would be sixteen times the target pension that would need to be added to the earnings to determine the effect, if any, of the tapering. In this case, sixteen times £1,500 equals £24,000 which when added to the £220,000 gives an Adjusted Income of £244,000 which is only just over the £240,000 point at which the Annual Allowance starts to reduce. The £40,000 would be reduced by just £2,000 leaving more than enough headroom for the contribution to proceed.
It should be noted that pension and tax rules can change meaning that the allowable contribution can change as well.
So, returning to our misused proverb, if your company Director clients are looking to plant now for their future retirement, a DB SSAS provides substantial tax efficient benefits that could be worth exploring.
DB SSAS should be viewed as a long-term commitment. Any activity that might seem to undermine this risks tax consequences – for example, making contributions only for a short term, and then transferring out soon after set-up, could lead to penalties.
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