TT7: Discover a tax-free bonanza

There’s gold in them there schemes

No, we are not suggesting that you should go out prospecting for gold or trying to find treasure buried by pirates, although if you need a hobby, why not! In this Issue of Topical Tips, we highlight an important planning point regarding pension schemes which amazingly is seldom reported.It is maximising the tax-free cash that can be taken from a company pension scheme – if you joined the right kind of scheme at the right time the opportunities are quite startling .

The rules regarding pension schemes have been subject to substantial changes over the last 15 years and continue to be so. In particular, big changes took place in the late 1980s and needless to say, the changes were designed to close perceived loopholes. However, the old rules still apply to people who were in pension schemes prior to the relevant changes. An important date is 17 March 1987 – if you were a member of a company pension scheme before that time you could be very lucky, especially if you are in a position to control the company and the scheme.

Unlimited tax-free cash??!!
Subject to complex rules regarding early retirement and length of service, a pre 1987 pension scheme member can take tax- free cash from the pension scheme of one and a half times final salary (as defined) and there is no limit on the level of the final salary.

Also, there is no requirement for the tax-free cash to be commensurate with the pension taken. This means that if the final salary is sufficiently high, the whole of the pension fund can be taken as tax-free cash and none of the fund need be used to provide a pension (which would be subject to income tax).

These rules are far more generous than current rules under which final salary cannot exceed the so – called earnings cap of £95,400, and under which the whole fund cannot normally be taken as tax-free cash.

For company directors who are 20% share holders in their companies, final salary usually means the average of the best 3 consecutive years in the 13 leading up to retirement. Clearly this gives scope for concentrating income into three consecutive years with a view to maximising the amount of final salary and, therefore, the amount of the available tax- f ree cash .

A further point should be borne in mind. It is that of ten, pension schemes that have been created after 17 March 1987 have been piggy-backed onto an earlier scheme so that the old rules continue to apply. It is, therefore, important that the whole history of a companys pension arrangements are known before any action (or inaction) is taken in this regard.

Barnes Roffe Topical Tips

  • This is a most valuable planning strategy for individuals who are within the last 13 years before retirement (especially in view of the fact that pension annuity rates are currently so low).
  • All such individuals must check to see whether they continue to be covered by the pre 17 March 1987 rules.
  • Suitable planning should be undertaken to try to make “final salary” roughly two-thirds of the likely value of the pension fund at retirement.
  • Beware of serious pitfalls associated with early retirement – the available tax-free cash can be significantly reduced and the Inland Revenue might even try to tax it!
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