Yellowtail Blog

Dennis appeared on CNBC to discuss the benefits of offshore savings and investments.

Watch the video on the CNBC website.

The only conclusion that I can draw from the proposed change to pension tax relief for high earners, is that it kills pension planning stone dead. The likelihood is that after paying a top marginal rate of 50% on their earnings, most will be paying 40% on their retirement income, yet tax relief on pension contributions will be restricted to 20%. This hardly seems equitable given that pensions generally only defer taxation. The tax pendulum has now swung so far in the government’s favour high earners need to find other retirement funding strategies.

So what do these proposals actually mean, let me take a look in detail. From April 6th 2011 the Government intends that individuals whose income is £150,000 or more will no longer receive tax relief at their full marginal rate of tax (currently 40%) on pension savings/contributions. Of course, as with the pension simplification exercise, it’s far from straightforward.

It has been outlined that the relief is to be reduced by a tapering mechanism so that those earning more than £180,000 receive relief at the basic rate only (currently 20%). This doesn’t only apply to personal contributions, as the budget papers refer to Pension Savings, which includes pension contributions (employer or employee) to money purchase arrangements, as well accrual of final salary benefits. Although the budget talked about the introduction of the reduced rate of tax relief taking effect from April 2011, in a surprise move the chancellor announced measures designed to pre-empt the reduction in tax relief.

Restricting relief before 2011

Legislation is being introduced designed to undo any tax reliefs that would be received by high earners trying to accelerate their pension contributions (or final salary benefits) prior to 2011. These restrictions are effective immediately – i.e. from 22nd April 2009.

High earners who have already made (or expect to make) contributions greater than £20,000 in the 2009/10 tax year, need to act quickly to avoid incurring a tax charge as a result of this “anti-forestalling” legislation. This is especially important if contributions have historically been made at irregular intervals.

With immediate effect the budget introduced a new “special annual allowance” of £20,000 maximum. For high earners, tax relief on pension savings above this allowance will only be at the basic rate of tax. The Revenue will recover any tax relief given at a higher rate than basic rate through a “special annual allowance charge” via self-assessment tax returns.

The special annual allowance charge will apply only if an individual:

• has “relevant income” greater than £150,000 in the tax year of the savings or the previous two (so for savings assessed for 2009/10, any tax year from 2007/08);

and

• the individual increases the level of their pension savings beyond their normal regular ongoing pension savings.

This means that an individual who is earning (or has earned) more than £150,000 yet simply maintains their level of regular pension savings as it currently stands should not be affected by the anti-forestalling legislation.

Pension savings greater than the normal regular ongoing pension savings made between 6th April 2009 and 21st April 2009 are not subject to the special annual allowance charge but will reduce the special annual allowance available in 2009/10.

Further clarification

“Relevant income” is defined as total income for the tax year less any normal deductions for reliefs (including pension contributions up to £20,000). Importantly, any salary sacrifice in respect of pension contributions or benefits must be added back to the income figure if the agreement took place on or after 22nd April 2009.

“Normal regular ongoing pension savings” for money purchase arrangements it refers to the level of payments that have been made before 22nd April 2009 which are at least quarterly; and for a final salary arrangement, it includes all benefits provided they are calculated under scheme rules that do not change on or after 22nd April 2009.

Calculating Pension Savings For the special annual allowance the basis of calculating the value of pension savings is similar to the existing Annual Allowance calculation. Brief this means that for money purchase arrangements, the value is the total contributions made in relation to that individual, including any from the employer, in the tax year;

And for final salary arrangements this means the increase in accrued rights over the tax year multiplied by 10. If an individual triggers the special annual allowance charge, the law will allow (subject to the pension scheme’s own rules) the member to unwind the pension savings that gave rise to it.

Note: This is a very short summary that aims to cover the broad implications of the budget proposals. The technical notes run to approximately 100 pages and we have barely covered the basics.

The big hurrah that greeted Alistair Darling’s increase to ISA limits is worth just £10.40 for those saving in a cash ISA, and even less if you’re a basic rate tax payer.  So the widely reported big incentive to encourage savings turns out to be marketing over substance – for now that is.

He (the chancellor) announced that the limit on ISA savings will be raised to £10,200, for the over 50s in the current 2009/10 tax year and for everyone else from April 2010.  But buried in the fine print was the news that the increased limit won’t be available until 6 October for the over 50s.  In keeping with the existing ISA rules half of the annual allowance can be invested in cash or the entire amount in Stocks & Shares based ISA.

So, what does it actually boil down to? Well the best ISA rates we could find right now will pay 3.5% interest, whether they are still paying that in October is another matter, but let’s press on.  The additional £1,500 invested in an ISA from October 6th would generate interest of £26.02 in the current tax year.   For a 40% tax payer the tax saving is a mere £10.40

Of course it’s better than nothing, yet the amount of newspaper column inches given over to a £10.40 tax saving this year is disproportionate to the size of the tax benefit.   Yet, if as we predict interest rates and inflation begin to rise, the tax benefits will become substantially higher in the coming years.

I was having lunch with Nick the Stick, so called on account the walking stick he uses to get around. Nick has a wicked sense of humour and refers to himself as a Raspberry Ripple, (if you understand cockney rhyming slang you’ll know why) recently he has taken to using the term impaired life after I mentioned it in a letter about annuity rates.

It was our regular half yearly visit to Lemonia in Primrose Hill, a family run Greek Cypriot restaurant: it’s Nick’s favourite, he celebrates everything with lunch at Lemonia. Last year was his 65th birthday; to commemorate I gave him a gold watch for his retirement. It was symbolic really as Nick hasn’t worked since breaking his neck some twenty years ago.

The unsung hero is the accountant who pushed Nick into making substantial pension contributions when he was working. The accountant has long since retired so for the past few years I have been advising Nick about his pension. I became involved following the collapse of the dotcom boom; with retirement looming large Nick was worried, and so was I.

His pension was invested in the With Profits fund, a misnomer if ever there was because despite the preceding dotcom boom the fund had hardly grown. Things didn’t look good for the With Profits fund so I set about restructuring his portfolio to provide some diversity. I wanted to capture growth but also introduce some security.

A reasonable chunk of the fund went into shares and property, and the fund grew significantly from 2003 onwards. But with retirement looming, and an eye on the bubble that was beginning to form, we gradually took profits and moved more into cash and government bonds. Nick said I was being too cautious; after the euphoria of annual double digit growth the investments looked boring.  “Don’t be greedy Nick” I said, “the fund is now large enough to give you the income you want, let’s not push our luck”.

Back to the Lemonia, we were well into our second bottle of wine, and Nick was looking back at the decisions we had taken. “Do you know” said Nick, “I think boring is the new exciting – Cheers!”