How can hard working entrepreneurs navigate the pension puzzle?

Pensions for entrepreneurs
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We all know that a good level of regular income will be important in the future to preserve our standard of living as we age, but how best to plan for this income? With the levels of investment capital required to generate a reasonable amount of interest income being extortionate, many entrepreneurs turn to investment in pension funds and residential property to provide income in the future.

Some aspects of pensions have improved a great deal in recent years, notably the government has removed the requirement to purchase an annuity at age 75, thus providing much more flexibility over the way pensions can be taken. However, along with this improved flexibility new tax relief restrictions have been put in place; currently, the total value of assets that a taxpayer can hold in a pension and still qualify for tax relief is £1m and any pension drawdown that exceeds this limit will be subject to a tax charge of 25% if paid as pension or 55% if paid as a lump sum.

Tax relief on pensions

In addition, tax relief on pension contributions has reduced, in the form of a reduction to the pension ‘annual allowance’. If you are a UK taxpayer, you can now receive higher rate tax relief on pension contributions of up to 100% of your earnings or a £40,000 annual allowance, whichever is lower.

For those who earn more than £150,000, this annual allowance will be restricted on a tapering basis, which starts when total income exceeds £150,000. The income test for this taper to apply includes unearned income, as well as earnings, and the taper progressively reduces the maximum pension contributions which attract tax relief down to £10,000 for those earning over £210,000. For those with a total income of more than £210,000, the cut in the annual allowance from £40,000 to £10,000 means a loss of 45% tax relief on a £30,000 contribution – a cost of £13,500.

For the hardworking, risk taking entrepreneur the situation when it comes to retirement planning is anything but fair.

So, whilst pension contributions can be attractive because they receive tax relief, this relief is curtailed and is minimal if you are a higher earner. In addition, the level of income which will be provided by a maximum £1m pension pot may not be sufficient in retirement.

It’s unsurprising then that so many entrepreneurs have turned to residential property as an alternative to a traditional pension for their retirement income. For a long time property was a good bet, but in recent years it has become more heavily taxed too.

Dwindling attractiveness of residential property

Now, anyone who buys an additional investment property or who already owns a second property and purchases a new one must pay a 3% stamp duty surcharge. We had hoped this additional stamp duty charge would be removed in the recent Autumn Statement, but it remains in place for the foreseeable future. 

In addition, tax relief on mortgage interest payments is about to be reduced. This reduction starts to become effective in April 2017 for the 2017–2018 tax year and is being introduced over a four-year period as follows:

  • 2017-18 – 75% of interest paid will receive higher rate relief, 25% will receive basic rate relief
  • 2018-19 – 50% of interest paid will receive higher rate relief, 50% will receive basic rate relief
  • 2019-20 – 25% of interest paid will receive higher rate relief, 75% will receive basic rate relief
  • 2020-21 onwards – all interest will receive only basic rate tax relief

There’s more. April 2016 also saw the removal of the original wear and tear allowance for landlords renting furnished properties. It is now only possible to claim tax relief on renewals when replacement furnishings are purchased.  And, as if these weren’t enough to deter anyone from using residential property as a pension pot, anyone who has decided they’ve had enough and wishes to get out of the rental property market also faces a higher capital gains tax bill.

Whilst other investments now attract a reduced rate of 20% capital gains tax, the rate remains at 28% for residential property gains (for higher rate tax payers). For the hardworking, risk-taking entrepreneur the situation when it comes to retirement planning is anything but fair. It takes a lot of capital to generate a decent standard of living and the government has effectively removed all the tax advantages of any low-risk investments.

What next for risk-taking entrepreneurs?

So, how can entrepreneurs save enough to provide for a comfortable level of income on retirement? There is no easy answer to this question, there are many pros and cons to consider with every option and the solution must be not to rely on tax reliefs to get there!

Lesley Stalker
Tax Partner
RJP LLP
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