When is £250,000 worth only £176,782?
The answer, unfortunately, is when you take it out of your pension fund. The headline announcement in last months Budget was that, from April next year, people aged 55 or more will be able to withdraw as much as they like, whenever they like, from their Personal Pension Plans and similar arrangements. However, the catch is that, while the time-honoured rule will remain, that a quarter of the fund may be taken as a tax free lump sum, anything more will be taxed as income of the year in which it is taken.
For example, suppose an individual has a pension fund of £250,000 and no income other than the National Insurance pension of (say) £6,000 a year. He or she might decide that a good plan would be to withdraw the whole fund, use £200,000 to purchase a buy-to-let property to provide an income for life and a worthwhile inheritance for the children, and keep £50,000 on deposit for contingencies. However, if the whole pension fund is withdrawn as a single lump sum, the income tax charged (at 2015/16 rates) will be £73,218, leaving the individual with only £176,782 of his or her original £250,000. This is because nearly two-thirds of the lump sum is taxed at 40% or even 45%.
Spreading the withdrawal over two tax years with the tax free lump sum taken in the first year, and the balance half in the first and half in the second would reduce the total tax paid to £58,686, largely because spreading means twice as much would be charged at the basic rate.
Looking at two smaller pension funds, a fund of £100,000 would suffer a tax charge of £21,843 if wholly withdrawn in one year, or £13,686 if withdrawn over two years, while a fund of £50,000 would suffer a charge of £6,483 or £5,700 (in all cases, assuming the only other income was the £6,000 pension).
The bottom line, perhaps, is that pension fund holders should think long and hard before taking a withdrawal which will suffer tax at more than the 20% basic rate. Very broadly speaking this means that, after taking a quarter of the pension fund as the tax free lump sum, further withdrawals plus pensions and any other income should not exceed about £42,000 in any tax year.
Another point to watch is that the tax charge on money withdrawn from a pension fund is likely to be even higher if the individual has substantial earnings or other income in the tax year he or she makes the withdrawal. If in our first example (of a £250,000 pension fund) the individual had earnings of £30,000 instead of the National Insurance pension of £6,000 (say, because he or she retired towards the end of the tax year and took the maximum withdrawal immediately), the tax charge on that withdrawal would be £80,118, reducing the after-tax sum available to £169,882.
One would hope that the pension provider will warn the investor if he or she applies for a withdrawal which is likely to trigger a significant tax liability. However, it is easy to see how cases might slip through the net, for example where the individual has invested in pension plans with several different providers and the overall scale of the proposed withdrawals is not appreciated.
Will temptation or prudence win the day?
It has been suggested that people reaching retirement age will not be able to resist the temptation to cash in their pensions and spend the proceeds on exotic sports cars and luxury cruises. However, we think there is a greater danger that the money will be frittered away on sensible things like helping sons and daughters to buy houses, or paying school fees for the grandchildren. People are going to have to make decisions, about how much they can sensibly afford to help their children and grandchildren, and how much they need to keep for their own old age. The trouble with having access to the money is that it will make it harder to say No.
Dont waste a valuable guarantee!
Hidden away in the small print of many older pension plans (especially those taken out before about 1990) is the option to take a pension calculated according to a set formula effectively a guarantee to pay a stated minimum pension. Originally, such guarantees were not particularly generous, but now that interest rates have fallen to historic lows, taking the guaranteed pension may well be a very attractive alternative. It will produce a far higher income than could be obtained by buying an annuity on the open market, and provide that income securely for life.
However, because the guaranteed pension is technically an option, it is up to the policyholder to claim it. Moreover, entitlement to the guaranteed pension is almost always conditional upon taking the pension at a fixed date usually the default retirement date specified by the policy. We would strongly advise anyone with a pension plan to see if it promises a guarantee and, if it does, to make a prominent reminder to self of the date by which it must be claimed. A lot of money could be at stake.
As stated in the first paragraph, withdraw as much as you like, when you like begins in April 2015. Until then, some of the existing rules are relaxed, to allow higher withdrawals under drawdown plans, and small pension savings to be taken as an immediate lump sum. Please contact us if you would like further detail on these changes.
Individual savings accounts
The Chancellor also announced that, with effect from 1 July 2014, the annual limit on ISA investments will rise to £15,000. At the same time, the scheme will be renamed the New ISA or NISA. Furthermore, from that date investments may be made in, or transferred between, Cash and Stocks and Shares NISAs in whatever proportions the investor chooses. For example, the whole £15,000 subscription for 2014/15 may be placed in a Cash NISA, or savings previously accumulated in a Stocks and Shares ISA may be transferred to a Cash NISA.
However, the rule will remain that an individual will be able to invest in only one Cash and one Stocks and Shares NISA each (tax) year, although it will also become possible to hold tax free cash deposits in a Stocks and Shares NISA. Existing ISAs will automatically become NISAs on 1 July 2014 and any ISA investments made since 6 April 2014 will count against the £15,000 annual maximum.
For many people, it is important to have the reassurance that they are covered by the Government Guarantee that their losses will be made good under the Financial Services Compensation Scheme, should a savings institution default. With the higher savings limit, and the increased ability to concentrate savings in a Cash NISA, they should now watch that their savings with any one institution (or group of linked institutions) do not exceed the compensation limits, which are £85,000 for cash deposits and £50,000 for investments.
Capital gains tax on houses
It has always been the rule that any profit a family makes on the sale of their main home (or principal private residence) is not liable to capital gains tax. That rule is not changing, but about a week after Budget Day it was announced that, from April 2015, people with two (or more) properties will no longer be able to choose which is to be treated as their principal private residence for capital gains tax purposes. Instead, it will have to be determined, as a matter of fact, which is the family’s main home. That might be simplified possibly at the cost of some rough justice by imposing a one-size-fits-all test, such as counting how many days were spent at each property. In any case, anyone with two properties will have to keep records to show which was the main home, otherwise (presumably) neither will qualify.
There is to be a public consultation, not on the principle of withdrawing an individuals right to choose which of two or more properties is his principal private residence, but on how the statutory test to identify his main home should be framed. There are likely to be some hard cases for example, that an individual who spends most of his time living in rented or employer-provided accommodation (so as to be near his work) may not be able to claim his weekend or holiday cottage as his principal private residence.
It is unlikely that the outcome of the consultation, and the final details of the changes, will be known before the autumn.
Capital allowances for machinery and vehicles
Annual Investment Allowances (AIAs) allow the whole cost of machinery and vehicles (other than cars) to be written off, for tax purposes, in the year of purchase. There is an annual ceiling on the maximum qualifying expenditure a business can incur, which bounces up and down like a yo-yo. It was originally set, in April 2008, at £50,000, but two years later in April 2010 it was doubled to £100,000. Three months after that, in the June 2010 Emergency Budget, the new coalition Government announced that it would be reduced to £25,000, but not until April 2012.
Nine months after the reduction to £25,000, in his December 2012 Autumn Statement, the Chancellor stated that the ceiling would be raised to £250,000, but only for the two calendar years 2013 and 2014. However, the real complexity is caused by the illogical rules for calculating the maximum allowable expenditure when the ceiling changes part way through the traders accounting year especially, when it is reduced. Time apportionments have to be made and, in the last edition of this newsletter, we pointed out that if, as then expected, the ceiling fell back to £25,000 in January 2015, a company with a 31 March accounting date would be limited to an Annual Investment Allowance of only £6,250 for asset purchases in the first three months of 2015.
However, in last months Budget the Chancellor changed his mind again, and said that the ceiling will be doubled to £500,000 for the 21 months April 2014 to December 2015, then reverting to £25,000 on 1 January 2016. Again, there will be transitional provisions, so where the accounting year began before April, the ceiling on qualifying expenditure will be less than £500,000, even if the assets are bought in May or later.
As a rule of thumb, asset purchases of up to £250,000 a year will not now be affected by the transitional rules, provided they are made in an accounting year which ends no later than 31 December 2015. However, the rules are so complex that we would strongly advise any business proposing a major purchase or programme of investment to discuss their plans with us before entering into any binding commitments.
Where family members work part-time in a family business, it is important to remember that worthwhile National Insurance pension rights can be accrued, at no cost, by paying them a salary just over, rather than just under, the Lower Earnings Limit. If you are already doing this, watch that the Lower Earnings Limit rises slightly each April this year from £109 to £111 a week (£473 to £481 a month) so you may need to increase wages accordingly. No employee or employer contributions are payable until earnings exceed £153 a week or £663 a month.
Pensions auto enrolment
Some clients have incorrectly assumed that their employees can opt out of auto enrolment.Â You may recall that this new scheme is gradually being introduced and larger employers should already have dealt with this. Smaller employers are being brought in to the system over the next couple of years. The new scheme works on the basis that all employees have to be enrolled initially before they can individually opt out. Thus it seems that all employers will need to deal with this aspect by the appropriate staging date which can be found for your individual employer using the link in the Useful websites lists towards the end of this newsletter. We should also stress that employers have a duty to take no action to induce or coerce any employee to give up pension membership or fail to take up pension membership.
If you require further information with regard to pension auto enrolment we suggest that you talk to your usual independent financial advisor, or we would be happy to put you in touch with one who is able to assist in this area, if you wish.
As you may be aware, Microsoft is no longer supporting its Microsoft XP operating system and if you have not already done so, it may be worth considering whether or not you should upgrade to a supported version. Concerns over the withdrawal of support have been raised, in particular whether operating systems will become more vulnerable to outside attack. It remains to be seen whether this will happen, however it may be worthwhile reviewing the position with your IT advisor.
We should also remind clients of the importance of implementing adequate backup procedures and these should be tested periodically to ensure that they do actually work.
One other hot debate in the area of IT is whether you should move your accounting software to an online solution or keep it solely installed on your own system with the periodic need for software upgrades. We think that there are advantages and disadvantages with both methods of working and again this is something that might merit further investigation. We have recently become a Sage One accounting software partner and if you would like more details of this online software please let us know.
Micro entity accounting exemptions
The Government have now introduced new exemptions applicable to micro entities in respect of the limited company accounts that are filed at Companies House. Having reviewed the disclosures under this new regime, we are of the opinion that there is no significant advantage in filing these accounts as opposed to the abbreviated accounts that may already be filed at Companies House for small companies. As the company shareholders and directors will still require full accounts to be produced, we would suggest that clients that wish to give less information to Companies House to place on public record use abbreviated accounts, if they are not already doing so. If you have any questions about your options, please contact us.
PAYE Real Time Information update
Employers will be aware of the introduction of Real Time Information reporting last April. Having endured the first twelve months of this new system, it is apparent that it does place additional burdens on payroll processing for employers compared to the old system, with only a relatively small saving in effort in relation to the year-end employers declaration. It is also apparent that HMRC are using the real time information to make sure employers pay over the right amount of PAYE and NI each month and to pursue this if they do not. One worrying side effect of the new system seems to have been that, either through a problem with the HMRC system or employer system, a number of clients have been incorrectly assumed to be working for employers they have left some time ago. This has caused a number of incorrect tax codes to be issued by HMRC recently. Although we do get copies of some client tax codes, HMRC do not send these to us automatically and, therefore, if you have recently received a tax code that seems to be incorrect and we have not already contacted you about this, please let us know.
Inheritance tax and wills
With the inheritance tax exempt limit being frozen for some considerable time it is likely that more estates in future will be subject to inheritance tax. If you are concerned about the 40% inheritance tax charge that may apply to part of your estate after death and would like to review possible means of reducing this, please contact us as soon as possible. It is also important to ensure that your Will is kept up to date, and if you have not made one, then you should consider doing so.
HMRC’s second income campaign
We have previously mentioned disclosure facilities offered by HMRC, giving taxpayers who have undeclared income the opportunity to bring their tax affairs up to date with a lower penalty than if HMRC had discovered the failure to disclose themselves. The latest campaign has recently been announced relating to individuals who are employed but have additional income that is not taxed. The examples they have given of this secondary income include: consultancy fees, training or public speaking fees, payments for providing entertainment or organising parties, taxi driving, hairdressing, fitness training, landscape gardening, making and selling craft items and buying and selling goods, for example car boot sales or market stalls.
Hopefully any clients with such sources of income will already have included these on their tax returns, however if there are potential sources of taxable income that have been missed, please contact us as soon as possible as these disclosure facilities have a limited period of duration. If there are individuals you know who need to deal with this aspect of their tax affairs, of course, we shall be more than happy to help.
Where an employer provides a company car, but the employee pays for the fuel, the employer may pay a mileage allowance for business journeys. HMRC accepts that payments not exceeding the advisory fuel rates are reimbursements of expenses, not subject to income tax or Class 1 National Insurance contributions.
The advisory fuel rates (AFRs) are now reviewed quarterly and the AFRs for journeys taking place on or after 1 March 2014 are as follows (old rates in italics):
Fuel rates – from 1 March 2014
These rates may be used to reclaim input VAT in respect of fuel used for business journeys (remembering that VAT receipts to cover the amount claimed are required).These rates are scheduled to change quarterly and the current rates can be found at http://www.hmrc.gov.uk/cars/advisory_fuel_current.htm