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July 2024 Newsletter

Rachel Reeves’s first speech as Chancellor focused heavily on housing targets, planning reform and investigating the ‘spending inheritance’, the results of which may well shape the next Budget due in the Autumn – will she use these as a means to justify some large tax hikes?

In the meantime, this newsletter covers the cost of matching the state pension, how company directors can extract profits as tax efficiently as possible and we look at pension lump sum recycling, which is often misunderstood and can lead to an unexpected and costly tax charge.

In this issue:-

The ‘£287,560’ Cost of Matching the State Pension
The Tricky Business of Profit Extraction
Pension Lump Sum Recycling
30 Years of Premium Bonds £1 Million Jackpots
JJFS News

We hope you enjoy the articles and find them useful.

PLEASE NOTE:

These articles do not constitute any form of personal advice or recommendation and are not intended to be relied upon in making (or refraining from making) any investment or financial planning decisions.

The ‘£287,560’ Cost of Matching the State Pension

During the election campaign, the Labour Party pledged to keep the pension ‘Triple Lock’ so the State Pension is set to continue to increase by the highest of either inflation, wage rises or 2.5%. The policy has seen the State Pension rise rapidly in recent years – from £185.15 a week in 2022/23 to £221.20 today, a rise of more than 19% in two years. That was thanks first to sky-rocketing inflation, and then surging wages.

The Personal Allowance currently stands at £12,570 a year, meaning that the whole of the typical current State Pension – worth £11,502.40 a year – falls within the Personal Allowance and can therefore be received without tax being due. Note: there are some exceptions where the amount can exceed the Personal Allowance as there are variables which can increase the “maximum” total.

However the Personal Allowance is due to be frozen under current plans until April 2028. According to The Resolution Foundation, estimated rises in the State Pension would mean that the payment would exceed the Personal Allowance by 2028, meaning some of it is taxed¹.

Putting a value on the State Pension – how much is it worth?

So, with the State Pension due to rise by the Triple Lock over the life of this parliament, this adds to its importance to the finances of retirees – and it is already very important as it’s extremely valuable income – and very expensive to replace.

How expensive? According to the latest market prices, the rate paid on an annuity right now to a healthy 65-year-old is around 5.148%². That’s with income payments escalating by 3% a year. On the basis of that rate, it would require £223,434³ of pension savings to replace the current full State Pension (available to those retiring after 5 April 2016) of £220.20 a week.

The reason it costs so much to replace is that the State Pension is, of course, both guaranteed and protected against inflation – two things that are precious and difficult to replicate any other way.

Drawdown is obviously another way to generate an income from retirement savings. If you assume withdrawing 4% a year from a drawdown pot provides a good chance that the savings pot will last for 30 years, then someone would need £287,560⁴ of pension savings in drawdown to recreate State Pension income – more than an annuity and without the guarantee that income will last until they die, but with the benefit that the money remains theirs.

Why the State Pension is so valuable

How to get there

Saving those sorts of sums can be a challenge – but the job is made easier if you start early. For example, someone aged 30 and saving until their projected state pension age of 68 would have to set aside about £225 a month into a pension, assuming 5% investment growth after all fees, in order to achieve a pot worth the £287,560 needed to recreate an income to match the current State Pension. However, the State Pension in the future is very likely to be significantly more than it is today in cash terms, so to truly match it with a pension would require significantly more.

Source:
¹Resolution Foundation, 29.5.24

² Sharing Pensions.co.uk, 22.5.24

³(£11,502.40 / 5.148) x 100 = £223,434.34

For more information please get in touch with your usual JJFS contact or email us on justask@jjfsltd.com.

The Tricky Business of Profit Extraction

Owners of SME companies need to ensure the most tax-efficient way of taking profits from their business for day to day living, and the dividend route has been favoured by many in recent years. However there has always been a strong argument in favour of pension contributions. In part, this is because dividends are paid after corporation tax, whereas an employer pension payment is an allowable deduction from profits before corporation tax. Given the main rate of corporation tax has risen to 25%, the pension option becomes even more compelling.

This advantage can be exploited further as the annual allowance has increased to £60,000 and tapering does not kick in until you have income of £260,000. If tapering does apply the minimum annual allowance is £10,000, up from £4,000. And of course there is no longer the need to worry about a lifetime allowance charge on amounts saved.

Ultimately, the decision will largely be based on the income levels required and the actual rate of corporation tax.

In reality, many business owners may pay themselves a mixture of both salary and dividend. But what about profits in excess of their living needs?

Due consideration should be given to a pension contribution. It is an allowable deduction from profits subject to corporation tax, just like salary or bonus, but unlike salary or bonus there’s no employer or employee NI liability – just like dividends.

And for those who do need access to maintain normal living standards, a modern flexible pension will allow directors over 55 access as easily as salary or dividends. With 25% of the pension pot normally available tax free, it can be very tax efficient – especially if the income from the balance can be taken within the basic rate. However taking drawdown income will trigger the MPAA, potentially restricting future saving options.

Wealth transfer

Thinking ahead to family wealth transfer the full pension fund will normally be paid tax free on death before 75, and at the beneficiary’s marginal rate of income tax for amounts taken where the member died after age 75. In addition, the pension wrapper offers protection from IHT as well as tax on the income and gains on investments

Benefits of making an employer pension contribution:

Avoid AA tapering – bonus and dividends count towards the £200,000 threshold income, but employer contributions normally don’t.

Deliver more tax efficient income – so that profits which may otherwise be taken as bonus or dividend don’t boost income to the point where the personal allowance is lost, or the child benefit tax charge applied.

Create a tax efficient legacy – pensions typically don’t form part of the estate for IHT.

Get in shape for retirement – to maximise tax efficient funding in the run up to retirement especially if you start to draw pension income, at which point any future funding will be restricted to the money purchase annual allowance of £10,000 and unused carry forward allowances lost.

For more information please get in touch with your usual JJFS contact or email us on justask@jjfsltd.com.

Pension Lump Sum Recycling

We regularly receive questions from clients about using their tax free lump sum to fund further pension contributions and boost pension benefits in the future.

However, using your tax free lump sum in this way is essentially generating tax relief on monies that have already benefitted from tax relief and is regarded as ‘recycling’ by HMRC.

There are 6 key factors that the Revenue will use to determine whether the recycling rules apply and if so, will levy a tax charge of 40-55% of the lump sum taken.

The individual receives a pension lump sum.
Because of the lump sum, the level of contributions paid into a registered pension scheme is significantly greater than it otherwise would be.
The additional contributions are made by the individual or by someone else, such as an employer.
The recycling was pre-planned.
The amount of the lump sum, together with any other lump sums taken in the previous 12-month period, exceeds £7,500 for events on or after 6 April 2015, or 1% of the standard lifetime allowance for events before 6 April 2015.
The cumulative amount of the additional contributions exceeds 30% of the pension lump sum.

Find out more about this in our factsheet which includes two examples and a flow chart ‘decision tree’ illustrating the potential of falling within the HMRC rules on ‘recycling’.

Note: the examples and decision tree are for information and illustrative purposes only and we strongly recommend taking professional advice.

For more information please get in touch with your usual JJFS contact or email us on justask@jjfsltd.com.

30 Years of Premium Bonds £1 Million Jackpots

Did you know:

the first £1 million jackpot was awarded 30 years ago in 1994
Since then, 528 people have won the £1 million jackpot
Over £30 billion has been won by Premium Bonds holders since the first prize draw in 1957

The first £1 million jackpot was awarded in April 1994, to a Premium Bonds holder from Surrey. Since then, Agent Million has travelled around 222,000 miles to deliver the good news to 528 bond holders, with the youngest winner being just three-years old and the oldest being 98-years old.

You don’t necessarily need a large holding to win the jackpot – in July 2004, £1 million was won by someone in Newham who held £17, the lowest holding to ever win the jackpot. They had purchased their Bonds in February 1959 and this is also the longest time before winning the jackpot.

More than ten Bond holders have won after just two months, the shortest time between investing in Premium Bonds and winning the £1 million jackpot.

For the very first Premium Bonds draw in 1957, the jackpot was £1,000. The first £1 million jackpot was in April 1994 and in August 2005, this increased to two jackpots until April 2009 when it went back to one. It increased to two again in August 2014.

There are five NS&I ‘Agent Millions’ who deliver the good news to winners and they derive as much pleasure and satisfaction delivering the news as the winners do receiving the news.

JJFS News

As some of you may already be aware, Simon has been leading the pack in terms of sport and fitness in the office. Being a keen runner and cycling enthusiast, he has taken part in numerous races over the years and provided us with much newsletter fodder and amusement / amazement.

More recently, in an attempt to maintain some level of fitness amongst the rest of the team, he managed to persuade us all to join a local gym only 2 doors away from our office – so we couldn’t use distance as an excuse. Attending 2 x 30 minute sessions each week of resistance training and stretches, we do feel it is beneficial taking an active break from our sedentary desk jobs and great for productivity and focus. Unfortunately we are unable to provide any photographic evidence of this initiative as it was unanimously agreed that the JJFS Lycra Mob is not for the faint hearted and you will just have to take our word for it!