Creative Pension Planning – How can one mitigate investment losses and boost retirement using creative planning

We’re living in extraordinary times: the value of investments in all four main asset groups – equities, bonds, property and cash – have all dropped simultaneously. This was not supposed to happen. It has, so economists need to re-evaluate their rule books. Meanwhile, back in the real world, we need to provide strategies to cope with the devastating loss of value of pension funds.

If you are close to retirement, you may be concerned as a loss of value of your pension fund will mean that you may have to suffer a loss of income, (unless you are in the fortunate financial position of either boosting your pension contributions, or delay the date for taking any benefits from your pension).

However if you are young, you may want to sit on your investments and wait for the upturn.

It’s not just investments in pension funds that have fallen, so have investments held in general investment accounts and ISAs.

I wonder though, if you do have personal investments that have taken a hit AND you need to boost your overall level of pension funds, if there is anything you can do to mitigate your loss?

Example 1

Barry, aged 56, is a higher-rate taxpayer with earnings of £250,000. His portfolio of quoted shares stands at £150,000, which is way below the base cost of the shares of £210,000. Barry decides to cut his losses and sell his entire portfolio, reinvesting the proceeds of £150,000 in his self-invested pension plan (SIPP). Since Barry is already over the retirement age for this pension scheme (55), he can take a 25% cash draw-down from the fund as soon as the Trustees have received the tax rebate from HMRC.

As Barry has not made any pension contributions for many years, he is allowed to roll up any unused contributions to a maximum of £50,000 gross, and can carry forward for three years only, i.e. three unused years plus current year.

The £150,000 will be treated as a net pension contribution. HMRC will add £37,500 to this and so the total gross contribution will be £187,500.

Barry gains in a number of ways from this transaction:-

By taking action now, before any uplift of values in his investment portfolio (when the market recovers), he is potentially saving on future Capital Gains Tax that may have been levied on his investment portfolio.

As well as the £37,500 tax relief gain on the net amount contributed to his pension fund, he will be able to claim a similar amount of relief against his earnings, so his Personal Tax Liability will be reduced by a further £37,500.

Alternative method

Barry sold his Share Portfolio and invested the cash proceeds in his SIPP; but the same effect can be obtained if Barry transfers his quoted shares into the SIPP as an in-specie contribution, (although not all SIPP providers will allow in-specie contributions). The SIPP provider must agree to receive the Shares in satisfaction of a promised contribution from the individual, and may require an independent valuation of the Shares where there is no obvious Market Value. The advantage of transferring the Shares themselves to the Pension Fund, is that Barry effectively retains control of those investments, but any future increase in the value of those shares, is protected from Capital Gains Tax.

Small company director

Barry is fortunate to have a high level of relevant earnings, but many small company share-holder/directors extract most of their income from their company’s dividends which do not qualify as Relevant Earnings. The level of pension contributions they can make personally in any tax year is thus limited by the level of their Gross earnings, once the minimum threshold of £3,600 is exceeded.

This problem can be circumvented by the employing company making the pension contributions on the Director’s behalf. [The link between pension contributions made by a company and earnings was broken in 2006].

Example 2

Adrian draws a regular salary of £25,000 plus dividends of £40,000 (gross) from his company Fine City Ltd, which has a 31 December year end. Adrian’s investments have suffered in the downturn, so he decides to cash-in his Corporate Bonds generating proceeds of £140,000.

Adrian’s relevant earnings for the year are just £25,000, which gives him scope to contribute £20,000 (net) to his SIPP. This contribution has the potential to reduce his taxable earnings for this year to within the basic rate band. He therefore has paid Net Tax so the SIPP will reclaim the tax relief of £3,750, and add this to his contribution. Adrian lends the balance of the proceeds of £50,000 to his company, which will be treated as a positive balance on his Directors’ Loan Account.

Fine City Ltd uses the cash from Adrian to make an employer’s pension contribution of £60,000 both before and after company year end. As long as Fine City Ltd has regular taxable profits of at least £60,000 each trading year, it will receive Corporation Tax relief for the pension contributions.

If HMRC query the payment, the company will need to show that Adrian’s total remuneration package for each year is not excessive in relation to the work he undertakes for the company, as described in the HMRC Business Income Manual at para. BIM 46035.

When Fine City Ltd has sufficient cash to repay Adrian’s loan account he can withdraw the balance of £120,000 from his Director’s Loan Account tax free.

The no-cash solution

Many companies do not have large cash reserves, but they may hold other assets, such as commercial property, that could be transferred into the pension fund as an in-specie contribution. Take care, as registered pension funds may face penalties if they hold residential property or tangible movable property as part of their investments, if so, making a transfer in-specie may not be an option.

Example 3

Mary Loo and Andy Pandy are the Directors and Shareholders of Toybox Ltd, which owns a commercial property worth £400,000. The company has agreed to pay contributions to a registered pension fund totalling £400,000 on behalf of Mary and Andy.

This contribution promise is satisfied by the transfer of the commercial property at its Market Value. This example illustrates again, the possibility of making large pension contributions (taking advantage of the roll-up of missed contributions over previous years).

The total value of the transaction is deemed to satisfy the promise to make two contributions of £200,000 each for Mary and Andy, which is within the rules (providing no pension payments have been made for several years).

As long as the Directors’ total remuneration packages, including the value of the pension contributions, are reasonable compared with the value of work those Directors do for the company, the employer can offset the payments against their Corporation Tax liability.

Please note that, once the commercial property has been paid into the pension scheme, the business would have to then complete a Lease Agreement with the SIPP Trustees for their Tenancy within the property. Rental payments at a ‘fair market rate’ would thereafter be paid into the pension scheme by the Company.

According to HMRC, http://www.hmrc.gov.uk/ct/forms-rates/claims/losses.htm#2 a trading loss can be carried back subject to certain conditions.

Toybox Ltd arranges for an independent valuation of the property to be carried out, and the transfer of the property is completed. The pension fund must pay Stamp Duty Land Tax on completion of the contract. The pension fund takes ownership of the property within the pension input period, for which sufficient Annual Allowance is available.

The Capital Gain or Loss, that Toybox Ltd made on the disposal of the commercial property is calculated based on the exchange date for the unconditional contract for the property transfer, not on the completion date.

Companies can still deduct from the gain, an indexation allowance based on the acquisition cost of the property, or on the market value at 31 March 1982 if the property was acquired before that date and a re-basing election has been made. The indexation allowance cannot turn a gain into a loss. The result in that case is a ‘Nil gain’.

Where the value of the property is so depressed that it produces a Capital Loss, that loss may only be set against Capital Gains arising in the same accounting period or carried forward to set against gains in subsequent accounting periods. A Capital Loss a trading company makes, cannot be carried back or surrendered to other Group companies. A Capital Gain a company makes is subject to Corporation Tax at the same rate as the Trading Profits for the period.

Other assets to be considered

Since 6 April 2006 there is only one set of rules governing the permitted investments for all registered pension schemes, although there are some restrictions for SIPP and SSAS schemes (see below). In brief, the following types of investment may be transferred as in-specie contributions into a pension fund:

  • commercial property in the UK or located overseas;
  • hotels, guest houses and nursing homes;
  • riding stables and golf courses; forestry, woodland and agricultural land;
  • non-income producing land;
  • shares in unrelated companies, including:
    – VCT shares
    – EIS shares
    – shares acquired from Employee Share Schemes
    – shares in Real Estate Investment Trusts (REITS).

Shares held as investments do not have to be quoted shares, but unquoted shares must be valued on a ‘fair market value’ basis before transfer. An SSAS can hold up to 5% of its fund value in shares of the sponsoring employer or an associated company, or up to 20% of the fund where the shares relate to more than one sponsoring employer. However, beware of the trap that may be set by a SIPP holding up to 100% of its fund in the shares of the scheme members’ employer, but not where that company has established a trust to run the SIPP – that would make the pension scheme an occupational scheme.

Conclusion

The examples demonstrate the possibilities for mitigating losses on investments, a note of caution is required before you embark on such an exercise. Always take professional advice and if this is an idea that may suit your circumstances consult a Pension Planning expert for comprehensive Financial Planning advice before you proceed.

Ray Best can help you protect your financial future. To find out more, simply click here!

About Ray L Best

Ray Best has had over 30 years experience of advising on complex financial matters. A published author of a number of books including “Partnership and Shareholder Protection”, Inheritance Tax Simplified”. We provide an initial meeting at no cost and only engage with clients when we can add significant value.

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