Covid-19 update: The significant changes to the taxation of pension death benefits in 2015 offer timely and tax-efficient ways to hand down pension assets from one generation to another, particularly where the pension arrangement is a trust-based one, such as a SSAS.
Using pension savings to purchase a commercial property to “leaseback” to a company is often a useful way to provide that company with a welcome cash injection. Rental income and capital gains are then tax-free in the hands of the scheme trustees and the scheme’s assets are generally outside of the member’s estate for Inheritance Tax purposes. However, generational planning involving business premises can be an administrative burden and costly. A Small Self-Administered Scheme (SSAS) is often a solution to achieve this over time.
If the premises are held within a SSAS, company contributions made on behalf of its junior directors can be used to fund retirement (and ultimately death) benefits for the senior directors. In the meantime, the ownership of the property shifts accordingly one brick at a time.
Take a SSAS with two members, husband and wife, and a net asset value of £800k as at April 2018. Aside from a small amount of cash, the sole asset is an £800k property, which is leased back to the couple’s company for £50,000 annual rent. The couple are looking to retire in the next few years and have two children, who have recently been made directors of the company and are starting to save for their own retirement. The children are each looking to utilise their full annual allowance of £40,000 per tax year by making tax-deductible employer contributions.
Assuming the value of the property increases by 3% a year and the children’s contribution are invested to yield 5% annual growth, two of the potential scenarios are set out below, depending on whether the children join the SSAS or each fund their own separate personal pension.
Scenario if junior directors save separately
Under this scenario, the senior directors would remain the only two members of the SSAS and would be entirely responsible for raising liquid funds to enable members to retire. Since members can generally draw 25% of their savings as a tax-free Pension Commencement Lump Sum (PCLS), the lack of liquid funds in the scheme makes this difficult to achieve in the short-term, particularly where the value of the property (an illiquid asset) increases over time. As is shown, the scheme’s liquid funds would not permit the full PCLS entitlement to be paid out until early 2025. The parents therefore decide to defer their retirement until 2025, at which point they will be able to draw their tax-free cash without the SSAS having to borrow from a bank to provide the liquid funds.
At that time, the senior directors have each accrued pension wealth of £670,000, thanks to the increase in the property’s value and rental income. Meanwhile, the children have each accrued £325,000 under a separate pension wrapper, having made use of their annual allowance in every year and investing the funds via an investment manager. All four members are satisfied with this potential outcome, however the children would prefer the company’s rental expenditure to complement their own pension contributions. In addition, the parents’ delayed retirement carries with it both market and legislative risk – the property’s market value could be less than expected in seven years time and the rules surrounding tax-efficient retirement options may be subject
to adverse legislative changes.
Scenario if all directors save together
If the total of £80,000 in gross annual pension contributions on behalf of the children were instead directed to the SSAS, this would take advantage of the scheme’s investment pooling facility and help to build up liquidity at a much higher rate. As is shown, the point at which liquid funds permit 25% of each parent’s fund to be paid out as a PCLS now occurs in early 2020, five years earlier than before. As such, the parents instead decide to retire from the company in 2020, each draws a PCLS of £118,000 and each commences an annual gross pension of £20,000.
The same improved liquidity can also protect the trustees from the need to borrow or even sell the property at times of extreme need for cash. Other liquidity examples, beyond the tax-free cash payments above, would be a transfer of benefits out of the scheme, or the payment of certain lump sum death benefits that would need to be made within a two-year window, in order to avoid significant tax charges.
For the members to whom benefits are paid, their share of the property within the scheme is gradually decreased over time. Meanwhile, for the members on whose behalf contributions are made, the share of the property within the scheme is gradually increased. As such, the children’s savings benefit more and more from the rental income, increase in the property value and the same investment returns as before. Under this scenario, by April 2025 the children’s funds have each grown to £355,000, rather than the £325,000 shown earlier.
A similar outcome may have been achieved by using the children’s pension savings elsewhere (or indeed their personal wealth) to buy the commercial premises in “tranches”. However, each transaction comes with its own legal costs and tax implications, whilst a change in the underlying ownership of assets within a SSAS is not a true change in ownership, thereby avoiding legal fees and/or stamp duty.
"...individuals who flexibly draw a pension from a scheme will vastly reduce their scope for making tax efficient pension contributions going forward..."
Since all members of a SSAS are usually trustees, they retain an element of control over the scheme’s assets. For example, they must unanimously agree to any sale of a commercial property, or the renewal of occupational leases. The same cannot be said for property transferred to the younger generation’s outright ownership, whether for consideration or not.
Following the introduction of the Money Purchase Annual Allowance in 2015, individuals who flexibly draw a pension from a scheme will vastly reduce their scope for making tax efficient pension contributions going forward, which may or may not be seen as an inconvenience given their reducing company involvement. The lifetime allowance will often also be a factor for individuals with significant pension wealth, which currently stands at £1.03 million – a great deal lower than its 2011/12 level of £1.8 million. These factors are far less likely to affect younger members of staff/directors, on whose behalf the company could instead make its tax-relievable contributions.
Ultimately, the holistic financial position of all members of the family would be relevant when considering whether inviting younger members to join the company SSAS is feasible. We are not authorised or regulated to provide advice; you should discuss this with your Independent Financial Adviser. Your usual Barnett Waddingham Client Manager will be happy to discuss in more detail the mechanics of inviting junior company directors to join your SSAS.