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Promises, promises: Unfunded pension contributions to reward key staff

Author

Andy Wood

Andy is a practical, creative tax adviser who assists a variety of clients in achieving their personal and commercial objectives in the most tax efficient manner.

Introduction

In our view, an unfunded pension scheme can be an extremely flexible way of providing for retirement without tying up cash with a third party provider.

This note considers the tax implications of such an arrangement.

First of all, we will set out the context of pensions generally.

 

Pensions generally

Apparently we are all living longer! Hurrah.

However, it also seems rather unlikely that the creaking welfare system will be able to support its productive members of society.

What can we do… other than win the lottery? Apparently you are many times more likely to be run over by a bus than win the lottery. The good news that, whether it is the lottery or the bus solution, successful implementation is likely to sort out your retirement conundrum.

We could have the following pension schemes:

  • ‘Approved’ or, using the more up to date terminology, ‘registered’ schemes
  • Unapproved or unregistered schemes
  • Other savings / investments – such as property, bonds, ISAS etc; or
  • Rely on the state….

Registered schemes

The main features of a Registered Pension Scheme could be described as follows:

  • There is a statutory CT deduction available for contributions made by employers;
  • There is tax relief for contributions made by individuals;
  • Tax relief is subject to annual allowance of £40k – this will dropto £10k for some scheme members;
  • Tax free investment growth – although the overall value of such relief is now capped at £1m, which is almost half of what it once was;
  • There is an effective restriction on certain investments being held within the scheme– eg most holdings of residential property;
  • Benefits can now be taken at age 55 in more flexible ways than has traditionally been the case;
  • When benefits are paid then they are taxable – though it may be attractive to be resident overseas when retire?
  • The Company usually needs to make actual cash payments in respect of its contributions (ie it must be funded)

Unregistered schemes

The main features of an Unegistered pension scheme could be described as follows:

  • It is possible to secure corporation deductions – though one needs to take greater care;
  • It is still possible to obtain tax free growth – though this will depend on the particulars of the tructure and situs of assets;
  • There will be no investment restriction from a tax perspective (though one would expect any asset to be a suitable asset for generating an income for retirement);
  • One needs to be particularly careful of Part 7A of ITEPA 2003.

 

Unfunded schemes: An overview

 

General

Mr X is the 100% shareholder and Director in his trading business. He has one or two key employees. He has done rather well this year. Up until now he has paid himself a bonus. This year, his profits are around £500k.

He wants to mitigate his corporation tax liability and wants to leave the cash in the business.

What would the tax implications be of a ‘notional contribution’ of £200k to an unfunded pension scheme.

Corporation tax

Under general principles, the obligation to pay a pension in retirement should achieve a corporation tax deduction. This assumes that it is ‘wholly and exclusively’ for business purposes and is of a revenue (rather than capital) nature.

The future liability to be paid on retirement would need to be discounted. However, this could be addressed by simply index-linking the pension.

It should be noted that the Company would not get a second deduction when the pension payment was eventually made.

The Government introduced a challenge, primarily for the use of Employee Benefit Trusts (EBTs) for tax avoidance purposes, to the general position where there is an ’employee benefit contribution’. However, in our view, a promise to pay a pension does not fall within this anti-avoidance provision.

 

Part 7A of ITEPA 2003 (aka disguised remuneration)

The disguised remuneration rules are designed to catch arrangements which involve sums being transferred to intermediaries for the purposes of providing reward. Again, a theme is developing here, this would catch an EBTs or EFRBS’.

Again, such an obligation should not fall within these provisions.

 

Miscellaneous points

This is an unregistered pension scheme, which results in the following other features:

  • The definition of retirement age has some flexibility (ie it does not need to be 55);
  • The Lifetime Allowance is not of relevance to this planning;
  • The Annual Allowance is not of relevance to this planning;

 

Summary

When reviewing key employees’ remuneration we would recommend that, where a pension contribution is being considered an unfunded contribution is contemplated. This is because future reward can be provided aligning the recipients interests with the business, does not tie up cash and also obtains a potentially attractive corporation tax deduction.

This is particularly germane in smaller family businesses and private companies where reward to a key stakeholder is being contemplated.

 

Please feel free to contact us for further information on this or any other aspect of remuneration planning

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