Following a government revamp of pensions legislation last year, it is now possible for parents and grandparents to save for their children's and grandchildren's future from birth and still take advantage of tax relief
How often have we promised ourselves that we will get away this summer but when we finally get round to booking the holiday, the bargain does not come up to expectation and the best deal has long gone? Is this what actually happens to many clients planning for retirement? Is their reality blurred?
The Government's attempt last year to make us all self-sufficient when looking at our retirement planning has not yet set the world alight. However, among the endless legislation lie some key opportunities for you to create your own packaged product and shape the future of tomorrow's pensioners.
As there is no longer any earnings needed, your client could contribute from a child's birth for the child's benefit. The most likely contributors are the child's parents or grandparents but these are not the only ones allowed to do so.
Let me first focus on the child who may be fortunate enough to benefit from such planning.
Each contribution will receive basic rate tax relief through which £3,600 a year becomes £2,808 at 22% relief. If directed into a suitable personal pension scheme, the funds could grow to more than £1.5m.
However, your client will need to consider education planning needs, as well as a possible boost to help buy the grandchild's first property. Packaging the product around other investment vehicles makes this a highly attractive option.
Consider the position where a grandmother invests £2,808 into a personal pension for her grandson and also invests £56,160 into a single premium offshore bond. She then sets up an annual withdrawal from the bond of £2,808 (5% of the bond value) to fund future contributions to the personal pension.
Over the next 20 years, the £56,160 has supported an extra 20 payments. In total, she would have invested £58,968 into the personal pension. The value of the personal pension fund after 20 years could be more than £175,000. Further, the value of the bond after the same time could be more than £90,000.
Personal pension contributions from the investment bond will probably stop at this point, as the grandson will probably have entered employment. This brings us on to phase two.
Let us assume that the grandson is now at university. He could do with some added support to pay the fees, and ensure that loans, if needed, are kept to a minimum.
It is at this point that we need to consider the structure of the bond. It is essential the insurer had issued it with a suitable number of segments. In this way, the grandson will be able to use any or all of his (otherwise) unused personal income tax allowance to mitigate any liability arising from cashing in all or part of the bond.
If the grandmother received no tax advice, then she would probably continue to draw funds from the bond without considering the best way to do so. However, she would be liable to income tax on any cashing in ' not very tax-efficient. If the grandmother assigned a segment to the grandson, then he can cash it in himself. Consider the following alternatives:
• First, the grandmother draws funds from the offshore bond. If the gains were £7,500 and the grandmother were a higher rate taxpayer then she would incur a tax liability of £3,000. Thus, the net payment to the grandson would be £4,500.
• Second, an individual segment assigned to and cashed in by the grandson. Assuming the same circumstances except that he is a non-tax payer then he would incur a tax liability of £427. Thus the net payment would be £7073. This represents an extra £2,573 or an increase of nearly 60% to the grandson.
At this point, we can review the object of the exercise. Pension planning can never start early enough and previously the rules hindered parents and grandparents from contributing to these tax efficient vehicles. Your client may be concerned that the grandson cannot access the personal pension funds until he is 50 ' but is that necessarily a bad thing?
For a 20-year-old to amass a pension fund of £1.5m by the age of 50, he or she would have to contribute about £1,600pm. Given that national average earnings are currently just over £22,000, how practical is this? I would not want to scare anyone with average house and mortgage costs, but as you can see, the older we get, the greater the demands on our resources.
The personal pension fund is not completely inaccessible until the grandson reaches age 50. The projected tax-free cash, assuming 25% of the fund, gives the grandson the opportunity to use the fund as a repayment vehicle for long-term borrowing, a mortgage for example.
The investment bond itself can also provide further funds for the grandson. The example above can also be carried forward into his working career. He may have exhausted the bond when he finishes his university education or, alternatively, he may not need it at all.
The projected values at age 50 for the bond and pension funds would make the grandson a multi-millionaire, having a retirement pot of more than £2m. All from a £60,000 investment.
Let me now focus on the way the grandparent could set up the bond and pension to maximise all the opportunities.
There is a growing trend for grandparents to seek to secure the future of their grandchild. Depending on the grandparent's tax position and the future objectives for the funds, you can help channel the recommendation.
School fees, university fees or a deposit for their first property are all considerations. Combining these objectives with child pension planning also enables the grandparent to have peace of mind that their grandchild will not squander it.
The following areas need consideration when looking at the packaged bond and pension plan idea: inheritance tax, income tax, future access to the funds, control, investment philosophy, and product and trust design.
The £56,160 invested in the bond could be an outright gift, using a flexible power of appointment trust. This would be a potentially exempt transfer and fall outside the grandparent's estate after seven years. Any growth is immediately outside their estate. The use of the 5% tax deferred allowance to support the pension contribution of £2,808 net each year will not result in any immediate tax liability. As previously discussed, in future years, the grandson may need withdrawals to aid university costs. Here we can look at all the routes available to lessen any tax liability.
Provided you have arranged a suitably segmented bond, you will have three choices around who may pay the tax and how much.
If the grandparent is alive and a 40% taxpayer, the gain on the bond will be assessed on him or her, even when held in trust. If the grandparent is dead and the trustees cash in segments, then we have the potential of a 6% saving as the trustees will be assessed at 34%.
However, where the trustees use their power to appoint capital to a beneficiary, we can save some or all of this tax depending on the gain on the policy.
If the gain is £4,000 and the trustees assign the segment to the grandson who is over 18 and has no other taxable income, then the whole gain is tax-free as it falls within his personal allowance.
The original £2,808 could be assessed against the grandparent's annual exempt gift allowance. This is £3,000 each year and they may carry it back for one year so £6,000 is immediately exempt. This would mean the original gift of (£56,160 + £2,808) £58,968 will reduce to £52,968. An immediate inheritance tax saving of £2,400.
Where a trust is not used, the annual withdrawal of £2,808 will still be available as an annual exempt allowance. This would allow the grandparents the ability to have access to all the funds.
A gift and loan scheme would enable access to original capital on a decreasing scale. This might give peace of mind to some investors. In particular, those who are happy to give away the future growth but fear that they might not be able to support an annual exempt gift for the next 20 years.
This idea takes financial planning from the cradle to the grave. The contribution and other limits forced on the industry by governments may seem to create difficulties for the business of advice. However, this idea is just one area where we are able to move the standard recommendation to the true financial planning exercise.
Amid last year's pension legislation, there are opportunities to create packaged products for children's pension planning.
School fees, university fees or a deposit for their first property are all considerations when planning a child's financial future.
Inheritance tax, income tax, future access to funds and product and trust design all need to be dealt with within the packaged bond and pension idea.
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