Individuals can now transfer relatively illiquid assets that could be better held in a Sipp, says Claire Court, head of self-administered pensions, Origen
The simplification rules introduced on 6 April have brought a number of changes, not only in how much can be contributed to pension funds in the future but also how they can be paid.
This gives our clients new opportunities to be creative about how they fund their self-invested personal pension plan (Sipp) in the future.
It is now possible for an individual to make a pension contribution equal to 100% of earnings. This is subject to an overall annual contribution limit (Annual Allowance) of £215,000 in 2006 rising to £255,000 by 2010. This limit is intended to be reviewed every five years.
Individuals continue to receive tax relief on their pension contributions up to the highest marginal rate. Employer contributions will be unlimited but will be subject to the "wholly & exclusive" test applied by the HM Revenue & Customs (HMRC). Any excess contribution above the Annual Allowance may still be paid but will be subject to a benefit in kind charge of 40%.
Most interestingly, an individual does not need to have the cash to make the pension contribution. A transfer of a non-monetary asset is allowed, as long as the asset is a permitted investment within a Sipp. The contribution must be expressed as a monetary amount, satisfied by the transfer of a non-monetary asset of equal value. It will get tax relief but is likely also to give rise to a stamp duty charge and possibly capital gains tax.
Instead of making a cash contribution into the Sipp, one could transfer a personal asset into the Sipp. For example, a commercial property or a share portfolio can be used as a net contribution to the pension fund. The ownership of the property or portfolio transfers to the trustees of the Sipp.
The pension fund would be credited with the basic rate tax relief on the value of the net contribution and the individual would receive the higher marginal rate of tax relief through his tax return or an adjustment of his tax coding. It will be necessary for an independent valuation of the asset to be prepared to demonstrate it is being transferred at market value.
It must be remembered that the transfer of an asset into a Sipp as a contribution will trigger a disposal for personal capital gains tax purposes and may incur other costs such as stamp duty and legal fees.
On each in-specie contribution, the ownership of all or part of the asset transfers from the individual to the trustees of the Sipp and tax relief is paid on the contribution. Once the asset is inside the pension fund, any income generated will be paid into the pension fund and will be virtually free of income tax. On disposal of the asset, the capital gain realised by the pension fund would also be free of tax.
The transaction will have to be made at market value. This is easy to establish for quoted shares, in other words price on day of purchase. For other assets such as commercial property, an independent valuation will be required.
On transfer into the Sipp, the individual will be subject to tax on any capital gain.
The pension fund will have to pay stamp duty on the purchase of the asset. Because basic rate tax relief is usually reclaimed and received within four weeks of the contributions, there should be sufficient cash to cover the stamp duty. However, in certain circumstances, the individual may have to cover the liability through short-term borrowing, an additional contribution or other available cash within the pension fund.
Not all Sipps currently offer the option for making in-specie contributions. The facility is usually offered on full Sipps offered by specialist Sipp providers.
John Smith earns £90,000 per annum and owns listed shares that have a value of £120,000. He wants to pay a pension contribution but does not have the cash. He transfers £50,000 of shares into a Sipp, which is treated as a contribution less basic rate tax. In addition, he will receive higher rate tax relief on the contribution. After the transfer, the pension fund will receive the dividend income on the shares.
The position at the end of this exercise after the tax reliefs have been paid will be as follows:
In summary, John now has a Sipp worth £64,103 with a net cost to him of only £38,461 (allowing for the higher rate tax relief) and no cash has changed hands in the process. John's accountant has calculated he has just £1,500 capital gains tax to pay on the transfer.
The market for in-specie contributions
This change represents a real opportunity for advisers to unlock assets held personally by their clients and to revisit the affordability of pension contributions. A number of clients have relatively illiquid assets that could be better held in their pension fund and they are now able to transfer them to their Sipp, often at little cost.
The taxation issues must be considered carefully, because the opportunity for income tax relief on contributions should not overshadow the potential capital gains tax and stamp duty on transfer.
Nonetheless, this is another example of how the new regime is able to give clients greater flexibility in reaching their personal and retirement goals.
The majority of financial advisers (85%) believe the number of self-invested personal pension (SIPP) providers will continue to fall in the coming year, according to Dentons Pension Management research.
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