One year ago, A-Day brought in major changes to the way pensions saving works. A key change was the ...
One year ago, A-Day brought in major changes to the way pensions saving works. A key change was the introduction of the lifetime allowance, which means that anyone whose total pension pot exceeds this amount (£1.6m for the tax year 2007/2008) will face a tax bill on the excess. For clients who have already exhausted their lifetime allowance - or who are likely to exceed it in the future - investing offshore can enable them to escape these tax penalties.
Offshore bonds can work well for flexible retirement saving as money grows virtually tax-free - but the client retains the ability to access their money at any time (subject to any charges that may be applied by the product provider). However, if pensions tax relief proves ultimately desirable, then the bond can be cashed in and the proceeds used to make a pension payment.
Significantly, using offshore bond proceeds in this way can prevent higher-rate taxpayers from paying higher-rate tax on bond gains. This works by the client making a large personal pension payment to change their tax status, and cashing in their bond in the same tax year.
The first step is to make a large enough pension payment to become a basic-rate taxpayer. For example, consider a client with an annual salary of £80,000 who consequently pays higher-rate tax on income over £39,825 (based on 2007/2008 limits: personal allowance of £5,225 plus higher rate tax band of £34,600). If that client makes a personal pension payment of £45,000, grossed up to £57,692, then this increases their higher-rate band to £97,517 (£39,825 plus £57,692). The higher-rate band has increased beyond the client's income so the higher-rate taxpayer is now a basic-rate taxpayer.
The second step is to cash in an offshore bond and use top slicing to avoid higher-rate tax on the chargeable gain. Let's assume that the same client invested £100,000 in an offshore bond 10 years ago and that the bond is now worth £200,000.
The amount of tax the client pays is calculated using top slicing tax relief, which adds a 'slice' of his gain to his salary when determining which tax bracket he is in. The slice is calculated by dividing the gain by the length of time the bond was held, so the gain of £100,000 divided by 10 years gives a slice of £10,000. When this is added to the client's salary, it gives a total taxable income of £90,000 and as this is less than his higher-rate band of £97,517, the chargeable gain is taxed at the savings rate for basic-rate taxpayers - currently 20% for the tax year 2007/2008.
As a result, the client saves 20% tax on his offshore gain, secures tax relief on his pension payment and retains the flexibility to access his money during the time the bond is invested. It should, however, be noted that if top slicing takes the client out of the basic-rate bracket then tax at the higher-rate would apply.
Offshore bonds aren't only useful for clients who are planning ahead for their retirement - they can also help when seeking a tax-efficient income in retirement.
Post A-Day, clients now have the ability to reduce their drawdown income in retirement and so become a basic-rate taxpayer. This ability, especially when combined with top slicing tax relief, is an effective way of reducing a client's tax bill when taking the proceeds from an offshore bond.
One final point to consider is that not all clients will want to spend their retirement in the UK. The flexibility of an offshore bond can mean the client can cash in the proceeds, either in the UK before they depart or overseas if the local tax conditions are more favourable. In addition, should that client have to return to the UK in the future, any chargeable event gain will be reduced by time apportionment relief.
A-Day introduced new flexibility to pensions savings but also limits for wealthier clients. An offshore bond can provide an additional, tax-efficient means for those clients to save for the future and then maximise their income in retirement n
Ian Searle is business development manager of international business at Standard Life
Tax and legislation may change. The value of tax relief will depend on the client's financial circumstances and may change in the future. The information given in this article is based on Standard Life International's understanding of law and tax practice in Ireland and the UK at the date of publication. The future tax position of a bond of the client's own tax position may alter.
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