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It is often said that where pensions are concerned, clients do not love pensions. They often contend with them or indeed loathe them, frequently for mistaken reasons. For example, this may be due to ‘poor performance’, ‘high charges’ or the fact that ‘you have to buy an annuity with it’!

We will, therefore, take the opportunity to try and put to rest some misconceptions and to explain why you should, if not fall in love with pensions, at least appreciate them.

Tax, Tax, Tax Relief

Where an individual receives the benefit of an employer pension contribution, the employer enjoys Corporation Tax at the prevailing rate. Typically for small Limited Companies, this will be at the present rate of 20%, although this will increase to 21% in 2008/2009. It should be noted that this is not automatically granted, and due care should be given when judging the level of pension contributions made this way. A ‘reasonableness’ test will be applied, assessing whether the employee’s total remunerative package including pension is commensurate with their role and occupation. Therefore, whilst the new rules seem to offer hugely generous contribution limits, one should proceed with caution as the above assessment will ultimately prevail.

Salary sacrifice is an option that is becoming increasingly popular with employees due to the additional National Insurance (NI) savings available. Pension contribution in lieu of salary can lead to both employee and employer benefiting from NI savings. Of course, it is for the employer to agree to pass on any such savings, but where this is agreed, it can be a very useful way of accelerating pension accrual. Any such sacrifice must be agreed in writing with no mention of the pension contribution. Also, this type of planning should be approached with care as a reduced salary may impact on other benefits such as death in service and adversely effect one’s ability to apply for finance, including a mortgage.

Where individuals are caught by legislation known as IR35, the tax reliefs can be significant, as the National Insurance relief (a tax in all but name) and Income Tax relief will equate to as much as 47.7%!! Where such individuals are working outside of this legislation, a pension contribution could not only be attractive in its own right, it could also be very effective, pre-emptive planning in the event that HMRC successfully challenge their status.

On top of that, substantial contributions from retained profits may well give rise to a further tax relief; Inheritance Tax (IHT) relief. Where such retained profit is not deemed to be working capital, this is unlikely to attract Business Property Relief (BPR). Hence upon death, such funds are likely to be assessable in full as part of the individual’s estate, and may attract IHT at a rate of 40%. If instead these are invested into a pension, these become exempt from IHT.

Restriction of Access

The inability to access funds, once within a pension wrapper, until age 50, or age 55 from 6th April 2010, can be considered to be advantageous or disadvantageous, depending on your way of thinking. Many clients structure their income through a combination of salary and/or dividends and endeavour to do so, where expenditure permits, within the basic rate threshold, thereby avoiding higher rate tax. In 2007/2008 this is £39,825 gross income. In this situation, there is to all intents and purposes a voluntary restriction on those funds anyway, as to do so otherwise would attract a 40% Income Tax liability and 1% National Insurance charge on salary or bonus, or 25% Income Tax on any net dividend declared.

High Charges

It is fair to say that certainly since the advent of Stakeholder pensions in April 2001, the pensions market has taken steps to reduce charges on pensions. The benchmarks for a competitively charged contract in today’s marketplace are low or nil up front charges and no penalties for early transfer away or retirement.

Poor Performance

More often than not, it is not the pension that has poorly performed, but the investment within it. This was commented on in a recent article 'Pension Performance Revisited – Again’. Ultimately client lethargy can give rise to below par performance, due to irregular reviews. Suffice to say, do not continue to be depressed by under performance and seek financial advice at the earliest opportunity.

Must Buy An Annuity

This may be the most mistaken belief conveyed by clients and one that has not been true for several years now.

Annuities should not be dismissed entirely. Whether it be impaired life annuities, temporary annuities, investment linked annuities, they remain popular due to the inherent guarantees, which often appeal to clients at retirement age and/or clients that are dependent on their pensions to provide the majority of their income in retirement.

However, we can confidently convey that there are different options available through which to derive an income in retirement, including phased retirement, Unsecured Pension (USP) or a combination of these. I am sure you can appreciate that planning your retirement can be a complex affair, therefore, all options should be given careful consideration and certainly with the benefit of specialist independent financial advice.

In conclusion, we may not have convinced you to go out and buy a bunch of flowers for your pension. Nonetheless, we believe that pensions deserve greater consideration within any sound financial plan.

Date of Article: 23rd January 2008