Despite the strict rules that limit the tax breaks on pension tax-free lump sums, you can use your pension savings to raise tax-efficient cash for your business. How’s it done?
Borrowing from pension savings
There are tough rules in the pension and tax legislation which prevent you from accessing your pension savings before you reach 55. There are exceptions but generally you can’t touch the money without getting hit with very tough tax charges. But, if you are 55 or older you might be able to use your personal pension savings to raise finance tax efficiently.
Acceptable recycling
Subject to tax anti-avoidance rules, you can take a lump sum from your pension and use it for whatever you want, e.g. to help out your company’s cash-flow problem. Your company can repay what it owes you by paying pension contributions into a different personal pension plan. This is called pension recycling. Care must be taken not to trigger the money purchase annual allowance (MPAA) as this would make the scheme less tax efficient.
Example - bank loan. Bob’s company, Acom Ltd, needs £30,000 to buy new machinery. The bank is prepared to lend to the company at an APR of 12% over four years, if Bob agrees to secure the loan with a mortgage on his home. Acom’s repayments would be £790 per month, that’s roughly £37,920 in total. It can claim a tax deduction for the interest which will reduce the cost by between £1,500 and £1,900 approximately, depending on the rate of corporation tax (CT) applicable to its profits, making the net cost between £36,020 and £36,420.
Example - pension recycling. Bob takes a tax-free lump sum of £30,000 from his pension savings (he reorganised his personal pension funds to accommodate this). Acom needs to pay just £690 per month into a new pension plan for Bob (assuming pension savings grow at 5% per annum, which is realistic even in these times of low returns on investments) for which it can claim CT relief. The total cost to Acom is therefore between £27,471 and £29,669 depending on the CT rate applicable. Therefore, Acom is better off by around £7,000 to £8,500 compared with taking a bank loan.
Flexible arrangement
If Acom can’t afford the pension contributions but must have the cash, using Bob’s pension fund as the source of capital is the ideal solution. Tip. Bob can instead take the £30,000 tax-free lump sum, lend it to Acom and leave it at that, or allow it to pay pension contributions for him as and when it can. This has the advantage of preventing or reducing the risk of the MPAA applying.
Tax-free payments
If Acom doesn’t pay pension contributions you might think that Bob has lost out by using the lump sum from his pension. That’s because you’re only allowed to take up to 25% of each pension fund’s value as a tax-free amount, and so what he takes from that fund in future will be taxable. Tip. The money from Bob’s pension fund counts as a credit to his director’s loan account with Acom. This means when it repays the money it will be tax free. Alternatively, if it doesn’t repay Bob and he sells the company or winds it up, £30,000 of what he receives for it will be tax free. So, one way or another, he hasn’t lost his tax-free lump sum.
This article has been reproduced by kind permission of Indicator – FL Memo Ltd. For details of their tax-saving products please visit www.indicator-flm.co.uk or call 01233 653500.