Investing lump sums into pensions has historically represented a means by which business owners could seek to reduce their tax liabilities.  The popularity of this practise has, in recent times, been eroded by a combination of the low returns that poor performing funds have achieved, the high charges imposed by pension companies, low annuity rates at maturity and the attraction of property as a so-called “alternative pension” investment. In recent years, the fall in house prices and the difficulty in obtaining funding for buy-to-let properties has reduced the attraction of this latter option to an extent, but what of pensions themselves?

The principle problem with pensions historically has been the imperative to buy annuities, even though this could be mitigated to a degree by various draw-down options that have been available.  In recent times annuity rates have been falling as a result of low interest rates and increasing life expectancies and consequently many people have considered purchasing an annuity to represent a very poor investment.  This lack of appeal is further magnified if the person taking the annuity feels they may die within a short time period of purchasing it.

The Government has been long aware of the inherent problems relating to annuities, but the fear that people will blow their pension funds and become a burden on the State has, until now, made them reluctant to make any significant changes. The changes that were announced in the 2014 Budget have therefore come as somewhat of a revelation.

Whilst it is inevitable that a minority of people will foolishly fritter away their pension funds, there now appears to be an acceptance that the sensible majority, having carefully accumulated their funds over their working lives, will not. This has prompted the present Government to  remove the compulsion to invest in an annuity and instead allow people to take the whole of their pension funds once the age of 55 is attained.  The proposals would allow 25{af331c3cb52abe27a47f1f5b71fb5068c938efb8d5a4e6cddc7f2780f48bb99c} of the pension fund to be taken as a tax free sum with the balance being subject to tax at the individual’s marginal tax rate, leaving them free to invest the net amount in any way they deem fit.

The opportunities for using pensions as a means of reducing tax liabilities will significantly increase if the proposals achieve Royal Assent. If the pension investment achieves 20{af331c3cb52abe27a47f1f5b71fb5068c938efb8d5a4e6cddc7f2780f48bb99c} tax relief as a minimum when the contribution is  made, and only 75{af331c3cb52abe27a47f1f5b71fb5068c938efb8d5a4e6cddc7f2780f48bb99c} of the amount extracted is taxed at a similar rate this would potentially offer an attractive profit extraction strategy. Needless to say, this will need to be carefully planned.

We must wait to see whether the proposals as they stand make it into the Finance Act later this year but, assuming they do, they could significantly increase the opportunities open to business owner managers in the future.