Martin Mitchell, Manager of Volaw's Employee Benefits Group, looks at a type of unregistered pension scheme that provides tax benefits for non-UK source income and gains.
Following the introduction of the annual and lifetime caps for UK approved schemes at "A Day" (6 April 2006), the use of unapproved or unregistered retirement benefit schemes has increased considerably. In addition, such unregistered arrangements have significant flexibility which make them very attractive, this attraction having been further enhanced since the announcement of the 50% tax rate (that will apply from April 2010) and the restrictions on tax relief for pension contributions to registered schemes that have already commenced.
What is an EFRBS?
An EFRBS is an Employer Funded Retirement Benefits Scheme, which is an unregistered pension scheme. Essentially, it is a scheme for the provision of retirement benefits to employees or former employees.
How does an EFRBS work?
An EFRBS can be set up onshore or offshore, but it is likely to be more favourable to be offshore as non-UK source income and gains can then roll up UK tax free.
The employer sets up a trust with powers to provide retirement benefits to employees and subsequently contributes sums to the trust, which are then allocated to employees.
Why use an EFRBS?
An EFRBS is an unregistered pension scheme and it is free to invest in any class of asset. It can provide a wider range of benefits to participants than a registered pension and is also not subject to the annual allowance and lifetime allowance limits that apply to contributions into a registered pension scheme.
The benefits of an EFRBS apply equally to UK and non-UK domiciled individuals. It can be particularly attractive to have non-UK domiciliaries who are seeking to mitigate the impact of the £30,000 remittance basis charge and those considering retiring abroad.
Where an EFRBS is genuinely established to provide retirement benefits for employees, it may also provide tax planning opportunities. These include National Insurance savings and a more beneficial post-tax position for a 50% tax rate employee than would be the case for payments above £20,000 (or, if higher, the protected pension input amount) into a registered scheme.
Beneficiaries can include family members. An EFRBS can pay a pension or annuity at retirement age, which could be lower than the minimum age of 55, which is imposed for a registered scheme from next year and without the upper-age restrictions that apply to registered schemes. However, if payment is made before normal retirement age it may be subject to National Insurance.
Income Tax and NIC
There is no employment tax or NICs on employer contributions to an EFRBS.
Broadly the payments of qualifying benefits out of an EFRBS are not subject to NICs provided they could have been paid under a registered pension plan. A lump sum which is a "relevant benefit" is taxable and liable to PAYE. The payment of an annuity or pension will be taxable as pension income.
A UK resident employee in receipt of a pension or annuity may also benefit from a 10% discount for tax if the foreign pension criteria are met. This should be the case if the EFRBS trust is offshore.
If the employee has left the UK and become non-resident in the UK then any pension paid from an offshore EFRBS would not be subject to UK tax.
The employer will not be entitled to a corporate tax deduction until "qualifying benefits" are paid out of the EFRBS.
Qualifying benefits are provided where there is a payment of money or transfer of assets otherwise than by way of loan and include pensions, annuities, lump sums or other payments out of the EFRBS. There is no requirement that these payments be chargeable to income tax in order for the employer to obtain a corporate tax deduction.
Capital Gains Tax ("CGT")
If the EFRBS is located offshore there should be no CGT on any gains realised on capital assets held within the EFRBS or on any UK beneficiary.
Inheritance Tax ("IHT")
There is no IHT on the creation of an EFRBS or on the death of a participant.
Death in service benefits provided by the EFRBS can fall within the employee's estate and it may therefore be advisable not to provide them from the EFRBS.
There should be no exit charges or 10-year charges on payments out of an EFRBS provided it satisfies specific criteria.
Foreign income and gains realised within an offshore EFRBS will be free from UK taxation. However, pension benefits paid from the EFRBS will be subject to the remittance basis rules as will any other lump sum or benefit from the EFRBS.
For whom is an EFRBS suitable?
An EFRBS would be particularly attractive to the following types of employee:
- Employees with income of £170,000 or more who will not be eligible to claim higher rate tax relief on pension contributions.
- Employees close to retirement age.
- Employees enjoying large discretionary bonuses who do not need immediate access to the funds.
- Employees already at or approaching the lifetime allowance cap for registered pension schemes.
- Non-UK domiciliary employees.
- Employees considering retiring abroad.
Employers that would typically find an EFRBS attractive would include:
- Companies seeking to provide retirement benefits to employees with the added benefit of non-aggressive tax planning.
- Owner-managers of close companies.
- Companies not concerned by the deferral of the corporate tax deduction for the contributions.
- Employers with contractual obligations to make payments to employee pension schemes (e.g. law firms – although it will not be appropriate for partners or members of an LLP).
- Employers who pay large discretionary bonuses.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.