UK: Tax Efficient Pension Provision Post ‘A-Day’

Last Updated: 31 March 2006
Article by David Pett, Judith Greaves and Lynette Jacobs

Companies wishing to enable their employees to optimise the tax reliefs afforded to savings for retirement should now consider adopting an HMRC-approved employees' Share Incentive Plan (SIP) as part of their ‘post A-Day’ planning for pension provision.Why? Because the tax reliefs afforded to participants in a SIP (and their employer companies), when coupled with the tax relief afforded to post A-Day contributions to a Registered Pension Plan (RPP), afford the potential to enhance significantly the value of an employee's pension fund. Until now, transfers of shares from a SIP could be made only to a stakeholder pension or an ISA. From A-Day, such transfers can be made into any form of RPP.

Of course, monies contributed to a SIP can be invested only in ‘own-company’ shares. However, the fact that contributions may be made out of gross salary, coupled with tax-free growth in value in both the SIP and, subsequently, the RPP, and tax relief for contributions to an RPP, mean that if, after 5 years, the shares are transferred from a SIP to an RPP (or sold in the market, and the proceeds contributed to an RPP), the value of the pension fund may be significantly greater than if the money had simply been contributed to the RPP in the first place.

Under a SIP, employees may make contributions, out of gross salary, of up to (currently) £1,500 per tax year, which are invested in ‘Partnership Shares’ in the employer company. In addition, the employer can fund the appropriation of ‘Matching Shares’ (tax-free) on a basis of up to 2 matching shares for every partnership share so acquired. Dividends on SIP shares of up to £1,500 per tax year may be reinvested, free of tax, in shares in the employers company, to be held in the SIP.

Illustration

Assume:-

  • An employee has the choice of contributing a (net of tax) amount of, say, £100 to either an RPP or a SIP. By way of comparison, he could instead invest that sum in an ISA.
  • There is 50% underlying growth in value of the investment over 5 years.
  • The employer is willing to match the contributions to a SIP or an RPP on a 1 for 1 basis.
  • The employee remains employed within the group for 5 years, after which the SIP shares are transferred (or sold and the proceeds transferred) to an RPP (being a company pension scheme, a personal pension plan or a stakeholder pension).
  • An amount equal to the tax relief for the pension contribution (or transfer of shares from SIP to RPP) is itself invested in the RPP.

Higher rate tax payer

Plan

Cash Contribution

Net (of tax) Cost of Contribution

Employer Matching

Total Invested

Value After 5 Years

Tax Relief on Transfer to Pension*

Total Value Accrued

ISA

100

100

-

100

150

100

250

Pension (RPP)

166

100

166

332

500

-

500

SIP

166

100

166

332

500

333

833

*Note: the employee can use the tax relief to increase the amount contributed to the RPP after 5 years OR take the benefit of the relief through Self- Assessment

Basic rate tax payer:

Plan

Cash Contribution

Net (of tax) Cost of Contribution

Employer Matching

Total Invested

Value After 5 Years

Tax Relief on Transfer to Pension*

Total Value Accrued

ISA

100

100

-

100

150

100

250

Pension (RPP)

128

100

128

256

384

-

384

SIP

128

100

128

256

384

108

492

The difference between 500 and 833 (for a higher rate taxpayer) represents the amount of tax relief upon a transfer of the SIP shares (or their cash proceeds) into an RPP, grossed up by the amount of the tax relief on such transfer (or contribution). The illustration above assumes that the employer's matching is made at the outset by funding the appropriation of ‘Matching Shares’ when the employee first acquires ‘Partnership Shares’ under the SIP. Alternatively, the employer could defer the matching until the SIP shares, or their sale proceeds, are transferred into the RPP. The matching would then take the form of an additional employer pension contribution. Using the assumptions above, this would have the following consequences:-

Cash Contribution

Net (of tax) Cost of Contribution

Total Value Invested

Value After 5 Years

Employer Matching/Contribution to Pension Plan

Value of Tax Relief on Employee Contribution to Pension Plan

Total Value Accrued

Higher rate (40%) taxpayer

166

100

166

249

249

166

664

Basic rate (22%) taxpayer

128

100

128

192

192

54

438

By deferring the matching, the employer will incur a potentially greater cash outflow representing the growth in value of the SIP shares over the 5-year period.

The rules governing RPPs permit contributions to such plans to be made by way of transfers of shares held in a SIP within 90 days of the employee directing the SIP plan manager to make such a transfer. To avoid any clawback of tax reliefs, such a direction would normally be given with effect on, or after, the fifth anniversary of the appropriation of the Partnership and Matching shares.

Transfers are also permitted of shares acquired under an SAYE share option plan. However, a crucial difference between shares acquired under a SIP and those acquired under an SAYE scheme is that, in the case of the former, their base cost for CGT purposes is their market value at the time of their withdrawal (as opposed to the price paid for them). It follows that, if transferred immediately upon withdrawal, the growth in value of the ‘own company’ shares transferred from a SIP to an RPP is entirely free of tax.

Transfers from a SIP to an RPP can only be made if the RPP so permits. If it does not, it may nevertheless be possible to achieve a similar result by selling the SIP shares and reinvesting their proceeds (grossed up by the tax relief for the cash contribution) into the RRP.

Data protection issues mean that care will be needed to set up the processes for the SIP administrator to transfer shares from the SIP to a company or personal pension plan.

In the case of a company RPP, the tax relief for the pension contribution may be given through the payroll whereas, in the case of a personal or stakeholder pension plan, the relief will typically be partly through payroll and, in the case of higher-rate taxpayers, through Self-Assessment.

Actions Required:

The adoption of a SIP will not require prior shareholder approval unless the shares to be used are to be newly-issued shares. However, a SIP will need to be approved by HM Revenue & Customs and a trustee and plan administrator will need to be appointed.

It will be necessary in due course to liaise with your company pension scheme administrator to ensure that the Registered Pension Plan rules permit, and systems are in place to enable, shares to be transferred from a SIP to the company RPP within the 90 day time limit.

If the RPP rules do not, and cannot, allow for contributions in the form of shares, it may still be possible to achieve a similar result if the employee makes a cash contribution.You will, however, need to check the effect, on the employee’s pension benefits, of an employee making such an additional cash contribution.

Given the time-lag between appropriating shares under the SIP and subsequently transferring them to an RPP, the immediate action required is to consider the company's eligibility to establish a SIP, if it does not already have one.

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.

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