This Article first appeared in the Winter 2021/22 edition of The Law.
Please note, whilst there are elements of this article that have been simplified to help illustrate the position, the example is based on an actual client scenario. However, the solutions highlighted below are complex, and they will not meet everyone's needs, objectives and risk tolerances. They can though provide valuable financial planning tools in certain circumstances including where someone is already maximising other allowances, including Pension & individual Savings Accounts (ISAs).
Dave, Diane and Davina have been owners of DDD Law Ltd, their successful business for many years and are equal shareholders.
Dave has been navigating the complex tax rules, alongside his accountant, by drawing income of up to £100,000 per annum via dividends and salary, thus ensuring he can continue to maximise his annual pension contributions.
Fortunately he has reached the stage of life where he has paid off his mortgage and built a comfortable lifestyle with retirement now coming on to his horizon. He has also built up assets which could mean his family paying IHT on his death. Although death is most certainly not in his current thinking, retirement is!
Last year was a bumper year for the business. He has built up £700,000 in the company reserves and he planned to continue to put as much into his pension as he can each year, and then at some point walk away from the business. He understands that he is restricted to £40,000 gross per year pension contributions but he can currently use Business Asset Disposal Relief to help take the remainder of the reserves in a tax efficient manner.
However, the global health crisis has meant he is now considering accelerating his retirement plans. He feels the future of the business is now less certain and being much older than his business partners he would like to take his money out sooner to help him ultimately retire. He is an experienced investor, and feels now may be a good time to invest, however, he feels the amounts he can pay into his pensions is too restrictive in terms of getting the money out of his business as quickly as he would like to meet his future objectives.
So what can Dave do?
If he withdraws the £700,000 reserves his income tax liability could be £253,600. This will also add £446,400 into his estate, with the potential tax at 40% (£178,560) on his death.
He would like to legitimately mitigate as much tax as possible and wants to know of other options available to him. As he also understands there are restrictions on the amount you can contribute to a pension each year and there are also potential Lifetime Allowance (LTA) issues (LTA is currently £1.073m) as to this point he has been regularly funding his pension for many years already. Where a pension pot exceeds the LTA allowances there is a tax charge on the excess.
However, as he is an experienced investor we began discussions about potential investment in to Enterprise Investment Schemes (EIS) and Venture Capital Trusts (VCT). VCTs and EIS, both of which currently offer incentives including the potential for tax-free growth. They have the added attraction of providing investors with up-front income tax relief at the time the investment is made, providing they are held for a period of time. Due to his specific circumstances our discussions led him to consider an EIS.
EIS’s are investment schemes designed to encourage investment in small or medium sized companies. They do this by offering tax reliefs to individual investors who buy new shares in a company. One of the reasons these investments offer such tax incentives is that the incentive is to invest in small or new companies that are not listed on the main stock index (unquoted). The risks are multiple but perhaps most significant are the risk of capital loss, as not all businesses will be successful, and the liquidity risk. These businesses will not always have the capital available at the exact time you wish to withdraw your investment, so it can much more illiquid than a mainstream stocks and shares investment. Therefore, this will not be suitable for most investors.
To benefit from EIS relief, investors must hold on to the investment for a minimum of three years, however, they should also be seen as a medium to long term investment of five years or more.
In this example Dave has decided to withdraw all £700,000 of his reserves now, and to invest £500,000 into an EIS (after taking regulated financial advice on the underlying investment structure).
Therefore Dave has removed his capital from the company income tax efficiently, made good strides to protecting it from IHT, and has been able to invest during a time where he has felt comfortable to do so and in line with his personal attitude to risk and capacity for loss.
At Armstrong Watson we are Chartered independent financial advisers and can discuss and advise on all aspects of financial planning, including retirement, inheritance tax planning and other specialist investment areas. Our advice is personalised based on an individuals circumstances. As all our expertise is “under one roof” allowing our Financial Planners also work alongside our Tax advisers to ensure the right advice and support is at hand for business owners.