Loophole or pension tax dodge ?

fizio

Scenario is a LTD company director (John), over 55 and has started a SIPP 

• John pays himself 12.5k salary so no tax/ni
• John puts 10k into a SIPP and gets the govt to put the extra 2.5k in
• Johns company makes a 27750 contribution to the SIPP, thereby avoiding 19% corp tax
• John now has 40k in a SIPP which cost 37750 and saved a load of tax
• After 5 years John has 200k (growth) so takes 50k tax free and leaves the rest in drawdown
• For year 6 he starts a new SIPP and does the same for the next 5 years 

This almost seems ‘too good to be true’ but as far as I can tell its all legit and hmrc is fine with it ???

Dazed_and_C0nfused

fizio said:

Scenario is a LTD company director (John), over 55 and has started a SIPP 

• John pays himself 12.5k salary so no tax/ni
• John puts 10k into a SIPP and gets the govt to put the extra 2.5k in
• Johns company makes a 27750 contribution to the SIPP, thereby avoiding 19% corp tax
• John now has 40k in a SIPP which cost 37750 and saved a load of tax
• After 5 years John has 200k (growth) so takes 50k tax free and leaves the rest in drawdown
• For year 6 he starts a new SIPP and does the same for the next 5 years 

This almost seems ‘too good to be true’ but as far as I can tell its all legit and hmrc is fine with it ???

Does John have sufficient carry forward to support contributions in excess of £40k?

He couldn't do that in year 4 (or later years) as he wouldn't have any unused annual allowance available to carry forward.

You say after 5 years he has "200k (growth)".  But 200k is a (very small) loss on the gross amount contributed so what does the "growth" refer to?

Secret2ndAccount

I think you've got a slight miscalc in there: the company contrib would be 27500 to bring the total up to 40k, not 27750.
2nd miscalc: 5 yrs @ 40k = 200k, so no growth required.
Did John have a pension open already in prior years, but not pay in the full 40k limit? If so, his company contrib could be 50k or 60k for 1 year - he can fill up the previous 3 years of unused 40k. A total for this year and the 3 before of 160k minus prior contribs.
Assuming there is some growth, and some carry forward, that 200k pot could be 300k or 400k. In any case, John can take 25%, and carry on contributing 40k per year as proposed.
There are anti-recycling rules, but if your contributions are regular, and predictable then you are in the clear. If you were contributing 20k per year, then one year you took a 50k lump sum, and increased your contribs that year to 70k, you would be in trouble.

fizio

Thanks both and yes there is some carry forward but ultimately the company contributions can’t exceed the companies profit so 30-40k is about the max per year. 
My fault in that when i said 200k(growth) I meant 200k +growth but didn’t factor it in to the 25% tax free  to keep the maths simple. Thanks for correcting my 27500 calculation as well

On the anti-recycling, i don’t believe its relevant if contributions stay within earned salary limits and company contributions so hopefully ‘John’ doesn’t need to worry about that at least.

My main purpose was to check the principle as it seems strange for the govt to simple give someone earning uptown 12.5k a free 25% as opposed to it being a tax refund on tax paid. Not that I am complaining.
The second point was that taking one pension and starting another is not ‘frowned upon’ so that also seem fine as long as recycling is avoided.

Dazed_and_C0nfused

Some pension contributions do rely on tax having being paid.

But RAS (relief at source) contributions don't, the key factor is you must have pensionable earnings to match the (gross) contribution.

So earnings of say £9k, a more normal amount for many limited company directors, would limit the gross contribution to £9,000.

But there are plenty of retired non taxpayers making use of the £3,600 non earners limit to get a free £720 from HMRC.

A very generous system.

dunstonh

• John puts 10k into a SIPP and gets the govt to put the extra 2.5k in

in the real world John would not do that as personal contributions are less tax efficient than company contributions.  he would reduce the dividends paid, increase the company contribution and keep the money held personally in his own name to replace the dividends.

• For year 6 he starts a new SIPP and does the same for the next 5 years 

Why would there be a need for a new SIPP?

This almost seems ‘too good to be true’ but as far as I can tell its all legit and hmrc is fine with it ???

HMRC has no issue with it other than the company has to have the profits through trade to get a corporation tax reduction.

Generally, most shareholding directors would be on a mixtures of dividends and salary and any money held personally would already have been taxed at some point.

Many directors are holding back pension contributions this year (unless they max out) with the intention of paying them in the next tax year for obvious reasons on corporation tax.

• John now has 40k in a SIPP which cost 37750 and saved a load of tax

The SIPP still cost £40k but had reliefs off that figure which result in in a tax saving.

So earnings of say £9k, a more normal amount for many limited company directors, would limit the gross contribution to £9,000.

2022/23 is a bit messy as the primary threshold was changed mid year and has given directors the optimum salary of £11,908.  It did star the tax year lower.  23/24 will match the personal allowance.

fizio

dunstonh said:

• John puts 10k into a SIPP and gets the govt to put the extra 2.5k in

in the real world John would not do that as personal contributions are less tax efficient than company contributions.  he would reduce the dividends paid, increase the company contribution and keep the money held personally in his own name to replace the dividends.

Surely the extra free 25% top-up to a personal sips contribution makes this worthwhile? Put in 10k untaxed salary and sip gets 12.5k? I am less worried about dividends as making a company contribution of 30-40k uses up most of the profits

• For year 6 he starts a new SIPP and does the same for the next 5 years 

Why would there be a need for a new SIPP?

After 5 years the SIPP is put into drawdown so teh 25% tax-free can be accessed. My understanding is this means no no new contributions? 

This almost seems ‘too good to be true’ but as far as I can tell its all legit and hmrc is fine with it ???

HMRC has no issue with it other than the company has to have the profits through trade to get a corporation tax reduction.

Generally, most shareholding directors would be on a mixtures of dividends and salary and any money held personally would already have been taxed at some point.

Many directors are holding back pension contributions this year (unless they max out) with the intention of paying them in the next tax year for obvious reasons on corporation tax.

Personally, dividends comes after the non-taxed salary and company pension contributions so dependent on having 5-k odd of profits to start with.

• John now has 40k in a SIPP which cost 37750 and saved a load of tax

The SIPP still cost £40k but had reliefs off that figure which result in in a tax saving.

So earnings of say £9k, a more normal amount for many limited company directors, would limit the gross contribution to £9,000.

2022/23 is a bit messy as the primary threshold was changed mid year and has given directors the optimum salary of £11,908.  It did star the tax year lower.  23/24 will match the personal allowance.

Agree that 22/23 is messy and a 12.5k salary 24 on wards simplifies things a lot

Thanks Dunstoh for the input. 

Albermarle

My main purpose was to check the principle as it seems strange for the govt to simple give someone earning uptown 12.5k a free 25% as opposed to it being a tax refund on tax paid. Not that I am complaining.

It can seem a bit odd, but in reality the cost of it ( especially as many do not take advantage of it/are unaware of it) will be relatively small, compared to for example the large cost of 40% tax relief for higher earners. You can see it as a concession to lower earners, although whether it was meant like that I have no idea,

Malthusian

fizio said:

My main purpose was to check the principle as it seems strange for the govt to simple give someone earning uptown 12.5k a free 25% as opposed to it being a tax refund on tax paid. Not that I am complaining.

The 25% tax free lump sum is your insurance against the government messing around with the rules.
20% is a historic low for the basic rate of income tax. (Under Thatcher it was as high as 30%.) If the government hiked it to say 25%, people saving into pensions today (assuming the most common scenario of a basic rate taxpayer who doesn't benefit from NI relief) would get 20% tax relief on the way in but pay 25% tax on the way out.
However, thanks to the tax free lump sum, they'd be just ahead, with a final net tax take of 18.75%.
If the Government levied National Insurance on pension income, as is occasionally mooted in the papers, it would mess the equation up even more. 
Pension tax relief is correctly described as "tax deferred" but in practice it should nearly always involve an expectation that tax on the way out < tax relief on the way in.
If tax out = tax relief in then you essentially gain nothing for "locking up" your money in a pension - apart from tax free growth, and that isn't much incentive for hoi polloi who need a lot of money invested to pay income and capital gains tax on investments anyway.
If tax out > tax relief in then your friends down the pub were right and "pensions are a con".
It is in everyone's interests, including the Government's, that people expect to get "free money" from contributing into a pension and not just a refund of tax they are going to pay later anyway. Otherwise they won't do it, and will spend their money and expect the Government (i.e. younger taxpayers) to pick up the tab in retirement. 

dunstonh

Surely the extra free 25% top-up to a personal sips contribution makes this worthwhile? Put in 10k untaxed salary and sip gets 12.5k? I am less worried about dividends as making a company contribution of 30-40k uses up most of the profits

But any dividends you take out suffer corporation tax (which would be as much as 26.5% if profit is over £50k) and dividend tax.   So, using personal money to reduce dividend draws and using the company money to pay into the pension is more tax efficient.

It is very unusual for a shareholding director not to take any dividends.  So, you would be unusual in that respect.   If you continue to be "unusual" then it would work.

After 5 years the SIPP is put into drawdown so teh 25% tax-free can be accessed. My understanding is this means no no new contributions?

No, that is not correct.   Your pension will be segmented between uncrystallised and crystallised but can be within the same pension.