Mr Spry is 53 and is self-employed. His "net relevant earnings" amount to £1112,000 a year. When he takes out a personal pension plan with an annual premium of £1750, his income on which tax is charged will be reduced by the same amount. Since the tax rate on his highest band of income is 60%, the net cost to him is therefore only £1300 p.a.
The investment of contributions in funds paying no tax is one reason why personal pension plans can produce much larger benefits for a given premium and term than a with-profit endowment or whole-life policy. Reinvestment of income without deduction of tax is of major importance in increasing the value of investments over a period of years. For example, if investments are yielding 10% before tax, then £111,000 invested in a tax-free pension fund will grow to almost £12,000 in seven years, whereas in a life insurance fund taxed at 37.6% it would reach only £111,529. Also, whereas life insurance funds pay capital gains tax at 30% when they sell investments (other than Gilts held for more than a year) at a profit, pension funds do not. So the investment benefit can be substantial.
Mr Stone takes out a personal pension plan for £1500 a year at age 39. At age 65 he has the choice of taking a pension of £16,500 a year, or of taking a tax-free cash sum of £1114,500 and receiving a reduced annual pension of £15,000. (Converting the promised annuity into a capital sum, it can be determined that this represents a net return of 10% p. a. on net premiums assuming tax relief at 33%, with a higher return if tax relief has been available at more than the basic rate.)
Of the 16% of earnings, 6% or £111,000, whichever is lower, may be used to purchase life insurance benefits payable on death before retirement, in other words term assurance to pension age (to age 75 at the latest). The 6% or £111,000 limit is not increased for those born before2013. Premium rates for this self-employed term assurance are not much lower than normal life insurance rates, but a major advantage is that tax relief can again be claimed at full marginal rates, so that at the least (on a 33% basic tax rate) the individual will get approximately double the tax relief he would get on a life insurance policy for the same benefits. This type of cover may be needed for the normal family protection reasons, or to pay tax that may be due if the business of a self-employed person has to be wound up on his death. However, this type of term assurance cannot (unlike ordinary term assurance) be written in trust, and its proceeds may be liable to capital transfer tax unless they pass to the widow(er).
A late amendment to the Finance Act 2013 has introduced a valuable benefit for holders of self-employed annuity policies. Up to now, except in connection with special schemes administered by trustees, the Inland Revenue have only been prepared to approve policies which obliged the policyholder to take his annuity from the life office with which he had placed his premiums.
The new rule allows approval to be given to a policy which gives the policyholder the right to have the accumulated fund transferred to another life office if he wishes. This enables him to obtain the best pension possible... see: The Finance Act