Pension Actuarial Reduction Buy Out and the Pension Annual Allowance

Fixtheroof

I am considering using the money from my forthcoming redundancy to buy out the actuarial reduction in my final salary based pension, which would be being paid early.
I am stumped on how to calculate how much of my pension annual allowance (and unused relief from previous years) this would use up. Is it simply the monetary cost of the buyout, or is there some other method of calculation? (I don't want to assume anything here, as I know pensions rules are complex)
I have asked the Which money advice service, the Pension Advisory Service, and consulted the Pensions Tax Manual available on gov.uk, but so far no definitive answer.
Any informed advice greatly appreciated.

xylophone

Have you asked your DB Pension Administrator?

Fixtheroof

Yes. That was several weeks ago. No answer yet, although I have sent a reminder now

hugheskevi

I am stumped on how to calculate how much of my pension annual allowance (and unused relief from previous years) this would use up. Is it simply the monetary cost of the buyout, or is there some other method of calculation? (I don't want to assume anything here, as I know pensions rules are complex)

The HMRC Annual Allowance calculation does not take account of Normal Pension age. It simply takes the annual value of unreduced pension payable at the start and end of the pension input period. Buying out an actuarial reduction does not change the headline rate of pension entitlement, and therefore does not lead to a pension input under the HMRC valuation methodology.

The cost of buy-out may be in excess of £100,000 but the input arising from that will be nil.

This is somewhat similar to how the Lifetime Allowance is calculated, in that for LTA purposes it is the value of pension put into payment which is used in HMRC methodology. Hence if you were to take an actuarial reduction to have the pension early, HMRC methodology will value it as being of less value than a higher pension paid from a later age (despite the overall value being the same, as the reduction is actuarial).

To give you a reference to confirm this, look at this link - http://www.civilservicepensionscheme.org.uk/media/35525/epn298-annex-a.pdf

Buying out the reduction on pension benefits will not affect the member’s Annual Allowance calculation regardless of whether they are using their severance payment or own money or a combination of both to buy out the reduction.

zagfles

hugheskevi wrote: »

The HMRC Annual Allowance calculation does not take account of Normal Pension age. It simply takes the annual value of unreduced pension payable at the start and end of the pension input period. Buying out an actuarial reduction does not change the headline rate of pension entitlement, and therefore does not lead to a pension input under the HMRC valuation methodology.

The cost of buy-out may be in excess of £100,000 but the input arising from that will be nil.

This is somewhat similar to how the Lifetime Allowance is calculated, in that for LTA purposes it is the value of pension put into payment which is used in HMRC methodology. Hence if you were to take an actuarial reduction to have the pension early, HMRC methodology will value it as being of less value than a higher pension paid from a later age (despite the overall value being the same, as the reduction is actuarial).

To give you a reference to confirm this, look at this link - http://www.civilservicepensionscheme.org.uk/media/35525/epn298-annex-a.pdf

Sounds logical, after all employee contributions to a DB scheme don't count torwards the AA, the increase in pension value does.

However if the buyout cost exceeded 100% of earnings (inc the taxable part of redundancy), then I don't think the OP would be entitled to tax relief on the excess.

Fixtheroof

A pension input amout of nil seems well founded, and I thank hugheskevi for his post. In this case the buyout does exceed 100% of earnings (zagfles post above) for two reasons, which I suspect will not be atypical:
a) The pension would be being paid several years early
b) There would only be part year earnings for the year of the buyout
so I would request some further clarification on that point.
1. Is the suggestion that where the cost of the buyout exceeds earnings that excess is subject to tax at marginal rate as excess pension payment?
2. Can unused pension annual allowance from previous years be used to mitigate the potential charge.?
I must confess I thought I understood the position when it was suggested the pension input amount was nil with an actuarial reduction buyout, but am now a little confused again.
Is the suggestion that there is an effective pension charge on the excess cost of the buyout less earnings for pension allowance purposes?

GDB2222

Would the OP want to take £30k of his redundancy money tax free?

If the rest goes into the pension scheme, is that really a personal contribution at all? It's going direct from the company to the pension scheme.

zagfles

Fixtheroof wrote: »

A pension input amout of nil seems well founded, and I thank hugheskevi for his post. In this case the buyout does exceed 100% of earnings (zagfles post above) for two reasons, which I suspect will not be atypical:
a) The pension would be being paid several years early
b) There would only be part year earnings for the year of the buyout
so I would request some further clarification on that point.
1. Is the suggestion that where the cost of the buyout exceeds earnings that excess is subject to tax at marginal rate as excess pension payment?

No. You just wouldn't get tax relief on it. But unless it's a RAS scheme you wouldn't get relief on anything taking your income below the personal allowance anyway. How is it being paid?

2. Can unused pension annual allowance from previous years be used to mitigate the potential charge.?

No. The annual allowance isn't the issue, as per above. The 100% of earnings tax relief limit is completely separate to the AA, and there is no carry forwards.

I must confess I thought I understood the position when it was suggested the pension input amount was nil with an actuarial reduction buyout, but am now a little confused again.
Is the suggestion that there is an effective pension charge on the excess cost of the buyout less earnings for pension allowance purposes?

No, no charge but no tax relief on any excess over 100% of relevant earnings. Note - as above "relevant earnings" includes the taxable part of redundancy.

https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm044100

Fixtheroof

Yes, I am told it would be a direct employer contribution into the pension. In this case it would use up all of the redundancy (hence £30k alllowance would not apply) and I would need to fund the balance of the buyout from my own savings. Hope that clarifies.