Alpha / classic tax bill

WHUFC123

My close friend is in prison service, she earns just over 78k, has had a pension statement which when double checking seems to indicate over last 3 years she has accrued almost a 45k tax bill, as the annual allowance of 40k has been exceeded hugely in those 3 years, but her actual contributions herself are only about £5400 a year and then employer makes there contributions, but they say they work out using a formula which x16 plus lump sum at retirement age ( which penalises you if planning on leaving earlier as lump sum would be a lot less ) etc
is this right as it seems once you earn above 64k your going to be hit with huge tax bill each year on top of your normal tax , so setting you up to fail, there scheme pays  say it’s too late to apply even though they don’t actually explain what they do anyway. Anyone had experience or know any advice on how to go forward, as friends considering leaving , using a reduced lump sum to pay bill etc, 
thanks

hyubh

WHUFC123 said:

My close friend is in prison service, she earns just over 78k, has had a pension statement which when double checking seems to indicate over last 3 years she has accrued almost a 45k tax bill, as the annual allowance of 40k has been exceeded hugely in those 3 years, but her actual contributions herself are only about £5400 a year and then employer makes there contributions, but they say they work out using a formula which x16 plus lump sum at retirement age ( which penalises you if planning on leaving earlier as lump sum would be a lot less ) etc
is this right as it seems once you earn above 64k your going to be hit with huge tax bill each year on top of your normal tax , so setting you up to fail, there scheme pays  say it’s too late to apply even though they don’t actually explain what they do anyway.

For a defined benefit (DB) scheme, it isn't the amount of contributions, but the increase in the accrued pension at normal retirement age for the scheme that counts. (If you take the civil service scheme specifically - the employee contribution rates are pitiful and bare little relation to the extremely generous pension given.) The Alpha accrual rate is 2.32%, so 78K x 0.0232 x 16 = £28954, so well south of £40K. (Technically the AA is calculated by tax years and you get an allowance for inflation; the flip side, Alpha 'revalues' i.e. is adjusted for inflation too. However the inflation rate used is the same, and the scheme year is 1 April to 31 March which is only slightly different to the tax year.) 

However, there is also Classic to consider, which is final salary. If there is a large jump in pensionable pay, then the value of preceding years in the scheme will retrospectively inflate and this may lead to going over the AA. On the other hand, the accrual rate for Classic is a lot less than Alpha, i.e. each year counts a lot less. 

WHUFC123

Looks like there counting both classic and alpha on paperwork , and adding both coming up at 89k for last year,, 
how long would you get to pay it off if it’s correct, and is there any options as if it’s right the next years will be a massive tax bill too

hyubh

WHUFC123 said:

Looks like there counting both classic and alpha on paperwork , and adding both coming up at 89k for last year,, 
how long would you get to pay it off if it’s correct, and is there any options as if it’s right the next years will be a massive tax bill too

How? Your friend can't be accruing more Alpha and Classic years at the same time. With Classic it's simply the retrospective increase in value following a promotion/higher paid employment in the scheme that will have an affect on the AA calculation. If her pay just goes up by inflation one year, the Classic increase for the AA will be nil and the Alpha increase will be the just under 30K I mentioned before.

Also keep in mind with the AA, unused allowance for the previous three years rolls over.

WHUFC123

There saying the use a formula that 

the benefits you had built up at the end of the previous Pension Input Period and multiply this by a factor defined by HMRC - currently 16.
	Any automatic lump sum that you may be eligible for is added to the amount calculated in Step 1.
Step 3	We adjust the total amount in line with inflation; 2.4% for 2019/20. This is the value at the start of the Pension Input Period.
Step 4	We determine the benefits you had built up at the end of the current Pension Input Period and multiply it by the same factor as used in Step 1.
Step 5	We add any automatic lump sum that you may be eligible for to the amount calculated in Step 4.
Step 6	We deduct the value in Step 3 from the value in Step 5 which gives us your Pension Input Amount.

WHUFC123

They were promoted in 2018, but latest paperwork has increase in both yearly amounts for classic and alpha

hyubh

Because there is a final salary link maintained in respect of the Classic benefits, including the Classic pension (and as you rightly say, lump sum) in the AA calculation is correct since the amount of pension/lump sum may go up or down each year depending on what happens to her pay. However, if there is no pay rise, then the AA input will be nil for Classic since no more Classic years are being added (i.e. the number of eightieths isn't increasing).

In contrast, each year since she moved to Alpha does involve more Alpha years getting added to her pension. Nevertheless, since the 'revaluation' of past Alpha years is CPI, it's only the pension earned in the year that gives an AA input for Alpha (simplifying only very slightly).

Does that make sense? Once it does, she needs to put in the numbers to see whether there actually is an AA charge or not. I'm frankly doubtful at this point in time, and there certainly won't be one since 2018, assuming she hasn't had large bonuses pensionable under Classic.

hugheskevi

My close friend is in prison service, she earns just over 78k, has had a pension statement which when double checking seems to indicate over last 3 years she has accrued almost a 45k tax bill, as the annual allowance of 40k has been exceeded hugely in those 3 years

Hugely exceeded in each of the last 3 years? Has she had 2 or more significant increases in salary? A salary increase usually inflates pension inputs in two financial years, unless the pay increase is close to April, so the full effect falls in a single financial year.

Has she used the HMRC Annual Allowance calculator? And if she breached the £40,000 amount in previous years has she got the pension inputs for the 3 years prior to the first breach, as this is needed to correctly calculate carry-forward.

but her actual contributions herself are only about £5400 a year and then employer makes there contributions, but they say they work out using a formula which x16 plus lump sum at retirement age ( which penalises you if planning on leaving earlier as lump sum would be a lot less ) etc

As explained above, employee and employer contributions are irrelevant. The use of factor 16 is mandated by HMRC.

It does not penalise leaving early, as if leaving early the overall value of the accrued pension is the same, it is just spread over a longer period. Although there are many deficiencies with the crude use of factor 16 for pensions with very different Normal Pension ages and for all members regardless of their age.

is this right as it seems once you earn above 64k your going to be hit with huge tax bill each year on top of your normal tax

It is salaries of £108,000+ that lead to a tax charge every year.

there scheme pays  say it’s too late to apply even though they don’t actually explain what they do anyway.

The Civil Service operates both mandatory and voluntary Scheme Pays, enabling the use of Scheme Pays for any amount in any year. Full information about the Annual Allowance, Pension Saving Statement and Scheme Pays is detailed at this page.

Anyone had experience or know any advice on how to go forward, as friends considering leaving , using a reduced lump sum to pay bill etc,

Make sure you have all the necessary pension inputs, ie the figures for every year since the first breach of the £40,000 limit and the 3 years prior to the first breach. You may need to contact pss@mycsp.co.uk to obtain these. Use these in the HMRC Annual Allowance calculator linked above to find the amount on which tax is due. For years in which a charge is due open/amend Self-Assessment returns to declare the charge and arrange for a Scheme Pays payment to be made to pay the charge.

(Technically the AA is calculated by tax years and you get an allowance for inflation; the flip side, Alpha 'revalues' i.e. is adjusted for inflation too. However the inflation rate used is the same, and the scheme year is 1 April to 31 March which is only slightly different to the tax year.)

Just to note the CPI used to revalue the opening value of the pension input amount is misaligned to the CPI used to revalue alpha. For example, for 2019-20 you use September 2018 CPI to revalue the pension input amount starting value, but the alpha pension is revalued by September 2019 CPI just before the end of the pension input period. This means if inflation is rising the pension input will be higher, and if inflation is falling it will be lower.

Looks like there counting both classic and alpha on paperwork , and adding both coming up at 89k for last year,, 
how long would you get to pay it off if it’s correct, and is there any options as if it’s right the next years will be a massive tax bill too

Separate statements are provided for classic and alpha pensions. The individual pension inputs are added together, along with any other pension savings from other pension arrangements, to give total pension input.

How much carry-forward of unused Annual Allowance from the last 3 years is available to add to the standard £40,000 Annual Allowance?

If a tax charge is due for 2019/20 it has to be paid by 31st January 2021 through Self-Assessment. If using mandatory Scheme Pays this is extended to July 2021 for payment to reach HMRC, but Self-Assessment still has to be completed to the standard deadline. However, as the charge arises from a combination of two pension schemes, mandatory Scheme Pays cannot be used to pay the full charge (but voluntary Scheme Pays can still be used), so at least some of the amount due will be payable by 31st January 2021.

Why is the charge for next year expected to be massive? It is only if your friend has had repeated large pay increases this would be the case.

Are you sure you are calculating the charge correctly - even if your friend had no carry forward available from last 3 years, the breach for 2019/20 would be £49,000 (£89,000 less £40,000 standard allowance) and this would result in a tax charge of £49,000 x 40% = £19,600.

They were promoted in 2018, but latest paperwork has increase in both yearly amounts for classic and alpha

Depending on when in 2018 they were promoted, their pension input amount will be inflated for 2 years, as final pensionable pay in classic is based on salary over last 12 months. This means it takes a year for the full value of a pay increase to be reflected in the value of the classic pension.

If they have a large pension input for 2019/20 they were probably promoted in late 2018, in which case they should not breach in 2020/21 unless their pay increases again.

Assuming a charge is actually due, note that the McCloud judgment and consequent remedy will change all the numbers in future and the tax charge will change, most likely to be lower. Your friend will need to amend her Self-Assessment return and Scheme Pays debit once her pension record is changed, sometime in 2022 or later.

WHUFC123

Hugheskevi,, thank you that is a massive response, and I will pass on , I think last year they got a 6 percent pay rise but looking at there paperwork yesterday there last 3 years has seen increases on alpha and classic boxes,, hence looking at it they think they owe about 40k tax overall as it looks like it’s built up last few years ( I may be looking at it wrongly as May they as paperwork isn’t in layman’s terms or I may just be dumb )
I don’t think any bonus payments have been paid either 

AlanP_2

Do the scheme administrators not include an AA calculation / value as part of the annual statement?

Have the scheme administrators told your friend that she has exceeded the AA?

My wife and I are in the LGPS and all this comes as part of our annual statements so we know exactly where we are, and just need to adjust if SIPPS have benn contributed to during that year as LGPS know nothing about our personal pensions.

For the administrators this stuff is bread and butter and easy to calculate, programmed calculation & print answer in correct box on form. Does CSP not provide this? 

WHUFC123

The statements aren’t very clear / easy to follow, there’s a line that’s says you may have exceeded your allowance and then has a figure but it doesn’t say if you owe tax or how much