Tax on annual pension allowance excess and salary sacrifice

mike12738561

Hello,

I understand that the tax due when exceeding the annual allowance is the marginal rate of income tax (i.e. 20%, 40%, or 45%).

When paying into a pension via salary sacrifice, is this the only explicit and implicit tax due?

Assuming someone with a £40K annual allowance that earns £100K, and pays £60K into their pension via salary sacrifice, then I can see three additional possibilities:
 - employer national insurance avoided due to salary sacrifice (13.8% of £20K)
 - employee national insurance (2% of £20K)
 - personal allowance reduction (£12570 -> £0), resulting in >60% marginal tax rate

Or, as the person in this example has a gross salary of £100K after salary sacrifice, will the total tax due just be 40% of £20K, i.e. £8K?

Linton

What you pay into a pension via salary sacrifice is an employer contribution and so should not affect your taxation if you make no other pension contributions.   You are not getting any tax reduction and so cannot have one removed.

What happens if your employer exceeds your annual allowance I am not sure.  Looking at https://thepeoplespension.co.uk/help/knowledgebase/maximum-employers-contribution/ it seems that the employer may be stopped from including the excess as an allowable business expense which may upset them but it's a complex matter.  Perhaps your employer has rules to stop that happening.

Dead_keen

mike12738561 said:

Hello,

I understand that the tax due when exceeding the annual allowance is the marginal rate of income tax (i.e. 20%, 40%, or 45%).

When paying into a pension via salary sacrifice, is this the only explicit and implicit tax due?

Assuming someone with a £40K annual allowance that earns £100K, and pays £60K into their pension via salary sacrifice, then I can see three additional possibilities:
 - employer national insurance avoided due to salary sacrifice (13.8% of £20K) There is no employer's NIC on either the whole of the £60k (so the £40k annual allowance and the £20k excess).  For larger employers, there is also a 0.5% apprenticeship levy saving.
 - employee national insurance (2% of £20K) Again, no employee's NIC on the whole £60k
 - personal allowance reduction (£12570 -> £0), resulting in >60% marginal tax rate With the numbers you have chosen, the £60k sacrfice will (ignoring the extra annual allowance pension tax charge for now) bring someone down from the 60% marginal income tax rate to the 20% marginal income tax rate.  However, the £20k charge on exceeding the annual allowance is treated as extra income.  So if I simplistically assume that the 40% threshold is at £50k then £10k will be taxed at 20% and the next £10k taxed at 40%.

Or, as the person in this example has a gross salary of £100K after salary sacrifice, will the total tax due just be 40% of £20K, i.e. £8K?  Your example changes.  If you mean:

a. £40k after salary sacrfice then (roughly) £10k is taxed at 20% and roughly £10k is taxed at 40% - so £6k of tax (ignoring that the 40% threshold kicks is £50,270 for convenience).  I

b. £100k after salary sacrifice then the £20k will effectively be taxed at 60% (so £12k of tax).

See bits in bold above.

Dead_keen

Linton said:

What you pay into a pension via salary sacrifice is an employer contribution and so should not affect your taxation if you make no other pension contributions.   

No, that is not right.  The pensions tax charge is always on the individual, even if the employer makes the contributions.  There is scheme pay that means that the pension scheme can pay the tax.  But it is the individual's tax liability to start with.

What happens if your employer exceeds your annual allowance I am not sure.  Looking at https://thepeoplespension.co.uk/help/knowledgebase/maximum-employers-contribution/ it seems that the employer may be stopped from including the excess as an allowable business expense which may upset them but it's a complex matter.  Perhaps your employer has rules to stop that happening.

Nothing happens.  The employer can make contributions in excess of the annual allowance. For a normal employee, the employer will get its tax deduction. With these numbers, if the employee is also the 100% shareholder, it will get its tax deduction.  

mike12738561

Hello,

Perhaps the wording of my example was poor.

I meant someone earning 100K after the 60K salary sacrifice (not someone earning 100K then sacrificing 60K).

mike12738561

Dead_keen said:

b. £100k after salary sacrifice then the £20k will effectively be taxed at 60% (so £12k of tax).

From this, I understand you consider that the excess pension contribution of £20K will be added to the gross salary of £100K, resulting in a loss of personal allowance and a marginal tax rate of >60%?

Dead_keen

mike12738561 said:

Dead_keen said:

b. £100k after salary sacrifice then the £20k will effectively be taxed at 60% (so £12k of tax).

From this, I understand you consider that the excess pension contribution of £20K will be added to the gross salary of £100K, resulting in a loss of personal allowance and a marginal tax rate of >60%?

Actually, it looks like there is no loss of personal allowance with the pensions annual allowance charge.  On the basis that I'm retired and am just skimming the legisaltion on line...

The annual allowance charge is taxed at the individual's marginal rate (so 20%, 40%, 45%) to the extent it is in the band (my £10k at 20% and £10k at 40%) example.  This is s227(41) FA 2004 - https://www.legislation.gov.uk/ukpga/2004/12/section/227  But this is a strange way for the tax system to tax something. This strange way may mean that the annual allowance is not tapered away.

The personal allowance is set out in s35 ITA 2007 and this is where the taper is.  It is based on "adjusted net income" and this is, itself, based on "net income".  The term "net income" is defined in Step 2 of s23 ITA, the personal allowance is then deducted in Step 3.  The annual allowance tax due is then added to the tax due in Step 5 (by virtue of s30 ITA). 

So this means that method for calculating the taper of the personal allowance doesn't count the pension annual allowance tax charge.  I might be wrong as I'm skimming this before a dog walk.  But you might be lucky and only have to pay the tax at the 40% rate.

mike12738561

Sounds like I will need to study the legislation in depth.

Strange that this isn't common knowledge - I would think a lot of people must end up paying in more than their annual allowance via salary sacrifice.

NoMore

mike12738561 said:

Sounds like I will need to study the legislation in depth.

Strange that this isn't common knowledge - I would think a lot of people must end up paying in more than their annual allowance via salary sacrifice.

AA can also be extended by using the last 3 years unused AA, and as you don't have to declare this, some people will use it without even realising. Although I think your employer is supposed to inform you if your breaking the AA via their contributions (not including the 3 years previous)

mike12738561

Yes, that was what I originally intended to do, until I found out that my overseas pension wont be recognised, and there is some extra law that says that carry forward can only be used if you have a UK pension or a "qualifying" overseas pension. I consider this extra rule highly discriminatory, and its existence has led me to try to understand what I can do, without paying two thirds of my extra pension contributions as tax.

Dead_keen

NoMore said:

AA can also be extended by using the last 3 years unused AA, and as you don't have to declare this, some people will use it without even realising. Although I think your employer is supposed to inform you if your breaking the AA via their contributions (not including the 3 years previous)

If you're a member of a registered pension scheme, even if not contributed for many years, then you are right that you can carry forward unused AA from previous years.  However, the tapering of the AA would reduce that for many high earners (especially pre-6 April 2020).

I am not aware of any obligation on the employer to notify someone that they have exceeded their AA.  From a practical perspective, the tax rules means that it is not possible for an employer to know this (since the taper is not just based on income from a single employment).