Calculating Annual Allowance for DB pensions

michaels

hugheskevi said:

michaels said:

hugheskevi said:

michaels said:

hugheskevi said:

michaels said:

hugheskevi said:

So this starting value is simply the value of my pension (the closing balance) on my Statement as of 31/3/2021.

No, it is the closing value on the Statement (which includes the annual uplift of 0.5%) plus the accrual between 1/4/21 and 5/4/21 (inclusive), and to all of that an uplift of 0.5% is applied to generate the starting value.

Question - is this just the value of Step 3 plus the new accrued benefits (2.32% of pensionable salary), or do I need to adjust for 3.1% CPI inflation here too?

It is the value as at 5/4/2022 that is used, which will include the 3.1% inflation increase as well as service between 1/4/22 and 5/4/22 (inclusive), so yes, you include the 3.1% uplift.

Also, if you are affected by 2015 Remedy, all this becomes academic as your pension input will in due course become based on your legacy scheme.

I'm confused now - does the CPI uplift on your existing entitlement count against the AA - Suppose you have 25k entitlement and a 10% CPI uplift to 27.5k then 2.5k uplift x 16 means any contributions take you over the AA?!

The CPI uplift counts, simply as it forms your benefit entitlement. HMRC don't care how the level of benefit as at 5th April is calculated, they only care what the entitlement is on that date.

HMRC ensure you are not taxed on inflation by uplifting the starting value by inflation, although differences in date of CPI measurement may create differences. For example, for 2021/22, the pension is increased by September 2021 CPI shortly before the end of the year, whereas the Pension Input starting value is increased by September 2020 CPI. But with carry-forward it should be neutral over time in many circumstances.

Thanks

So checking I have got this correct, it is the difference between the Sep 2020 CPI uplift that the revenue applies to the annual pension value at 5th April 21 and the Sep 21 CI uplift applied to this plus any accrual during 21/22FY that can cause the problem - and could mean that someone who doesn't accrue any additional pension but simply has a decent size DB already earned might see an AA charge that they could not avoid if the differential between the two inflation rates was large enough?!

For example, accrued DB pension of 40k with no further contributions, inflation in Sep 21 3.1%, inflation in Sep 22 8.2%, actual inflation increases is 2.6k more than the calculated increase based on the Sep 21 inflation figure, 2.6k times 16 > 40k so with no carry forward then AA is exceeded?!

Correct principle, but if someone didn't accrue anything at all it is likely they are a deferred member, and hence would get the deferred member carve-out and have a nil pension input.

On second para (and ignoring deferred member carve out), starting value would be £40,000 x 3.1% = £41,240. Closing value would be £40,000 x 1.082 = £43,280. An increase of £2,040, which multiplied by 16 is £32,640. I'm not sure exactly where the £2.6K comes from?

Following on from that, do I need to factor in inflationary rises for my other two DB schemes that are long in deferment when calculating my Annual Allowance usage, or only the scheme(s) I've actually contributed to in that year?

No, due to deferred member carve-out.

Thanks again for the info, it was supposed to be 50k so that 5% inflation differential gave more than 2.5k to make the calcs work.

Making things more complicated.  I am joining Alpha in 22/23.  I am planning to do two things:
1) Transfer in DC to purchase DB of 20k
Add to the 2.32% enough extra contributions to take the accrued new pension to 2.5k based on the 2) AA limit (I have no carry forward)

Will this inflation uplift impact on my ability to do so?  My entitlement as at the start of the tax year is zero as I don't join until mid April.

Thanks for any advice or suggestions of where I could get advice.

The transfer doesn't produce any pension input in the first year (ref here).

The whole of pension built up by 31/3/2023 will be indexed by September CPI, and your starting value is zero. So assume inflation is 8%. If you had £2,314 of pension arising from normal accrual and Added Pension, that would be increased by 8% to £2,500 on 31/3/2022. There would then be accrual between 1-5 April 2023, which would reduce the amount you could have. Presumably you would also purchase maximum EPA, as that does not have any pension input.

Thanks so much, so if I aim for say 2250 and keep an eye on September's inflation figure that should be OK - can added pension contributions be amended during the year in case the September inflation figure comes into play higher than anticipated?

I am going for transfer in rather than EPA as this can come from my DC.  SO is it the case that EPA does not contribute to AA at all (and why not)?  How about lifetime allowance?

hugheskevi

michaels said:

hugheskevi said:

michaels said:

hugheskevi said:

michaels said:

hugheskevi said:

michaels said:

hugheskevi said:

So this starting value is simply the value of my pension (the closing balance) on my Statement as of 31/3/2021.

No, it is the closing value on the Statement (which includes the annual uplift of 0.5%) plus the accrual between 1/4/21 and 5/4/21 (inclusive), and to all of that an uplift of 0.5% is applied to generate the starting value.

Question - is this just the value of Step 3 plus the new accrued benefits (2.32% of pensionable salary), or do I need to adjust for 3.1% CPI inflation here too?

It is the value as at 5/4/2022 that is used, which will include the 3.1% inflation increase as well as service between 1/4/22 and 5/4/22 (inclusive), so yes, you include the 3.1% uplift.

Also, if you are affected by 2015 Remedy, all this becomes academic as your pension input will in due course become based on your legacy scheme.

I'm confused now - does the CPI uplift on your existing entitlement count against the AA - Suppose you have 25k entitlement and a 10% CPI uplift to 27.5k then 2.5k uplift x 16 means any contributions take you over the AA?!

The CPI uplift counts, simply as it forms your benefit entitlement. HMRC don't care how the level of benefit as at 5th April is calculated, they only care what the entitlement is on that date.

HMRC ensure you are not taxed on inflation by uplifting the starting value by inflation, although differences in date of CPI measurement may create differences. For example, for 2021/22, the pension is increased by September 2021 CPI shortly before the end of the year, whereas the Pension Input starting value is increased by September 2020 CPI. But with carry-forward it should be neutral over time in many circumstances.

Thanks

So checking I have got this correct, it is the difference between the Sep 2020 CPI uplift that the revenue applies to the annual pension value at 5th April 21 and the Sep 21 CI uplift applied to this plus any accrual during 21/22FY that can cause the problem - and could mean that someone who doesn't accrue any additional pension but simply has a decent size DB already earned might see an AA charge that they could not avoid if the differential between the two inflation rates was large enough?!

For example, accrued DB pension of 40k with no further contributions, inflation in Sep 21 3.1%, inflation in Sep 22 8.2%, actual inflation increases is 2.6k more than the calculated increase based on the Sep 21 inflation figure, 2.6k times 16 > 40k so with no carry forward then AA is exceeded?!

Correct principle, but if someone didn't accrue anything at all it is likely they are a deferred member, and hence would get the deferred member carve-out and have a nil pension input.

On second para (and ignoring deferred member carve out), starting value would be £40,000 x 3.1% = £41,240. Closing value would be £40,000 x 1.082 = £43,280. An increase of £2,040, which multiplied by 16 is £32,640. I'm not sure exactly where the £2.6K comes from?

Following on from that, do I need to factor in inflationary rises for my other two DB schemes that are long in deferment when calculating my Annual Allowance usage, or only the scheme(s) I've actually contributed to in that year?

No, due to deferred member carve-out.

Thanks again for the info, it was supposed to be 50k so that 5% inflation differential gave more than 2.5k to make the calcs work.

Making things more complicated.  I am joining Alpha in 22/23.  I am planning to do two things:
1) Transfer in DC to purchase DB of 20k
Add to the 2.32% enough extra contributions to take the accrued new pension to 2.5k based on the 2) AA limit (I have no carry forward)

Will this inflation uplift impact on my ability to do so?  My entitlement as at the start of the tax year is zero as I don't join until mid April.

Thanks for any advice or suggestions of where I could get advice.

The transfer doesn't produce any pension input in the first year (ref here).

The whole of pension built up by 31/3/2023 will be indexed by September CPI, and your starting value is zero. So assume inflation is 8%. If you had £2,314 of pension arising from normal accrual and Added Pension, that would be increased by 8% to £2,500 on 31/3/2022. There would then be accrual between 1-5 April 2023, which would reduce the amount you could have. Presumably you would also purchase maximum EPA, as that does not have any pension input.

Thanks so much, so if I aim for say 2250 and keep an eye on September's inflation figure that should be OK - can added pension contributions be amended during the year in case the September inflation figure comes into play higher than anticipated?

I am going for transfer in rather than EPA as this can come from my DC.  SO is it the case that EPA does not contribute to AA at all (and why not)?  How about lifetime allowance?

You cannot change monthly Added Pension payments during the year. You also cannot make a lump sum payment in your first 12 months of scheme membership. However, perhaps you could take advantage of carry-forward, setting a safe contribution rate for 2022/23 and then using up whatever is left unused in 2023/24?

A transfer is completely separate from Added Pension and EPA. EPA reduces the NPA, and HMRC only look at annual pension payable, not the age from which it is payable (so a pension payable at 60 is valued by HMRC as the same as one payable from 67). Hence purchasing EPA has no effect on Annual Allowance.

EPA does affect Lifetime Allowance however. Many misunderstand this though, and think it does not. However, as LTA is based on pension put into payment, the act of purchasing EPA means your pension is higher due to purchasing EPA than it would have been had you not purchased EPA, and hence your LTA usage is higher. It only doesn't have an effect if you work less by only working until you meet a particular income requiremen as a result of purchasing EPA - but that argument would apply to any form of pension contribution (ie if you made higher DC contributions to retire early the effect would be the same, but clearly DC contributes to LTA).

NedS

I'm still confused - or rather I'm still not sure I am performing the calculations correctly (and thank you @hugheskevi, you have the patience of a saint in answering all of our questions).

I have spent hours reading the Pension Tax Manual and other internet sources trying to find a worked example for a CARE scheme (like Alpha). There are loads of worked examples for Final Salary schemes, and those make perfect sense (e.g, https://www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm053320#IDAT4PMB )

Perhaps we could run through a worked example here for CARE (Alpha).

The first complication is due to the Alpha scheme year running until 31st March each year and the Pension Input Period being aligned to the tax year, thus running to 5th April. For now, to simplify matters, lets ignore any accrual between 1-5th April (I can always add that in later once I understand the rest of the calculation). It is the application of CPI inflation that is confusing me.

Lets look at an example for tax year 2020-2021 as I have these numbers.

To calculate my opening value (step 1), I need the value of my benefits at 5/4/2020. I have a pension statement for Alpha at 31/3/2020 which states a 'closing' balance of £2,967. This comprises the opening balance from the previous year + accrual for the year + the scheme rules increase of CPI inflation added (1.7% as per Sept 2019). Multiply this by 16 equals £47,472

The next step (step 2) is to add any lump sum amount, zero in my case.

Step 3 is to increase by CPI inflation (of previous Sept) 1.7% - this is what is confusing me as the scheme rules have already uplifted by CPI 1.7% so this is effectively being applied twice?? Anyway, increasing by 1.7% = £47,472 * 1.017 = £48,279. This is my opening value at 5/4/2020 (ignoring any accrual between 1-5th April)

Step 4 is to determine the closing value at 5/4/2021. My Alpha statement at 31/3/2021 shows £4671. This comprises the opening balance from the previous year (£2967 above) + accrual for the year + the scheme rules increase of CPI inflation added (0.5% as per Sept 2020). Multiply this by 16 equals £74,736. This is my closing value at 5/4/2021 (ignoring any accrual between 1-5th April)

The next step (step 5) is to add any lump sum amount, zero in my case.

The final step (step 6) is to deduct the opening value from closing value, £74,736 - £48,279 = £26,457

Is this correct?

Dealing with accrual between 1-5th April, I would calculate this as (annual salary * 2.32%)/365*5 = £X. I would add this to the opening and closing values in step1 and step 4 before multiplying the overall figure by 16. Ignoring this for now will have negligible effect on the overall calculation.

So what is really confusing me is that the CPI inflation is effectively applied twice for the opening value, once under scheme rules on 31/3/2020 and again at step 3 of the calculation, whereas the closing value has only had uplift for inflation applied once under scheme rules on 31/3/2021 (e.g there is no equivalent of step 3 when calculating the closing value)

michaels

More questions - if my plan is to put my pension into payment at 55 (in order to make the allocation to DW so we both have the same entitlement), what does EPA do for this - is it of no value as it only reduces the payment age to 65 form 67 or does it affect the reduction factors?  If the latter, is it cost effective - bearing in mind the AA advantage discussed?

hugheskevi

NedS said:

Step 3 is to increase by CPI inflation (of previous Sept) 1.7% - this is what is confusing me as the scheme rules have already uplifted by CPI 1.7% so this is effectively being applied twice?? Anyway, increasing by 1.7% = £47,472 * 1.017 = £48,279. This is my opening value at 5/4/2020 (ignoring any accrual between 1-5th April)

Just consider it a coincidence that they use the same CPI figure. The scheme rules could say, for example, a flat 2.5% increase applies each year, or that it increases with RPI, or whatever.

The key thing is the scheme does one thing, and HMRC has its own entirely separate calculation process that deals with all schemes, regardless of what their individual scheme rules say about revaluation. The scheme only cares about applying inflation uplifts as set out in scheme rules. HMRC is only concerned about not taxing inflation, and doesn't care how the figures which are plugged into the calculation are arrived at.

Is this correct?

Yes.

hugheskevi

michaels said:

More questions - if my plan is to put my pension into payment at 55 (in order to make the allocation to DW so we both have the same entitlement), what does EPA do for this - is it of no value as it only reduces the payment age to 65 form 67 or does it affect the reduction factors?  If the latter, is it cost effective - bearing in mind the AA advantage discussed?

EPA would reduce the actuarial factor applied - the factors include allowance for EPA and are set out at this link.

The price is identical to the price of Added Pension, as it is all calculated using the same actuarial factors. You pay an amount of money and get an annual pension in return, whether you buy Added Pension or EPA. If you buy added pension you can take that early and should achieve much the same outcome as EPA, and if you buy EPA you can take that late with actuarial uplift and achieve much the same outcome as Added Pension.

There are some marginal differences, eg, EPA doesn't improve survivor benefits or ill health benefits should you suffer something prior to taking pension, but these are a very small part of the overall value.

NedS

hugheskevi said:

NedS said:

Step 3 is to increase by CPI inflation (of previous Sept) 1.7% - this is what is confusing me as the scheme rules have already uplifted by CPI 1.7% so this is effectively being applied twice?? Anyway, increasing by 1.7% = £47,472 * 1.017 = £48,279. This is my opening value at 5/4/2020 (ignoring any accrual between 1-5th April)

Just consider it a coincidence that they use the same CPI figure. The scheme rules could say, for example, a flat 2.5% increase applies each year, or that it increases with RPI, or whatever.

The key thing is the scheme does one thing, and HMRC has its own entirely separate calculation process that deals with all schemes, regardless of what their individual scheme rules say about revaluation. The scheme only cares about applying inflation uplifts as set out in scheme rules. HMRC is only concerned about not taxing inflation, and doesn't care how the figures which are plugged into the calculation are arrived at.

Is this correct?

Yes.

Brilliant - thank you so much, your explanation makes perfect sense.

I will plug this model into my spreadsheet and should now hopefully be good to go.

michaels

hugheskevi said:

michaels said:

More questions - if my plan is to put my pension into payment at 55 (in order to make the allocation to DW so we both have the same entitlement), what does EPA do for this - is it of no value as it only reduces the payment age to 65 form 67 or does it affect the reduction factors?  If the latter, is it cost effective - bearing in mind the AA advantage discussed?

EPA would reduce the actuarial factor applied - the factors include allowance for EPA and are set out at this link.

The price is identical to the price of Added Pension, as it is all calculated using the same actuarial factors. You pay an amount of money and get an annual pension in return, whether you buy Added Pension or EPA. If you buy added pension you can take that early and should achieve much the same outcome as EPA, and if you buy EPA you can take that late with actuarial uplift and achieve much the same outcome as Added Pension.

There are some marginal differences, eg, EPA doesn't improve survivor benefits or ill health benefits should you suffer something prior to taking pension, but these are a very small part of the overall value.

Thanks - so the return on EPA and added pension are the same but EPA has no no AA consequence whereas added pension does?  (or be it at the expense of EPA not giving any uplift to survivors benefit nor ill health benefit that only apply before the pension is taken)

In terms of the amount of EPA I can purchase - is it basically enough to make the standard 2.32% accrual payable 2 years only?  Is it also possible to add EPA to any added pension purchased in the year? So many questions 

hugheskevi

michaels said:

hugheskevi said:

michaels said:

More questions - if my plan is to put my pension into payment at 55 (in order to make the allocation to DW so we both have the same entitlement), what does EPA do for this - is it of no value as it only reduces the payment age to 65 form 67 or does it affect the reduction factors?  If the latter, is it cost effective - bearing in mind the AA advantage discussed?

EPA would reduce the actuarial factor applied - the factors include allowance for EPA and are set out at this link.

The price is identical to the price of Added Pension, as it is all calculated using the same actuarial factors. You pay an amount of money and get an annual pension in return, whether you buy Added Pension or EPA. If you buy added pension you can take that early and should achieve much the same outcome as EPA, and if you buy EPA you can take that late with actuarial uplift and achieve much the same outcome as Added Pension.

There are some marginal differences, eg, EPA doesn't improve survivor benefits or ill health benefits should you suffer something prior to taking pension, but these are a very small part of the overall value.

Thanks - so the return on EPA and added pension are the same but EPA has no no AA consequence whereas added pension does?  (or be it at the expense of EPA not giving any uplift to survivors benefit nor ill health benefit that only apply before the pension is taken)

In terms of the amount of EPA I can purchase - is it basically enough to make the standard 2.32% accrual payable 2 years only?  Is it also possible to add EPA to any added pension purchased in the year? So many questions 

The price takes into account all the secondary effects, so the expected value is the same (ie for a given contribution EPA should be marginally more advantageous than Added Pension in terms of annual pension, due to the lack of ill health and survivor benefits).

The maximum EPA you can purchase is to reduce the main pension to be payable from Normal Pension age -2, so age 65 unless State Pension age changes. You cannot reduce the NPA of Added Pension.