Going over annual allowance

avdb

Hi,
I have a DB pension and pay into an AVC. In the past I’d never gone over the 40K annual allowance, but this year I have by about £35000! It’s only by using up my carry over that it’s taken it down to £800 over, which I now have to pay tax on. 

It was due I believe to the calculation of final pensionable earnings which factor in RPI & CPI. 

Anyway my question is…is it tax inefficient to go over the annual allowance? (I’m a higher rate tax payer)

Because of what happened this year I’m concerned it may happen again & considering pausing my AVC payments for a little while and putting the saved money elsewhere, and maybe restarting later in the year. 

Thanks for any thoughts!

zagfles

Generally yes, as you effectively get tax relief taken off you and then usually have to pay tax when you withdraw. There could be some circumstances where it makes sense eg if you get more employer contributions or if you're claiming tax credits etc, but generally not.

EdSwippet

avdb said:

... Anyway my question is…is it tax inefficient to go over the annual allowance? (I’m a higher rate tax payer)

Often yes, it is tax inefficient. As zagfles noted, you pay tax on the contributions, and then very likely pay tax again on the withdrawals. Although other effects such as sizeable employer match can offset things, as a rule double-tax is not a recipe for tax efficiency.

If you have the option, you should use 'scheme pays', so that you pay the tax on the over-contribution from within the pension; that is, with pre-tax money. That way, you reduce the bite of double-tax. For example, without 'scheme pays', tax on £100 contribution at 40% and 15% (basic rate after 25% PCLS) on withdrawal comes to (tada!) 55%, leaving you £45. With scheme pays, though, your £100 becomes £60 in the pension, and 15% tax on withdrawal of that leaves you £51, so £6 better.

A pension is only required to offer 'scheme pays' in some circumstances, and yours is probably not one of them. However, some pensions operate voluntary 'scheme pays', so worth using if available to you.

Simes122

I’ve had this query before myself and am still trying to get my head around it being inefficient in a scheme pays environment, with contributions made via Sal sac.

obviously my goal is to maximise any tax relief available in my final year of work.  I’ve used carry forward, and thus want to get every £ of relief which might mean I exceed my annual allowance.

If I do, then use scheme pays, my dc pot will reduce by the tax bill for the relief I should not have had (which is fine - it would otherwise be due tax).  But I’ll have had every £ of relief I should have, and will save 13.25% of NI contributions (because of Sal sac).

if I don’t, and waste tax relief by getting paid it instead, I’ll pay NI and tax along with any forgone tax relief.  I am a HR taxpayer in work, and will be in retirement as I already get a forces pension separately.  

So in either case, I pay the right tax, but using scheme pays, I save NI as well.  

Now I was told before there is a flaw in my logic, and I’d be paying tax twice.  But I haven’t paid tax (or ni) yet on my Sal sac contributions, and will pay tax, no ni on my withdrawals.

So is it really inefficient, or is it maximally efficient tax wise and optimal from an NI perspective to use scheme pays?

cheers, S

EdSwippet

Simes122 said:

If I do, then use scheme pays, my dc pot will reduce by the tax bill for the relief I should not have had (which is fine - it would otherwise be due tax).  But I’ll have had every £ of relief I should have, and will save 13.25% of NI contributions (because of Sal sac).

Maybe worth double-checking your numbers. Most people in higher rate tax have topped out NI contributions, so down from 13.25% to 3.25%. Your forces pension may however mean that you can achieve higher rate tax yet still have full NI contributions. That would be an overall 53.25% loss to the government on your efforts; not a huge encouragement to work there, then.

The other thing to be very careful of is that scheme pays is only mandatory for a provider where you pass the standard £40k annual allowance and your tax bill on the overpayment is £2k or more. Some providers offer voluntary scheme pays, but if planning overcontribution of less than £5k you'll want to be sure yours does.

Anyway, on the numbers given -- that is, 13.25% NI saving, but no employer match or NI uplift -- contributing £100 above the annual allowance to a pension produces £113.25 in the pension. Higher rate tax on that is £45.30. Scheme pays leaves you £67.95 in the pension. On withdrawal, 25% tax free and 75% taxed at 40% leaves you with £47.57. This is barely above the £46.75 you would have got by taking the £100 as income instead. Less than 1% gained, but with all the hassle of pension rules (no access until age 55/57, political risk), scheme pays, making a mistake with the tight numbers, potentially failing to fill a year of NI contributions, and so on.

Your call of course, but if it were me, on those numbers I'd probably pass.

ETA: Incorrect calculations struck through. Still a hard pass, anyway.

Simes122 said:

Now I was told before there is a flaw in my logic, and I’d be paying tax twice.  But I haven’t paid tax (or ni) yet on my Sal sac contributions, and will pay tax, no ni on my withdrawals.

But you have paid tax on your salary sacrifice contributions. It is just that you paid it out of pre-tax income, under scheme pays. You then pay tax a second time on withdrawal. You do avoid NI, but the tax double-dip removes any benefit from that.

Scheme pays is not free money. When you use it, your pension is reduced by an amount equal to the tax paid on your behalf by the scheme.

zagfles

EdSwippet said:

Simes122 said:

If I do, then use scheme pays, my dc pot will reduce by the tax bill for the relief I should not have had (which is fine - it would otherwise be due tax).  But I’ll have had every £ of relief I should have, and will save 13.25% of NI contributions (because of Sal sac).

Maybe worth double-checking your numbers. Most people in higher rate tax have topped out NI contributions, so down from 13.25% to 3.25%. Your forces pension may however mean that you can achieve higher rate tax yet still have full NI contributions. That would be an overall 53.25% loss to the government on your efforts; not a huge encouragement to work there, then.

The other thing to be very careful of is that scheme pays is only mandatory for a provider where you pass the standard £40k annual allowance and your tax bill on the overpayment is £2k or more. Some providers offer voluntary scheme pays, but if planning overcontribution of less than £5k you'll want to be sure yours does.

Anyway, on the numbers given -- that is, 13.25% NI saving, but no employer match or NI uplift -- contributing £100 above the annual allowance to a pension produces £113.25 in the pension. Higher rate tax on that is £45.30. Scheme pays leaves you £67.95 in the pension. On withdrawal, 25% tax free and 75% taxed at 40% leaves you with £47.57. This is barely above the £46.75 you would have got by taking the £100 as income instead. Less than 1% gained, but with all the hassle of pension rules (no access until age 55/57, political risk), scheme pays, making a mistake with the tight numbers, potentially failing to fill a year of NI contributions, and so on.

Don't understand your calcs. You're double counting NI.

£100 sal sac into the pension produces £100 in the pension (assuming no employer match/NI saving paid). Then higher rate scheme pays on £100 leaves £60, then on withdrawal after 25% tax free and 40% tax on 75% produces £42.

Compare with £100 taken as salary, after 13.25% NI and 40% tax would leave £46.75.

Or if OP actually is in the 3.25% NI band, then £56.75.

So either way it doesn't look to be a good idea.

EdSwippet

zagfles said:
Don't understand your calcs. You're double counting NI. 

...

So either way it doesn't look to be a good idea. 

Thanks. I was mixing up employer NI refund with employee NI dodged. Too early; not enough coffee. Original edited.

And yes, of course, hard pass all round. The double-tax more than destroys any benefit from saving employee NI.

Simes122

Ok thanks both - I’m seeing the problem with scheme pays.  

As additional info, I’m in Scotland as well.  My forces pension is about £36.5k gross, and the HR threshold up here is £43662.  For obvious reasons, I can only Sal sac down to min wage, but that plus my forces pension means anything I don’t Sal sac to min wage is taxed at 41%.   So I Sal sac to the max (min wage) to avoid that problem.    There is a double whammy with the Scottish system in that the NI threshold is £50k.  So between £43k and £50k earnings, you only receive £45.75 for every £100 earned - so clearly sacrificing to the max is my best option otherwise I’m on less than half pay here in Scotland. 

But, then I run out of annual allowance, which I absolutely want to fully exploit in my last year, otherwise I’m giving up lots of tax and NI needlessly.

so if scheme pays is not the answer, is ‘me pays’ a better option (to ensure I’ve used the full £40k AA?)

Id save the NI because that would have disappeared via Sal sac.  I’m answering my own question I realise I think…..id be paying tax with money id already paid tax on, or but…with potentially my tax free drawdown.  Let’s assume the latter.  Id only then be paying back relief I shouldn’t have had, but would have saved 13.25% NI in the process?

Im not talking huge overpayments above annual allowance (unless that was advantageous) - just enough to ensure I used every drop of the £40k AA in my final year of employment.  Would that be more efficient than forgoing any available AA? Thanks!

Exotoxin1

EdSwippet said:

Scheme pays is not free money. When you use it, your pension is reduced by an amount equal to the tax paid on your behalf by the scheme.

In my NHS England/Wales schme, Scheme Pays is charged for at CPI+2.4% each year. So incurring a Scheme Pays debt for 20 years say is a lot of real interest charge, so it's not simply "your pension is reduced by an amount equal to the tax paid on your behalf by the scheme".

Grumpy_chap

Simes122 said:

As additional info, I’m in Scotland as well.  My forces pension is about £36.5k gross, and the HR threshold up here is £43662.  For obvious reasons, I can only Sal sac down to min wage, but that plus my forces pension means anything I don’t Sal sac to min wage is taxed at 41%.   So I Sal sac to the max (min wage) to avoid that problem.   

so if scheme pays is not the answer, is ‘me pays’ a better option (to ensure I’ve used the full £40k AA?)

AIUI, the annual allowance is usually reduced for anyone already drawing pension benefits.  However, please note the inclusion of "usually" as there are some factors that may be different in the case stated:

• Scotland not England
• Forces pensions might be treated differently to any general DC (or DB) pension

Sorry, this is a bit of a vague comment, but I wanted to draw attention so that this is something you can investigate and confirm.

Simes122

Grumpy_chap said:

Simes122 said:

As additional info, I’m in Scotland as well.  My forces pension is about £36.5k gross, and the HR threshold up here is £43662.  For obvious reasons, I can only Sal sac down to min wage, but that plus my forces pension means anything I don’t Sal sac to min wage is taxed at 41%.   So I Sal sac to the max (min wage) to avoid that problem.   

so if scheme pays is not the answer, is ‘me pays’ a better option (to ensure I’ve used the full £40k AA?)

AIUI, the annual allowance is usually reduced for anyone already drawing pension benefits.  However, please note the inclusion of "usually" as there are some factors that may be different in the case stated:

• Scotland not England
• Forces pensions might be treated differently to any general DC (or DB) pension

Sorry, this is a bit of a vague comment, but I wanted to draw attention so that this is something you can investigate and confirm.

Thanks - If you mean the MPAA, this is not triggered by withdrawals from a DB scheme (Forces pension is DB). I’m not aware of any reduction in the AA that would apply here.