Is CPI included when calculating pension input for Annual Allowance (Alpha Defined Benefit pension)

pathsofdarkness

Objective: I would like to calculate my pension input in terms of the Annual Allowance for the 2021/22 tax year.

Problem: I'm confused about whether or not I include inflation as part of what I accrued during the year when it comes to the pension input amount at the end of the year.

Aside: I know I haven't gone over the AA this year but I need to understand the calculation so that I can figure out if I'm going to exceed the AA during the 2022/23 tax year due to high inflation. 

Additional Information: I am in the Civil Service Alpha defined benefit pension scheme. I earn £46k per year and my carry over from previous years is capped at £6k for the 2021/22 tax year due to my salary. Here is what I have accrued during last two years according to my Annual Benefit statement:



Question: In step 4 below, do I use my closing balance for 2021/22 (£12,692) or do I use the pre-adjusted amount (£12,310)? This is the part which is really confusing me. I have taken the method for calculating pension input from the Civil Service Pensions website: https://www.civilservicepensionscheme.org.uk/your-pension/yearly-pension-update/pension-saving-statement/annual-allowance/ 



Kind regards,
PoD

hugheskevi

pathsofdarkness said:

Objective: I would like to calculate my pension input in terms of the Annual Allowance for the 2021/22 tax year.

You will not be able to do it precisely, as you do not know what your payroll reports for salary between 1-5 April each year. However, this should be of little significance in the calculation so you can get very close, particularly as the opening balance also has 1-5 April accrual from the previous year added to it so it is omitted from both sides of the equation.

You can request a Pension Saving Statement to give you the exact figure to validate your calculation.

Additional Information: I am in the Civil Service Alpha defined benefit pension scheme. I earn £46k per year and my carry over from previous years is capped at £6k for the 2021/22 tax year due to my salary. Here is what I have accrued during last two years according to my Annual Benefit statement:

A salary of £46,000 gives a pension input each year of around £17,000 - are you making additional pension contributions? Accrual of £1,998 pension is consistent with a salary of £86,000 if not making additional contributions?

You can use carry forward from last 3 years, so would need the inputs for all of those years to determine your 2022/23 position. This would be shown on a Pension Saving Statement.

Question: In step 4 below, do I use my closing balance for 2021/22 (£12,692) or do I use the pre-adjusted amount (£12,310)? This is the part which is really confusing me. I have taken the method for calculating pension input from the Civil Service Pensions website: https://www.civilservicepensionscheme.org.uk/your-pension/yearly-pension-update/pension-saving-statement/annual-allowance/

£12,692, although to be precise you would also need to add accrual for 1-5 April to both opening and closing balance.

Note in your calculation highlighted in yellow you have £12,694 rather than £12,692.

pathsofdarkness

hugheskevi said:

You can request a Pension Saving Statement to give you the exact figure to validate your calculation.

Fantastic! I thought they only sent one out if you exceeded the AA, I didn't know I could just request one at any time, that's really helpful.

A salary of £46,000 gives a pension input each year of around £17,000 - are you making additional pension contributions? Accrual of £1,998 pension is consistent with a salary of £86,000 if not making additional contributions?

Yes, I am making additional pension contributions in Alpha. In 2021/22 I bought £938 as added pension.

My next problem is that I am currently buying £1,701 of added pension in 2022/23 which will most certainly result in a pension input which is above my salary and that really scares me. This is entirely my own fault for (a) not understanding that having £32k of Carry Forward doesn't mean that my AA is £72k but is instead capped at £46k due to my salary, and (b) not thinking that inflation would get so high when I made the commitment to buy. 

£12,692, although to be precise you would also need to add accrual for 1-5 April to both opening and closing balance.

Well, that's me screwed then given that it uses the inflation adjusted amount! I might have to stop my Alpha pension for a few months so that I don't exceed my AA in 2022/23 because that's the only way to stop my added pension contract for the year. Otherwise I'll have to pay a tax charge of some sort, hopefully only 20% as I'm a basic rate tax payer.

Note in your calculation highlighted in yellow you have £12,694 rather than £12,692.

Good spot, human error on my part trying to quickly come up with a table in Excel I could screen grab for this post

NedS

pathsofdarkness said:

Objective: I would like to calculate my pension input in terms of the Annual Allowance for the 2021/22 tax year.

Problem: I'm confused about whether or not I include inflation as part of what I accrued during the year when it comes to the pension input amount at the end of the year.

Aside: I know I haven't gone over the AA this year but I need to understand the calculation so that I can figure out if I'm going to exceed the AA during the 2022/23 tax year due to high inflation. 

Join the club - I'm predicting 10% inflation this year and it is going to put me right up against the AA including carry forward available from previous years.

As @hugheskevi says, your calculations are correct in using the closing balance of £12,692 (and ignoring for the period 1-5th April on both the opening and closing amounts, which will offset each other to a degree).

Having used around £33k of your AA last year, and less in 2020/21, you appear to have plenty of carry forward available to help smooth the effects of high inflation this tax year.

michaels

If unanticipated inflation means we face AA charge is there anything we can do to avoid it? 

I think added pension can only be adjusted annually?

Is scheme pays an option like with DB?

hugheskevi

pathsofdarkness said:

My next problem is that I am currently buying £1,701 of added pension in 2022/23 which will most certainly result in a pension input which is above my salary and that really scares me. This is entirely my own fault for (a) not understanding that having £32k of Carry Forward doesn't mean that my AA is £72k but is instead capped at £46k due to my salary, and (b) not thinking that inflation would get so high when I made the commitment to buy.

Your Carry Forward is not capped by your salary.

If you have £32K of unused Annual Allowance from the last 3 years, your available Annual Allowance is £72,000 regardless of your salary in this or any previous year. You can only receive tax relief up to the level of  earnings which attract tax relief (ie £46K), but that is not relevant here. Unfortunately there is quite a lot of slack phrasing around Annual Allowance and carry-forward in discussions, which may usually work for DC pensions but not for DB pensions.

If unanticipated inflation means we face AA charge is there anything we can do to avoid it? 

Not much, other than opt-out of the scheme (or switch to Partnership for Civil Servants). Although if doing that, it would ideally have been done before the tax year start, as then the pension would be deferred and hence eligible for deferred member carve out and a nil pension input regardless of inflation level.

Is scheme pays an option like with DB?

Yes, the Civil Service scheme operates voluntary scheme pays with no restrictions.

NedS

pathsofdarkness said:

hugheskevi said:

You can request a Pension Saving Statement to give you the exact figure to validate your calculation.

Fantastic! I thought they only sent one out if you exceeded the AA, I didn't know I could just request one at any time, that's really helpful.

A salary of £46,000 gives a pension input each year of around £17,000 - are you making additional pension contributions? Accrual of £1,998 pension is consistent with a salary of £86,000 if not making additional contributions?

Yes, I am making additional pension contributions in Alpha. In 2021/22 I bought £938 as added pension.

My next problem is that I am currently buying £1,701 of added pension in 2022/23 which will most certainly result in a pension input which is above my salary and that really scares me. This is entirely my own fault for (a) not understanding that having £32k of Carry Forward doesn't mean that my AA is £72k but is instead capped at £46k due to my salary, and (b) not thinking that inflation would get so high when I made the commitment to buy.

Unless I'm mistaken, I think you misunderstand.

There are two separate independent limits here - the first that you cannot contribute more than you earn, and the second being the Annual Allowance.

I believe I'm correct in that the first limit is based on your actual contributions to alpha - so as long as the cost to you to purchase added pension is covered by your earned income, you are fine. It is not based on pension input amounts. If you are paying for added pension monthly out of your salary then it is clearly covered by your earned income.

Secondly, there is the AA limit of £40k, plus any carry forward you may have available. This is calculated using the pension input amount as you have done. Here your AA figure may well be £72k using your available carry forward so again you may be fine. Here you are not capped by your salary as it is based on pension input amounts, not the actual contributions you have made.

pathsofdarkness said:

Well, that's me screwed then given that it uses the inflation adjusted amount! I might have to stop my Alpha pension for a few months so that I don't exceed my AA in 2022/23 because that's the only way to stop my added pension contract for the year. Otherwise I'll have to pay a tax charge of some sort, hopefully only 20% as I'm a basic rate tax payer.

I don't believe you can start/stop your monthly contract to buy added pension - if you exceed your allowances you would have to pay any resulting tax charge.

pathsofdarkness

hugheskevi said:
You can only receive tax relief up to the level of  earnings which attract tax relief (ie £46K).

Ah, yes, that makes sense, cheers.

hugheskevi said:
it would ideally have been done before the tax year start, as then the pension would be deferred and hence eligible for deferred member carve out and a nil pension input regardless of inflation level.

Out of curiosity, what does "deferred member carve out" mean? I've not heard that phrase before.

NedS said:

I don't believe you can start/stop your monthly contract to buy added pension - if you exceed your allowances you would have to pay any resulting tax charge.

I spoke with myCSP and they said that there are only two ways to cancel an added pension Alpha contract:

1. Opt out of the main Alpha pension scheme and this will automatically stop your Alpha Added Pension contract for the current tax year. If you opt out you can opt back in at any time.
2. Switch out of the main Alpha pension scheme and into the Partnership defined contribution pension scheme and this will automatically stop your Alpha Added Pension contract for the current tax year.

So I'm thinking I'll opt out of the main Alpha scheme for a month to stop my added pension contract and then opt back in the following month to the main Alpha scheme but with no added pension contract in place because it will have been cancelled.

hugheskevi

pathsofdarkness said:

Out of curiosity, what does "deferred member carve out" mean? I've not heard that phrase before.

If a member is deferred (ie opted out) out a DB scheme for the entire year and their pension doesn't increase beyond prescribed limits (which generally means does not increase in real terms), then there is a zero pension input for that arrangement.

BillyHorner

Apologies for coming to this late and resurrecting an old thread, but some of the replies to the OP have me doubting myself, so wanted to check if my understanding is correct?

When calculating a PIA for 22/23, isn't it just the CPI rate for September 2021 that matters, not the likely CPI rate for September 2022?

Notwithstanding this, I'm confused as to how a rise in CPI to 10%+ would have a detrimental impact on the PIA? The purpose of adjusting the opening balance by CPI is to protect the member from the affects of inflation, not penalise them for it. Surely, it is a recognition that if, say, the closing balance has increased by 5% but CPI inflation was also 5%, the member has not seen any real terms growth in their pension, so would have a PIA of nil?

My understanding (which may be wrong) is that CPI adjustment is only applied to the opening balance which is then deducted from the closing balance. Therefore, a higher rate of CPI should result in a lower PIA not a higher one?

hugheskevi

BillyHorner said:

When calculating a PIA for 22/23, isn't it just the CPI rate for September 2021 that matters, not the likely CPI rate for September 2022?

Yes and no. In the HMRC calculation formula of pension input it is only CPI rate for September 2021 that matters.

However, in the calculation of benefits for closing amount, the pension is increased in line with inflation shortly before the closing amount is calculated. That increase is based on September 2022 CPI.

Notwithstanding this, I'm confused as to how a rise in CPI to 10%+ would have a detrimental impact on the PIA? The purpose of adjusting the opening balance by CPI is to protect the member from the affects of inflation, not penalise them for it. Surely, it is a recognition that if, say, the closing balance has increased by 5% but CPI inflation was also 5%, the member has not seen any real terms growth in their pension, so would have a PIA of nil?

For illustration, ignore any new pension accrual in a year, and just examine what happens to the pension a member brought into the year.

Assume a member starts the year with £20,000 of accrued annual pension. To calculate the starting value for Annual Allowance this is increased by 3.1% (September 2021 CPI) and multiplied by the standard factor of 16, giving a capital value of £329,920.

At the end of the year the £20,000 is increased by 10% based on (assumed) September 2022 CPI. The closing capital value is £352,000 (£20,000 x 10% x 16). The pension input is closing value minus opening value, which is £22,080. That is the pension input arising solely from the pension brought into the year, there have been no new contributions and yet over half of the standard Annual Allowance has been used.

The key point is that there is a mismatch between the year of CPI the starting value is based upon and the CPI by which the pension is increased. Usually this doesn't matter very much, but with a huge difference between one year to the next in the rate of inflation it does. If inflation falls back the following year the process works in reverse, but some members may be pushed into paying a charge they wouldn't otherwise have paid, or leave and not benefit from the subsequent year, etc.