Ooh, Time to Start Speculating About LTA Changes Again

Flugelhorn

that is a good point about it being cancelled out by the CPI increase on the pension - money given with one hand and taken away with the other. 

actually thinking about it you end up paying CPI + 2.4% on 45% of the excess rather than the whole lot so do end up with more than you started with 

Albermarle

Pat38493 said:

Albermarle said:

My understanding of lta is if exceeded you pay the tax rebate back, is that correct? If so surely there is still a benefit just not as lucrative as before?

This only really applies if you get 40% tax relief when contributing and pay 20% tax in retirement. If you are a 40% taxpayer in retirement, then you have to give back more than you gained in tax relief. 55% as opposed to gaining 40%.

Are you here only talking about DB schemes?  With DC scheme it wouldn't be quite that clear cut would it?  If you keep that gained tax invested long enough to make > 15% return, you would still gain at least some amount in the end, plus there might be advantages in terms of inheritance.  Also you would automatically see the benefit of any future LTA increase if it ever happened.

You would be better to stop contributing to the pension (with a guaranteed 15% tax loss) and invest it elsewhere instead.
Only if avoiding IHT was the primary motivation , could it make possible sense to keep contributing to the pension. However there are other relatively simple ways to reduce IHT liability, like spending more, gifts, charity donations etc  

DoublePolaroid

Minor thread hijack that is close enough to the topic at hand; seemed better than starting a new thread.

This thread and the recent announcement of September’s CPI figure prompted me to do an estimate calculation of my AA tax position. I’m fortunate to have had growth over the last three years, that I have confirmed figures for, of £40k each give or take and have never had an AA tax charge. For the current pension year, modelling no increase in my income, I expect growth of £74k which will result in a circa £15k tax bill. 

Now this can of course be seen to be a nice problem to have, since it requires some combination of a high income and a substantial existing annual pension accrual. However what is perverse is that as my pension contributions and income are virtually unchanged, this is essentially an “inflation tax”. To illustrate further if my income were to increase by tens of thousands next year, I might well not incur a tax charge next year if inflation, as expected, is lower in September 2023. The explanation for this is that for reasons I can’t fathom, the opening value of the pension is calculated using the previous September’s CPI whereas the growth is calculated using CPI for September of the pension input period. Where inflation is stable, growth is basically proportional to income, which is entirely fair. Where inflation rises sharply, as now, it taxes people rather arbitrarily. 

To quote a poster on another thread, as well as a mediocre but dashing crooner, cry me a river. That’s not the point of the post; I’ll be more than fine. However, I had expected that the Government would do something about this, because it is going to pish a lot of consultants/GP’s off; the only reason it hasn’t already is because most people in the NHS pension scheme are oblivious as to how the scheme works (including me, until very recently). However given the kamikwasi budget, it now seems likely that any kind of pension reform that benefits high earners has the potential to be political Kryptonite. The “easiest” solution would seem to be to amend legislation to align the CPI figures applied to input and growth. In reality I don’t know how easy that would be. For the 19/20 tax year NHS staff incurring tax charges had them paid by NHSE because Covid but that is clearly not a long term solution. So does anybody think such reform is likely? 

Pat38493

Albermarle said:

Pat38493 said:

Albermarle said:

My understanding of lta is if exceeded you pay the tax rebate back, is that correct? If so surely there is still a benefit just not as lucrative as before?

This only really applies if you get 40% tax relief when contributing and pay 20% tax in retirement. If you are a 40% taxpayer in retirement, then you have to give back more than you gained in tax relief. 55% as opposed to gaining 40%.

Are you here only talking about DB schemes?  With DC scheme it wouldn't be quite that clear cut would it?  If you keep that gained tax invested long enough to make > 15% return, you would still gain at least some amount in the end, plus there might be advantages in terms of inheritance.  Also you would automatically see the benefit of any future LTA increase if it ever happened.

You would be better to stop contributing to the pension (with a guaranteed 15% tax loss) and invest it elsewhere instead.
Only if avoiding IHT was the primary motivation , could it make possible sense to keep contributing to the pension. However there are other relatively simple ways to reduce IHT liability, like spending more, gifts, charity donations etc  

Maybe I'm going mad, but the way I saw it was that if you don't contribute that money to the pension when you are a 40% taxpayer, you have a guaranteed instant 40% loss because that money went straight to HMRC in tax.  I am referring to the portion of money that you would have paid in tax right away if you didn't put it in the pension.  If you can use that money over the following x years to make a return > 15% you would be better off at the end, or am I going crazy?

So you are trading off a guaranteed instant 40% loss, against a future 55% tax loss that could possibly be offset by investment gains?  I guess the investments gains would also be taxed at a high rate but it still might be something?

Albermarle

Pat38493 said:

Albermarle said:

Pat38493 said:

Albermarle said:

My understanding of lta is if exceeded you pay the tax rebate back, is that correct? If so surely there is still a benefit just not as lucrative as before?

This only really applies if you get 40% tax relief when contributing and pay 20% tax in retirement. If you are a 40% taxpayer in retirement, then you have to give back more than you gained in tax relief. 55% as opposed to gaining 40%.

Are you here only talking about DB schemes?  With DC scheme it wouldn't be quite that clear cut would it?  If you keep that gained tax invested long enough to make > 15% return, you would still gain at least some amount in the end, plus there might be advantages in terms of inheritance.  Also you would automatically see the benefit of any future LTA increase if it ever happened.

You would be better to stop contributing to the pension (with a guaranteed 15% tax loss) and invest it elsewhere instead.
Only if avoiding IHT was the primary motivation , could it make possible sense to keep contributing to the pension. However there are other relatively simple ways to reduce IHT liability, like spending more, gifts, charity donations etc  

Maybe I'm going mad, but the way I saw it was that if you don't contribute that money to the pension when you are a 40% taxpayer, you have a guaranteed instant 40% loss because that money went straight to HMRC in tax.  I am referring to the portion of money that you would have paid in tax right away if you didn't put it in the pension.  If you can use that money over the following x years to make a return > 15% you would be better off at the end, or am I going crazy?

So you are trading off a guaranteed instant 40% loss, against a future 55% tax loss that could possibly be offset by investment gains?  I guess the investments gains would also be taxed at a high rate but it still might be something?

Instead you reduce contributions and invest the money outside the pension. Then if they make a 15% gain, you keep that gain rather than using it to pay the LTA charge. For example

£100 into pension for a higher rate taxpayer costs you £60 . It grows by 15% say over 5 years. When withdrawn and subject to LTA then £115 minus 55% ( for a higher rate taxpayer in retirement ) = £51.75

Instead if you put your £60 in a S&S ISA and it grew 15% you would have £69 . Outside an ISA it might be a bit less due to tax  depending on amounts involved.

NedS

DoublePolaroid said:

Minor thread hijack that is close enough to the topic at hand; seemed better than starting a new thread.

This thread and the recent announcement of September’s CPI figure prompted me to do an estimate calculation of my AA tax position. I’m fortunate to have had growth over the last three years, that I have confirmed figures for, of £40k each give or take and have never had an AA tax charge. For the current pension year, modelling no increase in my income, I expect growth of £74k which will result in a circa £15k tax bill.

I'm in a similar position, and I only earn around £28k per year. For 2022/23, I now calculate my AA usage will be £48.5k.

DoublePolaroid said:

Now this can of course be seen to be a nice problem to have, since it requires some combination of a high income and a substantial existing annual pension accrual. However what is perverse is that as my pension contributions and income are virtually unchanged, this is essentially an “inflation tax”. To illustrate further if my income were to increase by tens of thousands next year, I might well not incur a tax charge next year if inflation, as expected, is lower in September 2023. The explanation for this is that for reasons I can’t fathom, the opening value of the pension is calculated using the previous September’s CPI whereas the growth is calculated using CPI for September of the pension input period. Where inflation is stable, growth is basically proportional to income, which is entirely fair. Where inflation rises sharply, as now, it taxes people rather arbitrarily.

Yes, it is, if you are unlucky enough to get caught out in a year with high inflation. The response I commonly hear is that for most normal people this will be absorbed using carry forward from previous tax years, which is great if you have any - but if you are close to retirement and have been contributing up to the max for the last few tax years, or are a high earner, then you may not have any carry forward available.

You may find next year, or whenever inflation does drop (I am modelling for 10% again next year), that you are able to rebuild some carry forward capacity to help in future. It won't help me as I will have retired by then.

DoublePolaroid

@NedS yes I’ve already modelled for the following year assuming inflation is circa 5% (evidently I’m an optimist) and the silver lining is growth may be less than £20k which will help going forward. 

It is problematic to have a tax which is entirely beyond the individuals’s ability control and absent of the possession of a flux capacitor and aluminium brick on wheels, impossible to plan for in advance as your example illustrates. 

The illuminating thing for me is that the scheme rules simply break with extreme inflation. It’s perfectly possible to model scenarios where inflation runs at 15% (so historically very high but not unprecedented) where people will run into tax bills that amount to more than their net annual income. 

NedS

DoublePolaroid said:

@NedS yes I’ve already modelled for the following year assuming inflation is circa 5% (evidently I’m an optimist) and the silver lining is growth may be less than £20k which will help going forward. 

It is problematic to have a tax which is entirely beyond the individuals’s ability control and absent of the possession of a flux capacitor and aluminium brick on wheels, impossible to plan for in advance as your example illustrates. 

The illuminating thing for me is that the scheme rules simply break with extreme inflation. It’s perfectly possible to model scenarios where inflation runs at 15% (so historically very high but not unprecedented) where people will run into tax bills that amount to more than their net annual income. 

Yes, I agree. I got caught out because, a year ago I could see inflation was going to be high so decided to increase my purchase of added pension in my current DB CARE scheme, knowing it would benefit from the high CPI uplift next April, but didn't fully appreciate PIA's at the time (it takes some time to understand that you can still massively breech the £40k AA limit when you only earn £28k). By the time I did realise, I was able to mitigate the damage by reducing my SIPP contributions but this was undesirable as I am now less able to take advantage of the current lower stock market prices. Now the Sept CPI inflation figure is published, I know exactly where I stand and can plan accordingly.

Pat38493

Albermarle said:

Pat38493 said:

Albermarle said:

Pat38493 said:

Albermarle said:

My understanding of lta is if exceeded you pay the tax rebate back, is that correct? If so surely there is still a benefit just not as lucrative as before?

This only really applies if you get 40% tax relief when contributing and pay 20% tax in retirement. If you are a 40% taxpayer in retirement, then you have to give back more than you gained in tax relief. 55% as opposed to gaining 40%.

Are you here only talking about DB schemes?  With DC scheme it wouldn't be quite that clear cut would it?  If you keep that gained tax invested long enough to make > 15% return, you would still gain at least some amount in the end, plus there might be advantages in terms of inheritance.  Also you would automatically see the benefit of any future LTA increase if it ever happened.

You would be better to stop contributing to the pension (with a guaranteed 15% tax loss) and invest it elsewhere instead.
Only if avoiding IHT was the primary motivation , could it make possible sense to keep contributing to the pension. However there are other relatively simple ways to reduce IHT liability, like spending more, gifts, charity donations etc  

Maybe I'm going mad, but the way I saw it was that if you don't contribute that money to the pension when you are a 40% taxpayer, you have a guaranteed instant 40% loss because that money went straight to HMRC in tax.  I am referring to the portion of money that you would have paid in tax right away if you didn't put it in the pension.  If you can use that money over the following x years to make a return > 15% you would be better off at the end, or am I going crazy?

So you are trading off a guaranteed instant 40% loss, against a future 55% tax loss that could possibly be offset by investment gains?  I guess the investments gains would also be taxed at a high rate but it still might be something?

Instead you reduce contributions and invest the money outside the pension. Then if they make a 15% gain, you keep that gain rather than using it to pay the LTA charge. For example

£100 into pension for a higher rate taxpayer costs you £60 . It grows by 15% say over 5 years. When withdrawn and subject to LTA then £115 minus 55% ( for a higher rate taxpayer in retirement ) = £51.75

Instead if you put your £60 in a S&S ISA and it grew 15% you would have £69 . Outside an ISA it might be a bit less due to tax  depending on amounts involved.

Ok yes I see what you mean because you ended up paying 55% on the original £60 as well.  However now I’m confused on another aspect - as I understood you can take the money as income or as a lump sum.   If I understand you, lump sum above the LTA is only subject to the 55% charge but is not subject to income tax afterwards (which makes the same result as if you had got 25% tax free then paid 40% on the rest plus a 25% LTA charge on the full amount)?   

But if you moved that into a drawdown you would end up paying 65% tax?

EdSwippet

Pat38493 said:

... But if you moved that into a drawdown you would end up paying 65% tax?

No, because moving the money into drawdown ("crystallisation") reduces it by the 25% LTA penalty.

Suppose you crystallise £100 with zero LTA remaining. At crystallisation, you pay 25% LTA penalty, and get £75 in your drawdown pot. Draw that at 40% tax gives an effective 55% (25% + 40% of 75%).

Pat38493 said:
... (which makes the same result as if you had got 25% tax free then paid 40% on the rest plus a 25% LTA charge on the full amount)?

Note that there is no 25% tax free above the LTA, only below it; the LTA is a de facto cap on the tax free lump sum. Another way of thinking about the LTA penalty is that below the LTA, you get a quarter of your pension tax free, and above the LTA, the government instead takes that full quarter for itself.