AVC advice

Aylesbury_Duck

I'm in the fortunate situation of being a higher rate taxpayer (c.£95k salary) and having to monitor my annual pension allowance, but need some advice.  I am in a local authority LGPS scheme, with an attached Prudential AVC scheme.  A few years ago I started making substantial AVCs (£36k in one of the years) to take advantage of unused allowance from prior years.  Since then, I've tapered my AVCs down to try and hit the magic £40k once aggregated with my LGPS growth, knowing that my prior years have no more allowance to carry over.

I've had a letter from the LGPS scheme, notifying me that I've exceeded my allowance in each of the last two years.  The first of those years is fine, because I know I had enough unused allowance from prior years to cover the excess (and have all the documents and spreadsheet to show the calculation if I need to), but last year I overshot by about £3k.  I've completed an online HMRC self-assessment to pay the excess charge in my tax code for next year.

My question is this: How critical is hitting the £40k target?  I have been using LGPS allowance calculators to calculate LGPS growth, but they only look backwards.  I've made an educated estimate of LGPS growth for this year (c.£33k), and adjusted my AVCs accordingly (so they will total £7k), but I still might overshoot the annual allowance slightly by April because it's only an estimate.  Apart from the small hassle of having to complete a self-assessment each year I do that, with the resulting adjustments to my tax code, are there any other disadvantages to exceeding the £40k allowance?

Is there any tax advantage to being very slightly under the £40k allowance compared to exceeding it, or does it all net out pretty much the same in the end?  My thinking is that every pound of AVC I make is saving me 40p tax today.  The AVC scheme has a considerable advantage of being able to be taken tax-free if I access it at the same time as my LGPS benefits (as long as I keep the pot at less than 25% of my total LGPS+AVC value) so it makes sense to maximise my contributions.  Save tax on the way in, pay no tax on the way out.  Is it simply a case that any AVC contributions that take me over the annual allowance aren't taxed in my payslip this year, but will be taxed next year as part of my tax code adjustment, so are therefore tax-neutral?

mark55man

Hello @Aylesbury_Duck - - I'm sorry your question hasn't had an answer.  My role is to help things along, but I was away on work last week

As I understand it (not very well) if you exceed the £40K AA without being able to use any carryover from previous years, you will not be penalised although you will have to pay 40% on the excess.  So tax neutral, unless your tax rate is over 40% in which case it may be tax advantageous. I don't know the precise mechanics

Hopefully someone will answer on Monday

Marcon

...and with luck that someone will be @Silvertabby

Silvertabby

Thanks for the vote of confidence Marcon, but I have to confess that my knowledge of AA rules are somewhat limited.

In the LGPS I worked for only a very small number of the highest paid came anywhere near AA territory, and they were senior enough to expect their queries to be dealt with by our pensions manager or her deputy, not a lowly senior pensions administrator!

That said, I know from former colleagues that AA calculations are now starting to affect many more, and next April's CARE revaluation of 10.1% (probably) may pull even more into the equations.

In your own case, I would say that the benefits of maximising your AVC contributions outweigh any minor tax bills now.  Tax relief in, tax free (up to a limit) out.  But if you do exceed the tax free limit, then you have the option of using the surplus AVC funds to buy additional index linked LGPS benefits at very favourable rates.

It sounds like your LGPS is on the ball with their advice letters, so it may be worth having a chat with your LGPS to get their input.  Now that AA does seem to be more of an issue than in my day, it should be possible for them to give you at least an idea of your AVC 'sweet spot'.

AlanP_2

That said, I know from former colleagues that AA calculations are now starting to affect many more, and next April's CARE revaluation of 10.1% (probably) may pull even more into the equations.

Can you expand on this point please as I don't get it?

If the accrued CARE benefits are increased by CPI before doing the AA calculation then, is the AA value not 16* the current years earned benefit? My understanding was that the CPI increases cancelled themselves out effectively.

Thanks

Silvertabby

AlanP_2 said:

That said, I know from former colleagues that AA calculations are now starting to affect many more, and next April's CARE revaluation of 10.1% (probably) may pull even more into the equations.

Can you expand on this point please as I don't get it?

If the accrued CARE benefits are increased by CPI before doing the AA calculation then, is the AA value not 16* the current years earned benefit? My understanding was that the CPI increases cancelled themselves out effectively.

Thanks

From chatting with one of my ex colleagues (we still meet for coffee and a catch up every so often).  Based on a mini in-house training course on future AA calculations.

NedS

AlanP_2 said:

That said, I know from former colleagues that AA calculations are now starting to affect many more, and next April's CARE revaluation of 10.1% (probably) may pull even more into the equations.

Can you expand on this point please as I don't get it?

If the accrued CARE benefits are increased by CPI before doing the AA calculation then, is the AA value not 16* the current years earned benefit? My understanding was that the CPI increases cancelled themselves out effectively.

Thanks

CPI inflation is applied to both opening and closing amounts when calculating the PIA. The opening amount would have had 3.1% CPI applied and the closing amount, in April 2023 will have 10.1% CPI applied. The issue this year is the 7% difference, so the closing amount will be 7% higher than the opening amount after adjustment for inflation.

If you had a CARE scheme with £20k of accrued benefits, the 7% difference in CPI x 16 will use up £22,400 of AA before considering any contributions made to the pension in the current year.

If you have exceeded the AA (with any carry forward), you will be liable for the tax relief. You should complete a self assessment and pay the tax that is due.

Aylesbury_Duck

Thanks everyone, that all makes sense.  I think the sensible strategy is to ensure I at least reach the £40k pension input each year, there's little point overdoing it by lots, but any slight over-input just then gets corrected with an annual self-assessment declaration.  That way I maximise my £40k and pay taxes due.

Of course things may change slightly when the chancellor makes changes this week!

NedS

Aylesbury_Duck said:

Thanks everyone, that all makes sense.  I think the sensible strategy is to ensure I at least reach the £40k pension input each year, there's little point overdoing it my lots, but any slight over-input just then gets corrected with an annual self-assessment declaration.  That way I maximise my £40k and pay taxes due.

That's fine as long as you have flexibility about when and how you make your contributions. The issue is that you will not know how much inflation is for the closing amount to the PIA until mid-October each year which is fine if you are then able to adjust your contributions to hit the £40k AA target. It's a lot harder if you are purchasing added pension on a contract agreed at the start of the financial year that cannot be changed, where you have to make an assumption what inflation will be nearly a year down the line.

Aylesbury_Duck

NedS said:

Aylesbury_Duck said:

Thanks everyone, that all makes sense.  I think the sensible strategy is to ensure I at least reach the £40k pension input each year, there's little point overdoing it my lots, but any slight over-input just then gets corrected with an annual self-assessment declaration.  That way I maximise my £40k and pay taxes due.

That's fine as long as you have flexibility about when and how you make your contributions. The issue is that you will not know how much inflation is for the closing amount to the PIA until mid-October each year which is fine if you are then able to adjust your contributions to hit the £40k AA target. It's a lot harder if you are purchasing added pension on a contract agreed at the start of the financial year that cannot be changed, where you have to make an assumption what inflation will be nearly a year down the line.

That's what caught me out last year.  I was heading for what I estimated to be a smidgeon under £40k and ended up £3k over.  I hadn't appreciated the effect of inflationary adjustment so didn't bring my AVCs down sufficiently.  I can adjust my AVCs with about a month's notice, so have just reduced them to come in around £40k this year by April, but it looks like the inflationary figure will take me over again.  The self-assessment is not too much hassle, I had hoped to avoid it though.

SarahB16

Silvertabby said:

In your own case, I would say that the benefits of maximising your AVC contributions outweigh any minor tax bills now.  Tax relief in, tax free (up to a limit) out.  But if you do exceed the tax free limit, then you have the option of using the surplus AVC funds to buy additional index linked LGPS benefits at very favourable rates.

May I ask a question please regarding the above. 

For me to fully understand what @Silvertabby is very kindly saying.  Am I correct in thinking that if the tax free limit (on the lump sum amount from the AVC contributions) is exceeded then yes you have the option of buying additional index linked LGPS pension however you would still need to be mindful not to exceed the lifetime allowance (currently £1,073,100)?  

If the lifetime allowance is exceeded, then tax would be paid on the amount above £1,073,100?