There was a good to fair chance of me hitting George Osborne’s pension allowance taper this year, so I spent the last couple of months trawling the internet, looking for ways to avoid this eventuality.
The results were mixed
The good news is that I can keep my pension allowance at £40,000, probably for the last time. The bad news is that I’ll have to pay more NI than I would’ve if George had not been inspired to meddle with pensions in the first place.
Here’s how it used to work.
- My employer’s pension plan is non-contributory. They pay a percentage of my salary into my pension regardless of whether I choose to contribute myself.
- On top of that, I can salary sacrifice whatever I like – as a lump sum or a monthly payment – into the company pension from my pay, and my employer will chuck in an additional 7.5% of the amount sacrificed. Because: ‘ee NI is 2% and ‘er NI is 13%, which is 15% in total, divide that in half and you get 7.5%.
- For every pre-tax £100 I salary sacrificed into my pension I had £107.50 paid into the plan.
- Naturally, each year I would salary sacrifice whatever I could in order to get the 7.5% uplift. Then I would transfer that amount from the company pension into my SIPP. Because: lower fees.
Enter George G. O. Osborne. Things become complicated.
Those whom George considers to be “high earners”, now have their £40,000 pension allowance tapered down to £10,000 if their adjusted income exceeds £150,000. BUT only if their threshold income is more than £110,000. Mechanically pension allowance taper works the same way as the personal allowance taper for incomes over £100,000: for every £2 of income over the limit you lose £1 of the allowance. Does that sound unnecessarily complex? That’s because it is, and wait till you hear more.
My threshold income is as follows:
- My net income (which includes my salary, bank interest, SAYE dividends and P11D benefits); plus
- Any salary sacrifice I make into my pension (since the arrangement is flexible, it’s caught by the anti-avoidance clause); minus
- The gross amount of my SIPP contributions.
The last point is key: if I make pension contributions via salary sacrifice, then they are part of my threshold income, but if I make a personal contribution into the SIPP where tax relief is given at source, then that amount is excluded from my threshold income. Of course, by doing so I lose the 7.5% uplift I would have received from the company and I have to pay 2% employee NI.
Each £100 of pension allowance I keep by claiming relief at source costs me £19 (I have to forgo £200 of salary sacrifice given the 1:2 taper), but its value to me is the £15 tax deferral and £25 tax saving. So the differential benefit is at least £6.
My adjusted income is:
- My net income (same as above); plus
- Any salary sacrifice I make into my pension (same as above); plus
- Any pension contributions my employer makes;
In my case the difference between adjusted income and threshold income is pension contributions – my own, paid into the SIPP, and my employer’s, paid into the company plan. Pension contributions made as salary sacrifice are included in both.
Bad laws badly written
It annoys me how poorly drafted the rules are. The whole thing is rife with contradiction and confusion. Let’s take the definition of net income. The HMRC website states that the net income is taxable income less any reliefs. You’d think this would mean gross income less personal allowance, dividend allowance and personal savings allowance, which would be consistent with the verbiage in the self assessment tax return, where total income on which tax is due equals total income minus personal allowance.
But no, it does not. Net income is in fact gross income: your personal allowance doesn’t enter the calculation, neither does the £5,000 dividend allowance, nor the personal savings allowance. So if your income is more than £150,000, the interest and dividends you receive in taxable accounts – even if the amount received is less than the tax free limit – reduce your pension allowance due to the taper. It would be nice if the HMRC Pensions Tax Manual made this clear.
Another thing that strikes me as inconsistent is that rental income is included net, i.e. after subtracting allowable deductions. I can’t claim platform fees against my SAYE dividends, but a buy-to-let investor can deduct property expenses from the rent he receives. As an aside, rent-a-room scheme is looking increasingly attractive: £7,500 p.a. tax free AND it doesn’t impact the pension allowance by the virtue of being tax exempt and hence not part of the net income.
One last time
My past disregard of all matters Personal Finance has endowed me with some carried forward pension allowance, which is the sole reason I can avoid the blasted taper this year. I’m over the limit on adjusted income, but my threshold income is under the £110,000 mark. Next year … unlikely, but we shall see.
I never thought I’d say this, but at least I don’t have a DB pension. From what I’ve glimpsed on the DB plans, the rules there appear even more confusing.
Guides and tools
Below are some resources I found useful.
As per usual, reader beware: I have gathered only what I deemed applicable to my current situation. The reference list is not intended to be complete, nor can I vouch for the accuracy of any of the materials.
- Willis Towers Watson provide a free app for calculating annual allowance, but you’ll have to input your own figures.
- Pru’s Annual Allowance Calculator is a version of the Towers Watson app, and you still need to provide your own numbers. It won’t tell you what sources of income should or should not be included in the calcs, but despair not: this guide will.
- Scottish Widows clarify the components of net income, threshold income and adjusted income.
- AJ Bell’s guide has some easy to follow examples.
- Royal London have more examples. With diagrams.
- You can call the Pensions Advisory Service on 0300 123 1047.
- If you have 30 minutes to kill listening to elevator music as you wait for someone to answer the phone, you can also ring HMRC on 0300 200 3310. If you manage to get through to them, they’re actually very helpful.
A few words on the subject of LISAs
If in future my pension allowance is reduced, I may have to open a LISA account. That’s annoying because a LISA isn’t as good a deal to a higher rate tax payer as the pension.
A higher rate taxpayer wants to save £100 of his pre-tax income into a pension at the age of 39, and earns a 5% annual return until he retires at 58 (let’s ignore NI).
In 19 years’ time his pension will be worth £100 x 1.05 ^ 19 = £252.70. A quarter of this can be withdrawn tax free. The rest of it can also be withdrawn tax free, provided he keeps his annual pension drawdown within his personal allowance. This shouldn’t be very difficult, as any tax free income from his ISAs can be used to supplement the pension income. With no mortgage and living modestly, he doesn’t need to pay much (or even any) income tax post-retirement.
A higher rate taxpayer wants to save £100 of his pre-tax income into a LISA at the age of 39, and earns a 5% annual return until retiring at 58.
In 19 years’ time his LISA will be worth £60 x 1.25 x 1.05 ^ 19 = £189.52. This is tax free, but so what? If he’s living modestly and has tax-free income from other ISA products, that’s a waste of his personal allowance.
Also, LISAs don’t have the same protections as pensions, e.g. in case of bankruptcy, and they will count as “savings” if you ever need to claim unemployment benefits. Granted, the possibility seems is remote, and having other ISA products renders it a moot(ish) point. Still, one can never be sure.
LISAs weren’t brought in for the benefit of the people – they were brought in so that HM Treasury can get more tax revenue sooner. If I were a conspiracy theorist, I’d say the additional complexity and confusion that the taper rules introduced to pensions were part of Osborne’s plan. But I am not. And I don’t think they were.
I think the hurried, badly written legislation, which has turned an already complex area into a multi-layered clusterfuck of convoluted rules, guidelines and definitions, really was the best he could do. George Osborne simply wasn’t a good Chancellor.
- With no differentiation between the cost of living in London vs the rest of the country.
- There are more things to take into account, which are not relevant to me. The full list can be found on the HMRC website.
- I don’t expect to pay 40% tax after I retire, so ignoring any investment return and assuming tax rates don’t change, the tax I’ll pay on the £100 when I start drawing my pension is £100 x 75% x 20% = £15.