Defined benefit scheme members will need to ‘guesstimate’ their pension input periods, because they may get salary increases which would send them over the limit of their annual allowance, according to Old Mutual Wealth.
Speaking to FTAdviser, their retirement planning manager Adrian Walker called calculating pension pot value “a bit of a minefield” because some scheme members will get salary increases, or may have bonuses that come quite near to the end of the tax year.
“People could get promoted part way through the year, if they suddenly got a promotion or a pay rise part way through the year then you might as well tear up that estimation and throw it away, so maybe you don’t need to fund it.”
He explained that there are a number of required steps pertaining to pension input periods for DB schemes, however, if the client also has an element of defined contribution pension, they would need to be done in parallel, since each person only has one allowance.
These steps are as follows:
• The total annual allowance calculated in accordance with HM Revenue and Customs guidance if any pension input periods end in the 2012 to 2013, 2013 to 2014 and 2014 to 2015 tax years. Where this does not apply, or no annual allowance accrued in any of those periods, confirm as a nil return.
• Or, if the above calculations are not available, the pension entitlement accrued at the start and the end of each pension input period that ended in the 2012 to 2013, 2013 to 2014 and 2014 to 2015 tax years.
• This is specifically for some public sector schemes - if it accrues a pension commencement lump sum separately from the pension, that figures at the start and end of each of the same pension input periods.
David Brooks, technical director at Broadstone, stated the ‘gamble’ is that as the member has no control over this accrual, accepting a promotion or salary increase could result in a spike in the accrual across the input period, meaning they would attract a tax charge.
He added that there are two further issues, the first being that when inflation is high you have more scope for accrual, resulting in a lower tax charge.
“When inflation was around 5 per cent, this was to the advantage of many defined benefit members as they could accrue more pension before exceeding the annual allowance. However, the inflation is outside the member’s control.
“Carry forward of unused annual allowance does exist for members that have a flat or lower level of increase in the value of their pension, so in the years when the salary/pension jumps they’d have something to fall back on.
“However, if the salary jumps a lot frequently then this can be used up easily.”
Mr Brooks added that the scheme pays option is also there, pointing out that if the resulting annual allowance tax charge is over £2,000 then the member can force the scheme to pay the tax for them.
“However, the scheme would reduce their benefit in the scheme but as the tax charge is being met from a gross pension (rather than net earnings) and also is deferred for a number of years it may not be a bad option.”
He continued there are myriad methods for reducing this and every scheme will have their own method, so the member will need to understand and make their own judgement which can be tricky.
“I think I would describe defined benefit accrual and annual allowance as a double edged sword. You are benefitting from an excellent benefit, which you’d be a fool to give up, but when large salary increases are given be sure you understand the impact.
“When it becomes a problem is for high earners that have large pensions, as they run the risk of contributions being taxed via the annual allowance, the final benefit taxed via the lifetime allowance and then taxed as income; hardly equitable.”
Mr Brooks added that some schemes do cap accrual to the annual allowance and some clients either offer cash in lieu of pension of the annual allowance to avoid the tax. “This does feel like the tax tail wagging the pensions dog.”
ruth.gillbe@ft.com
