1. Personal contributions to defined contribution schemes are not efficient if they will fall into the LTA charge when benefits are drawn.
2. Employer contributions to defined contribution schemes that will fall into the LTA charge may or may not be tax-efficient:
• Where there is the potential to renegotiate remuneration with the employer (for example, to take the equivalent of the employer contributions as salary or other benefits in kind), the net benefit of the alternative should be compared against the net benefit of the pension contributions.
• If employer contributions are ‘free’ and there is no alternative on offer it is probably more efficient to continue receiving the contributions. Even where employer contributions are falling directly into the LTA charge, 75 per cent of that contribution is better than no contribution at all.
• If the level of employer contribution is determined by the level of employee contributions, the tax efficiency will depend on the proportions involved because the personal contributions are effectively not attracting tax relief.
3. Defined benefit accrual may be worthwhile even if it is falling straight into the LTA charge. Instead, opting out freezes the salary and number of years’ service used to calculate the starting pension.
Therefore the pension at retirement may be considerably lower than if they had remained an active member and had their starting pension reduced by a LTA charge.
The further the individual is from normal retirement age the more valuable active membership of a final salary scheme is. The increase in benefits in the last few years of a final salary scheme is disproportionately higher than the cost to the individual.
Taking an LTA excess
The decision on whether to draw any LTA excess as a taxed lump sum or as taxable income will depend on the individual’s wider circumstances and objectives.
If the LTA excess is taken as income, the net benefit of withdrawals will be determined by income tax bands. This method is not efficient if the pension income will fall into additional rate tax.
The lump sum option provides flexibility and investment opportunity. If it is used for gifting it will generally be removed from the estate after seven years. However, if the lump sum is not spent but simply accumulates in the estate (or any gifts fail), the impact of IHT makes the lump-sum option less tax efficient than if the LTA excess had simply been left in the pension.