Here’s what you need to consider in relation to the Annual Allowance to see if pension saving is still right for high net worth clients.
Contents
Why you need to carry out calculations
Tax charges may not always be a bad thing if the overall outcome is better for the client. What is crucial is that the relevant calculations are done so that the client knows what to expect.
This article deals with planning for the high net worth client.
In 2016 there was a change to annual allowance with the introduction of the Tapered Annual Allowance. This change may have had an impact on high net worth clients. Calculations need to be carried out on an annual basis to decide if pension saving is still appropriate.
"Opting out to save a tax charge, even if the net benefit is better, would be a bit like a client asking their employer to stop paying their salary because there is a tax charge."
Annual allowance planning
There are lots of different types of clients who all have different circumstances, are members of different types of schemes and have a range of different benefits. Planning will be different for each of these clients but the process for all may be the same.
- Calculate benefits based on existing arrangements projected to retirement
- Calculate overall cost of maintaining existing arrangements
- Calculate benefits payable net of any tax charge
- Calculate the value of “paid up/deferred” benefits at retirement date with no further accrual or contributions
- Identify the value of alternate arrangements
- Add the value of “paid up/deferred” benefits to the value of any alternative arrangements at retirement date.
The process is logical, consideration should also be given to the LSA and LSDBA available as that will impact the overall net return.
Considerations for each step
1. Calculate benefits based on existing arrangements projected to retirement
- Defined contributions - levels of employee, employer and third party contributions
- Defined benefit – benefit structure, accrual rates. Assumptions on salary increases and CPI for CARE schemes.
- There will still be at least £10,000 tapered annual allowance available (or £10,000 for DC savings if the MPAA is triggered) so no need to fully stop pension saving
2. Calculate overall cost of maintaining existing arrangements
- To allow fair comparisons the net of tax relief costs should be considered
- There may be no/little cost to the individual if benefits are solely/mainly employer funded
3. Calculate benefits payable net of any tax charge
- Scheme Pays – mandatory only or voluntary available?
- Schemes arrangements for actuarial reduction of benefits including commutation factors.
4. Calculate the value of “paid up/deferred” benefits at retirement date with no further accrual or contributions
- Where pension contributions cease or member opts out of active membership there will be no more annual allowance usage
- Carry Forward (for standard or tapered AA clients) will build up potentially allowing savings restarting in future (although re-joining is unlikely to be an option with DB schemes)
5. Identify the value of alternate arrangements
- What benefits would be provided by investing the net cost elsewhere?
- There may be other losses through stopping e.g. employer matching contribution, employer sponsored life cover
- Will the employer remodel pension / remuneration package and what are the tax implications?
6. Add the value of “paid up/deferred” benefits to the value of any alternative arrangements at retirement date.
- Will clients want an increased salary now instead of a pension contribution?
- Alternate benefits could be accrued in another tax wrapper
- There will still be at least £10,000 tapered annual allowance available (or £10,000 tapered annual allowance for DC savings if the MPAA is triggered) so no need to fully stop pension saving
Most clients will be unlikely to work through this process themselves and even where they could there’s still the need for advice to help them make the right decision.
If the client believes that the benefits payable (Step 3 of the process) represent value for money then the tax charge (Step 2) may be worth it.
Annual Allowance Case study
In this case study the client is 45% taxpayer with a salary of £360,000 (as such AA has been tapered to £10,000) and has no carry forward available.
The comparison made below is:
- a member of a DB 1/60th scheme, with employee contribution of 6% where the scheme pays the AA charge (based on commutation factor of 20:1).
- a member of a DC scheme where employer pays 6% of salary as standard, employee contributions are matched 1 for 1 up to 6%. Scheme pays AA charge
|
Defined Benefit | Defined Contribution |
|---|---|---|
| Pension accrued | £6,000 p.a. | £64,800 |
| AA used | £96,000 | £64,800 |
| AA excess | £86,000 | £54,800 |
| AA charge | £38,700 | £24,660 |
| Benefit reduction | £1,935 p.a. | £24,660 |
| Post AA charge benefit | £4,065 p.a. | £40,140 |
| Net cost | £11,880 | £11,880 |
*Assumptions: inflation ignored
Therefore, the client of the DB scheme pays £11,880 net to generate an additional pension of £4,065 per annum and the member of the DC scheme generates an additional fund of £40,140 at the same net cost.
The calculations and value judgement to be made is perhaps easier where Annual Allowance is an “issue” – would a client pay £x to get £y.
If annual allowance and the LSA/LSDBA are both an issue then the process is the same but the calculations are trickier as they have to take account of potential LSA/ LSDBA excesses.
Summary
Whether it’s DC, DB, Annual Allowance or Lump Sum Allowances or a mixture the thought process should be broadly the same. Maths ability may be just as important as pension knowledge.
- Alternative tax efficient strategies that may be suitable could involve vesting to drawdown and recycling income efficiently (but bearing in mind any potential reduction in the MPAA) or paying into others pensions, EIS, VCT, OEICs, Bonds or ISA? Perhaps because most unused pension and death benefits will fall into client’s estates for inheritance tax purposes from 6 April 2027 it is increasingly important to consider estate and inheritance tax planning when discussing pensions with high net worth clients, especially if you are considering contributions that may trigger an annual allowance charge.
The key point that clients need to remember is that tax is only bad if the net benefit is not deemed “worth it”. Opting out to save a tax charge, even if the net benefit is better, would be a bit like a client asking their employer to stop paying their salary because there is a tax charge.
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