Estimated reading time: 3 minutes
The 31 January deadline for paying tax for 2016/17 has now passed. Senior staff now have to think ahead to the end of the current tax year, ending on 5 April 2018. So, what planning opportunities are there for minimising the impact of the present unbelievably complex pension legislation?
Top management (typically those earning more than £200k p.a.)
Relatively little can be done here. In most cases, the Annual Allowance (AA) will be tapered down to its minimum level of £10,000, and carry-forward from earlier years will already have been used up. Pension accrual in excess of the £10,000 figure is not tax efficient. Common practice is for any excess pension contributions simply to be applied as extra remuneration, reduced for employer National Insurance Contributions (NICs) and subject to Income Tax and employee NICs.
Different considerations apply in the public sector, where pay supplements in lieu of pension contributions are not normally available. Our experience here suggests that membership of the underlying pension scheme may still make financial sense for the executive, despite the tax penalties. We recommend those affected seek appropriate advice.
Middle management (typically those earning between £100k and £200k p.a.)
Here, there is more scope for planning. We need to see if the individual’s AA can be made as large as possible – up to the standard level of £40,000 if possible. For the tapering to apply, two tests must both be met:
- The individual’s ‘threshold income’ must exceed £110,000; and
- The individual’s ‘adjusted income’ must exceed £150,000
We now look at both in turn.
This is the total taxable income of the individual before AA issues are considered – i.e. it is the total taxable income of the individual (including all taxable investment income) less gross pension contributions and charitable donations. If threshold income is less than £110,000, then the full AA of £40,000 is available.
Pension contributions can be used to reduce threshold income – provided, of course, that they do not bring the total pension accrual to more than £40,000 plus any available carry-forward.
If the individual is already making charitable donations, and has a particular one-off problem with the AA, making one or more years’ charitable donations in advance – either directly to the charities concerned, or via a charitable bank account – could be beneficial in terms of reducing (or even eliminating) any AA tax charge.
"Pension contributions can be used to reduce threshold income – provided they do not bring the total pension accrual to more than £40,000 plus any available carry-forward."
We should also comment that aiming for a threshold income below £110,000 puts the individual in the position where, because of the tapering of the personal allowance (which happens over the range from £100,000 to £123,000), the individual is subject to a marginal rate of tax of 60%; conversely, they also benefit from tax relief at 60% when their income is reduced. Indeed, an individual may find that that reducing their threshold income still further – down to below £100,000, thus giving them the full personal allowance – is an option worth exploring.
Finally, in this section, we should mention that salary sacrifice (or “smart pay” as it is sometimes known) does not work. The legislation provides that any salary sacrifice entered into after 8 July 2015 is ignored for the purposes of threshold income.
This is defined to be the individual’s threshold income, plus the value of their pension accrual in the tax year – i.e. all contributions paid to defined contribution (DC) arrangements, plus the deemed increase in value of defined benefits.
So, because pension contributions to DC arrangements are added back, they do not have any effect on adjusted income. Charitable donations do work though, in the manner described above.