Tapered AA - Salary vs Employer contributions
Jamie_Barnes
Member
Hello,
I've had a number of scenarios since the start of the new tax year where I am being asked by the financial adviser to calculate whether a high earner (fully tapered) should carry on paying into their pensions via employer contributions, or try and ask the employer to pay the premium as salary instead to mitigate a potential Annual Allowance charge.
All of my workings so far have shown it to be cost/benefit neutral apart from a slight increase in employee NI, and large increase in employer NI if taken as a salary, so actually a better idea to take the tax hit. Has anyone else come across this situation and had any similar/different results?
Seems like a massive catch 22 situation!
I've had a number of scenarios since the start of the new tax year where I am being asked by the financial adviser to calculate whether a high earner (fully tapered) should carry on paying into their pensions via employer contributions, or try and ask the employer to pay the premium as salary instead to mitigate a potential Annual Allowance charge.
All of my workings so far have shown it to be cost/benefit neutral apart from a slight increase in employee NI, and large increase in employer NI if taken as a salary, so actually a better idea to take the tax hit. Has anyone else come across this situation and had any similar/different results?
Seems like a massive catch 22 situation!
Comments
http://www.pruadviser.co.uk/content/knowledge/oracle_archive/oracle-technical/oracle-tech-february16/annual-allowance/
Hi Jamie,
Generic 'advice' is of course nigh on impossible for this area (isn't it always!).
In simple terms let us assume that a client has the option of having employer only contributions.
Let Employer Pension contribution = PCER
Let member Annual Allowance = AA
So the issue (obviously) arises when PCER > AA
The extent of the issue is the excess contribution which is PCER - AA = XSERCont
So if you have XSERCont paid into a pension, client will pay tax of a maximum of 45%. This results in overall gross wealth increase of 55% of XSERCont.
If we then (for ease in what is a stupidly complex situation created by a Chancellor with little idea of what he has done in the pensions arena) ignore any investment growth, this contribution can, in the future provide:
25% PCLS + income on balance (which we will assume is at 40%).
Then net value of an excess contribution is (25% x XSERCont) + (75% x 60% x XSERCont) - (45% XSERCont) i.e. PCLS + Net Income - Excess Contribution Tax Charge
= 0.25XSERCont + 0.45XSERCont - 0.45XSERCont
= 0.25XSERCont
Alternatively, negotiation with employer to have excess contribution as a salary (with employer insisting on a cost neutral basis) then you have:
Additional Salary + Employer NI = XSERCont
This then results in:
Additional Salary = XSERCont / 1.138 = 87.87% of XSERCont
As salary his will be subject to 2% client NIC and 45% income tax so net pay would be 53% of the salary = 53% of 87.87% of XSERCont = 46.57% of XSERCont.
So, ignoring investment growth take it as salary.
I'm working on the investment growth side of this, so more to follow. ( I think I've got this right so far!)
I follow your above thoughts, that's a really helpful piece. It is difficult as the client will likely leave the pension untouched for many a year (or forever), so the investment growth side could become incredibly relevant over time.
To this point, I've used listentotaxman's income tax calculator to get the 'neutral' results so I'm going to try and build something into Excel to take all of this into account and different scenarios (might take a while!)
Cheers
I've now done the excel calcs (attached)
Unless you can deliver at least a pension investment return of 92% more than the personal investment (the time period is not relevant) then the client is better off overall taking he excess contribution as a salary.
This increases to 153% if you sued an EIS / VCT.
(Based on 45% income tax rate now, 40% in retirement and assumes you can run the investment portfolio without incurring CGT.)
Thanks for your help.
Was the 152% growth an arbitrary figure used or is there some more science to it that I'm missing?
Paraplanner. F1, Apple, Nutella, ice cream. No trite motivational quotes. Turning a bit northern.
Always (nearly) a science behind my figures!
The 152% arises from a goal seek.
Seek the growth rate needed in Cell B23 such that the value in B45 matches the value in B31. What this means is that in the 45% tax now, 40% tax alter situation a pension contribution would need to deliver 152% more, after charges, than a VCT / EIS (after allowing for the 30% tax relief) for client to break even.
Thanks!
Andy