Exceeding the Lifetime Allowance and further Salary Sacrifice calculation
aald10074
Member
Hi guys,
Just a bit of a common sense check here, and also hopefully some of you may have done something like this before / have come across some calculators?
A client has just got in touch to see what they should do in respect of Salary Sacrifice into their personal pension, and it is looking very likely that they are going to exceed the Lifetime Allowance.
Currently, they are sacrificing 35% of their Salary, and the Employer is contributing 10% (for a total of £2,623.22 pm)
The pension is worth £945,477.95 and so I think it's safe to say that allowing for even conservative investment growth of, say, 5% pa, then the pension will most likely end up exceeding the Lifetime Allowance.
The client is a 40% tax-payer and the maximum that the Employer will match is 10%, I believe (and will definitely confirm) that they are also paying the 13.8% NI into the Employee's scheme for them as well.
In the first instance, I believe the client should match the 10% to get the most out of the employer (even with the 25% tax-charge, this seems to be a no-brainer).
Secondly, looking at the 25% charge on any investment growth becomes pretty murky, as it seems to follow the same sort of calculations as 'gross roll-up' in offshore bonds, as the charge could only be applied at age 75 (or when the spouse inherits), after many years of tax-free growth. Therefore, I am minded to ignore investment growth as a factor (rather than comparing the positions to, say, a General Investment and ISA strategy).
The client wants to know whether they should stop salary sacrificing, and instead make contributions into their partner's pension (20% tax-payer).
So, I am doing calculations based on for every £10,000 they salary sacrifice into their pension, assuming no growth, and no income (if they get the 13.8% NI, I assume this will effectively mean £11,380 in the pension) compared to what they would get if they took it as salary (£5,800 allowing for 2% NI and 40% Income Tax) and made this as a net contribution (grossed up to £7,250) into their partner's scheme.
The key difference here of course is that the partner will be able to take 25% tax-free-cash, with the remaining 75% being taxable at the relevant bands - I will assume that their income will be the same when they come to draw.
The general calculation seems to be then that through the salary sacrifice route the £11,380 will take the 25% LTA charge hit to be £8,535 before all of this being taxable at, lets say 20% to net down to £6,828.
Through the net contribution to partner's scheme route, the £7,250 would be paid £1,812.50 in Tax-Free-Cash with the remaining £5,437.50 liable at 20% to net down to £6,162.50.
All things being equal then, ignoring investment growth and with the employer refunding unpaid NI's, despite the LTA tax-charge, the salary sacrifice appears to be the better choice.
Only other thought would be that the partner's pension is comparatively small (under £100,000) and equalising the levels between the two pensions would allow for more flexibility in using their Personal Allowance and Basic Rate tax band in future years.
TLDR; Has anyone done this sort of calculation before, and if so do they have any pointers / calculators???
Comments
Do you use Voyant? There may be some limitations, but it should be able to plug in the numbers inc salary exchange and give you a clearer picture. I agree, first thoughts though no brainer to continue and get the employer conts. 75% of something is better than 100% of nothing.
Although I do have a specific calculator to answer the question 'should i pay an AA charge or not?' for very high earners, I've always defaulted to the 75% of something being better than 100% of nothing outcome for LTA, when the pension isn't going to be fully used.
But... in this case I'm left wondering about the opportunity presented via the spouse. Especially if the pension is going to be used in retirement to provide income.
I agree that the contribution up to the matched amount is a no-brainer. But with a net outcome of only around 10% extra income from the salsac route (and this assumes Er NICs rebated - I agree you have to know that this is going to happen?) is it worth accruing for the spouse on the grounds of, as you say, increasing flexibility?
I think you've done everything you need to reach a point where this can be discussed with the client. Ultimately, salsac gives a marginally better net financial outcome (per £10k), but there are very valid non-financial reasons to split the strategy. You could make a case for either, once the client understands both and you have their thoughts recorded.
As @Nath says, you could spend some time trying to model it in Voyant, this might give you lifetime tax charts based on the two options?
@Nath and @benjaminfabi thanks for your responses on this! It turns out that the Employer does not rebate Er NICs, turning this into a simpler conversation. In the end they have opted to reduce the sacrifice to the level that achieves the maximum employer contribution (I like '75% of something being better than 100% of nothing') before getting the 20% relief, and IHT efficiency of contributing into their spouse's pension.
Additionally, I cannot of course guarantee the way in which the client would actually draw down on the pension, and the calculation above assumes that they would never exceed the Basic Rate band in a given year, hence a total charge of c.45%, as opposed to 65% when paying Higher Rate tax.
I will have a look at Voyant today: we have been using our own in-house cash-flow modelling software, however this is becoming very out-dated and its time to start looking for alternatives (I am of course open to suggestions on this, good to pick the right one at outset - Intelliflo integration would be ideal!)
Thanks again guys.
Alex
Alex,
Glad you got a good outcome. Just be careful on those marginal tax rates. The effective tax charges on a post LTA tax charge fund are:
BRT - 40%
HRT - 55%
ART - 58.75%
This is because the 20%, 40% and 45% rates respectively are charged to the net fund, after the deduction of the 25% LTA charge. eg, for a higher rate taxpayer with £100 of pre-LTA fund:
£100, less
25% LTA tax charge (£25), less
£75*40% income tax charge (£30), equals
£45 net income, or a 55% tax charge.
When the 25%/55% LTA charge percentages were set, for income and lump sum respectively, it was intended that they'd produce equivalent outcomes for a HR taxpayer (there was no ART band back then). Obviously this ignored IHT, but I think it was also expected that the instances of LTA excesses would be much lower than they are (due to the savage reductions to the LTA since) and you'd spend that excess in the first few years after age 75.
@benjaminfabi my thanks again - it is always particularly useful to understand the 'spirit' of what the tax rules are trying to do! And you're right, it does feel like a bit of an oversight that HMRC are missing out on the IHT on any further growth post age 75!
In the end I discussed the position with the client primarily as if the 55% tax-charge for the lump-sum were being taken, as this felt like a more concrete position to better understand how the LTA really took all of the wind out of the tax relief (I also explained that taking the excess as income attracted the smaller immediate 25% charge, but I could not completely guarantee what the additional income tax to pay after this would be in the future).
Alex