Christina Nawrocki FCCA on how pension scheme contributions are complicated and creating unwanted tax bills for many.
The press headlines screamed waiting lists are up 50% in England!
One explanation, NHS consultants are refusing to do unplanned overtime resulting in delays in operations. Worse still many consultants are choosing to retire early, with good reason!
They're doing so because this is what the financial incentives are guiding them towards. It's a potential trap that many, not just doctors, could fall foul of. The issue relates to pension schemes, namely rules around what you can contribute to a pension every year and receive tax relief on.
Large numbers of people, who are either self employed or have multiple income streams, are having to pay large, upfront tax bills on pension contributions they can't then access for several years. Be sure to read on to understand what to do about this financial predicament resulting from the tapered annual allowance.
How the Exchequer's tinkering with pension tax relief created a mess
Since 2006, the UK has had a system that limits the amount people can contribute into a pension scheme before a tax charge arises. In the 2009/10 tax year it stood at £255,000. However, in 2011/12 this was reduced to £50,000 and then subsequently fell to £40,000. Further restrictions were introduced in 2016 by the then Chancellor, George Osborne, in the form of the tapered allowance.
At the time, and still today, there was a lot of political debate around wealth inequality and how to make those on higher salaries pay their fair share. So Osborne created the taper whereby people with an income greater than £110,000, coupled with more than £40,000 of pension contributions/growth, would see their pension allowance cut to potentially £10,000.
The complexities the taper creates for you
If you have a variable income, or several potential sources of income, then you may not know what you will earn in any given year. This now creates issues for you! You won't then likely know what your tax-free pension allowance will be.
This uncertainty is compounded if you are fortunate enough to have a final salary (defined benefit) scheme where you have limited control over how much is contributed into your pension pot.
This means doctors, consultants, and many others won't know if they may go over the taper. Work schedules are often subject to change. Predicting overtime is uncertain. It's often beyond your control. Exceed the taper and you get a bill that has to be paid in the year it's incurred!
This can create a cashflow problem for you. In effect you're paying tax today on money you won't receive until you decide to retire. That can be quite a hefty sum, with some bills reportedly over £80,000!
According to the FT, 4,000 members of the Armed Forces pension scheme have fallen foul of this. They could be liable for tax bills of up to 6 figures having gone over their annual pension contributions allowance. In the 2017/18 tax year, 3,840 members were said to have breached the limit.
Then you also have the lifetime allowance to consider! If you accumulate over £1m in pension funds that makes you liable to pay tax on it.
What you need to do and consider
Firstly this is not something you can ignore. It won't go away.
To avoid hefty tax bills you need to understand your current and forecasted financial position to determine what your pension contributions should be. You also have to take into account the taper system and the complicated rules around it when filing your tax return. In essence you need a very good understanding of UK tax legislation.
If you find yourself in a position facing a potential pension tax liability, consider the following options:
Pay it through self assessment whereby the marginal rate of tax is applied or;
Ask your pension scheme to pay the bill and then reduce your pension fund accordingly, but this is time limited. A point to note regarding the NHS scheme is this is classified as a loan which means a rate of interest will apply along with the admin of processing it, or;
Question and query your pension scheme growth figures, we have seen circumstances where they are wrong!
Areas where a good accountant can help you:
Calculate potential allowances from prior years you can carry forward;
Review and consider the validity of your pension growth figures;
Review your sources of income with a view to considering whether you're operating under the right structure to minimise the chance of a tax charge;
Ensure calculations are done on a timely basis to allow you to qualify for scheme pays if a tax charge does occur.
In the meantime we'll have to hope that this is something the Chancellor addresses in the next Budget. Perhaps a lower lifetime allowance would be a better, less complicated solution?
The content of this post is up to date and relevant as at 26/09/2019.
While every care has been made in preparing these articles to ensure their accuracy, they cannot be considered to be exhaustive and are no substitute for detailed examination of the relevant statutes, cases and other material when advising clients on particular matters. The opinions expressed herein represent the view of the authors at the time of preparation and should not be interpreted as advice. No responsibility can be accepted either by PQR Financial Planning or any of the authors and their representatives for any loss occasioned to any person acting or refraining to act in reliance on anything contained in these articles. No part of any of the above articles may be reproduced in any form without the prior written permission of the Author.
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