Technical Specialist Pensions at Prudential
The Government announced their intention for the Money Purchase Annual Allowance (MPAA) to reduce to £4,000 from 6 April 2017, in their final spring Budget on 8 March 2017. Finance (No.2) Bill 2017 included this clause but it was dropped prior to the general election, then reintroduced in the Finance Bill published on 8 September 2017 – in, out, in, hence the reference to the hokey cokey.
You’ll remember the logic for the £4,000 limit is based on minimum and maximum auto-enrolment qualifying earning figures of £5,824 and £43,000 respectively. If you apply the 8% maximum combined contribution this figure is below £4,000.
However, many employer pension schemes offer more generous terms than the auto-enrolment limits. So, say you have earnings of £43,000 and both you and your employer pay contributions of 6% of salary, this is a total contribution of £5,160. In fact, using a 12% contribution rate and a salary in excess of £33,335 would give you a contribution in excess of the reduced MPAA limit. So, if someone is subject to the MPAA (you can read about the MPAA rules here), what does this change mean for them? It’s probably simplest to explain by looking at a few case studies. In Prudential’s July 2017 edition of Oracle Technical, we provided an example for a client impacted by a tapered annual allowance and the MPAA, which you can read here. The following examples all assume the client does not have a tapered annual allowance.
Meet Jack who first accessed flexible benefits in tax year 2016/17.
Following an illness in June 2015 he needed an extended time off work. A year later his salary (usually £60,000pa) stopped, and replaced with a smaller amount of sick pay. He took an uncrystallised funds pension lump sum (UFPLS) to maintain his mortgage payments and other household bills.
In June 2017 he was fully recovered and returned to work. Both Jack and his employer resumed contributions at 5% of salary to the company’s defined contribution pension scheme. So, say he’ll have 10 months salary (£50,000), a total 10% monthly contribution would mean defined contributions (DC) inputs of £5,000. The UFPLS payment in June 2016 triggered the MPAA which means Jack has the MPAA limit of £4,000 for all DC inputs in 2017/18. Remember you cannot use carry forward to increase this limit.
This would give Jack an annual allowance excess of £1,000 for 2017/18 which he must report through self-assessment leading to a minimum tax charge (the rate for the tax charge depends on total taxable income) of 40% of this ie £400 to pay by 31 January 2019.
Richard is in a slightly different place as he only first accessed flexible benefits in the current tax year of 2017/18.
Richard has his own business. He pays a personal contribution of £500pm (on 28th of each month) and tops this up with an employer contribution of £34,000pa to fully use his annual allowance each year. The employer contribution is paid just before the end of the company’s accounting period which is 31st October.
Richard’s daughter separated from her civil partner and needed funds to buy out her share of their home. Richard offered to help and took benefits from his paid-up personal pension, which had a value of £200,000, on 4 July 2017. He took £50,000 pension commencement lump sum and an ad-hoc flexi-access drawdown payment of £20,000. His plan was that with his salary of £8,000 and dividends of £78,000 he would not lose any personal allowance, nor would he breach the threshold income limit of £110,000 for the tapered annual allowance, but he overlooked the implications of triggering the MPAA.
It’s not as simple as looking at the total pension inputs in the tax year of £6,000 against the MPAA limit of £4,000 and saying the annual allowance (AA) excess is £2,000. We need to look at the standard annual allowance rules for contributions paid before the MPAA trigger date of 4 July, and also the MPAA rules for any DC contributions paid after that date.
Monthly contributions paid 28 April, May and June, so 3x £500, are tested against the standard annual allowance of £40,000 less the MPAA limit of £4,000 where this has been used, as it has been in this scenario. £1,500 is less than £36,000 so there is no excess amount at this point. If there had been an excess amount here, you can use carry forward of unused annual allowance to reduce/absorb it.
If monthly contributions continue to be paid between 28 July 2017 and 28 March 2018 inclusive, this would add up to 9x £500 = £4,500. This exceeds the MPAA limit of £4,000 leading to an MPAA excess of £500. It is not possible to use carry forward to reduce or absorb any of this excess amount.
Any employer pension contribution paid between 4 July 2017 and 5 April 2018 would simply add to this annual allowance excess amount, which Richard would need to report through self-assessment working out his tax charge using the relevant tax rate.
Estelle also has a trigger event in tax year 2017/18 and she has the added complication of defined benefit inputs as well as defined contributions using up her annual allowance.
Estelle was earning £30,000pa working part-time for an employer with a non-contributory defined benefits pension scheme. On 1 September 2017 she increased her hours to full-time working and, because of this sharp increase in pensionable pay, she’s been warned her pension input amount will be larger than normal, expected to be around £16,000 for 2017/18.
Estelle also works on contracts arranged with her own limited company. She takes no salary but pays herself a monthly pension contribution of £2,000 on the 1st of each month.
To supplement her, formerly part-time, income she has a capped drawdown arrangement from which she takes £1,250pm (£15,000pa). Due to the 1 July 2017 change where the Government Actuary’s Department of HMRC provided drawdown tables for gilt yields between 0 and 2% for capped drawdown review calculations, Estelle’s maximum GAD reduced to £14,000. However, Estelle asked her provider to maintain her income at £1,250pm. To achieve this, the arrangement was converted from capped to flexi-access drawdown immediately before the payment of £1,250 made on 4 July 2017. This payment triggered the MPAA.
This is similar to Richard’s scenario in that we need to look at the standard annual allowance rules, but this time we look at the total of the defined benefit pension input amount (DBPIA) plus the value of money purchase contributions paid before the MPAA trigger date of 4 July, and then the MPAA rules for any DC contributions paid after that date.
So, we’re expecting a DBPIA of £16,000. We know monthly contributions have been paid on 1 May, June and July, so 3x £2,000 = £6,000. A total of £22,000 is tested against the standard annual allowance of £40,000 less the MPAA limit of £4,000 where this has been used. Remember Estelle is not affected by a tapered annual allowance or else it would be used instead of the standard annual allowance figure. £22,000 is less than £36,000 so there is no excess amount at this point.
If monthly contributions continue to be paid between 1 August 2017 and 1 April 2018 inclusive, this would add up to 9x £2,000 = £18,000. This exceeds the MPAA limit of £4,000 and would lead to an MPAA excess of £14,000.
Estelle would have been able to avoid an MPAA excess providing she stopped employer pension contributions after the one paid on 1 September 2017. Her DBPIA amount does not count towards this £4,000 limit. You can look at other ways of extracting her company profits tax efficiently. There’s an article on the PruAdviser website and a calculator tool that may help.
One last point, an annual allowance charge obviously reduces tax efficiency of pension saving but it may still be a better option than the available alternatives;
- Will the employer offer more salary instead of pension provision and what are the tax implications?
- What benefits could be expected from investing the net cost elsewhere?
- How will you replace any other benefits that are given up if you opt-out of your employer’s pension scheme?
We’ve previously covered planning for the high net worth client in this area in the technical section of the PruAdviser website.
It is crucial that clients who intend to flexibly access retirement benefits are fully aware of the MPAA and how it will affect any future pension savings they are planning to make. The MPAA limit may seem to work against individuals who have the means and the will to save for their own retirement, however, where it applies, it will reduce the cost to the Treasury of pensions tax relief and that’s what it’s all about.
For more around tax planning at tax year end, take a look at our tax year end hub.