An individual earning £100,000 could see an additional tax hit of £25,000
The low level of the Consumer Price Index (CPI) announced by the Office for National Statistics (ONS) will increase the number of individuals affected by the Annual Allowance threshold in 2013-14, says Mercer. The consultancy also says that the amount by which individuals exceed the Annual Allowance will be much higher.
The Office for National Statistics has just published its figure for the increase in the Consumer Prices Index (CPI) for September 2012. The CPI figure, which stands at 2.2% (compared to 5.2% in 2011), is at its lowest level for nearly three years and the September CPI figure is expected to be used by the Government for the uprating of many State Benefits from next April, 2013. It is also used to work out the value of an individual’s pension accrual under a defined benefit (DB) scheme in the following tax year for pension taxation purposes.
Nigel Roth, a Pensions Tax expert at Mercer, said, “The very low level of CPI will mean that more individuals will now be affected by the Annual Allowance in 2013-14 than anticipated. Not only that, but the extent to which they exceed the Annual Allowance will be that much greater and so many people could encounter very large pension taxation bills a couple of years from now. This problem may be particularly acute in the Public Sector where DB pension provision is widespread.”
To provide an example: Adam has been working for the same company for 30 years and is receiving a Pensionable Salary of £100,000 in April 2013. This increases to £110,000 at the end of the 2013 -14 tax year in part due to a modest promotion. He is paying into a defined benefit scheme with an accrual rate of 1/50th. At the beginning of April 2013, having served 30 years, he has so far accrued £60,000 in his pension scheme (30/50 x £100,000). At the end of March 2014, taking into account his pay increase, he will have accrued £68,200 (31/50 x £110,000). The method used to calculate pension accrual is 16 x the end of year pension less the value of the pension at the beginning of the year as increased by CPI. In this case, the value of pension accrual for 2013 - 14 amounts to 16 x [68,200 – (60,000 x 1.022)]. This is 16x (6,880) = £110,080. Then, after subtracting the Annual Allowance of £50,000 (and assuming there is no Annual Allowance carry forward available), the value of Adam’s pension accrual in excess of the Annual Allowance is £60,080. If, in this calculation, we assume that Adam is a 40% income tax payer, he will have to pay an additional tax charge of 40% of £60,080 on the excess pension accrual, which amounts to £24,032.
“It is quite likely that, after allowing for the value of his pension accrual, he will actually be in the 45% income tax band for part of his earnings,” said Mr Roth. “His additional pension tax charge will be even worse. This pension tax charge is payable on top of his regular income tax and National Insurance costs.”
“Sponsors of defined benefit schemes may wish to examine whether alternative, more tax effective forms of reward, may be made available for their senior employees for at least part of the pension accrual to help mitigate the potentially very significant pension tax charges for 2013-14.”
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