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Can’t pay? We’ll take your pension away!

Author Image Jacqueline Clezy Technical Manager
7 minutes read
Last updated on 17th Jul 2018

Overview

Your client has an annual allowance excess which means they’ve a tax charge to pay. You’ve heard a pension scheme will pay this charge from a member’s benefits using ‘Scheme Pays’.

If your client is in the fortunate position that they could afford to pay the tax charge on their own, should they pass up an offer for Scheme Pays and pay their own way?  Let’s work it out.

If you need a refresher on the basics for working out an annual allowance (AA) excess and its tax charge, or the rules around mandatory/ voluntary scheme pays, you’ll find relevant information in our technical centre - Annual allowance for pension savings.

Case study

Jason, based in Manchester, is a member of a defined benefit pension scheme which has an accrual rate of 1/60th for each year of service. His pensionable pay in tax year 2017/18 was £198,000 which means he gained (198,000/60) £3,300 pa pension entitlement, we’ll assume he’d no pay rise or the gain would be higher.

To make the annual allowance sums simpler let’s assume CPI was nil, and this equates to a pension input amount of (3,300 x 16) £52,800. We’ve worked out Jason’s adjusted income and find that he is subject to a tapered annual allowance of £10,000, meaning an AA excess of £42,800. Adding this amount to Jason’s other taxable income means the tax rate for his charge is 45%, i.e £19,260.

Jason’s scheme administrator has sent him a Pension Savings Statement (PSS) as his inputs have exceeded the annual allowance. Remember the scheme won’t necessarily have enough information to know if any member actually has an AA excess, as they won’t have information for any other schemes their members may be contributing to. In any event, they’re only responsible for tracking member’s standard or money purchase annual allowance in their scheme. Everything else, e.g. tracking available carry forward of unused AA, is up to each individual. The scheme information received by Jason confirms the factor for giving up pension to pay an AA charge will be 20:1. 

How much does ‘scheme pays’ cost?

How much pension will be used to meet the charge? It’s a straightforward monetary value from money purchase funds but, for defined benefits, how much pension must be given up to pay the charge? This will depend on the scheme rules. Legislation doesn’t dictate how pension benefits must be reduced, only that the scheme must make the adjustment on a demonstrably just and reasonable basis using normal actuarial practice.

Using 20:1 in our example means a reduction in Jason’s pension of (19,260/20) £963 pa. If you had the choice, would you choose to give this up or pay £19,260 today to buy, from your scheme pension age, £963 pa inflation-proofed income for life? Does your client consider this to be good value for their money?

As with the majority of pension planning, you need to know your client’s needs and intentions, then do the sums to work out if the net benefit makes it worthwhile. For starters:

  • How much will scheme pays cost?
  • Where else could the money (equal to the amount of the charge) be invested to get similar income?
  • Is the aim to use the pension for retirement income, or to pass on after death?
  • Might there be a desire to transfer out in future, what would the transfer value on £963 be?
  • And perhaps checking solvency levels for the DB scheme and the likelihood of it being referred to the Pension Protection Fund (PPF), as this could ultimately restrict personal entitlement to income due to PPF’s application of compensation caps.

For details of our generic six step planning guide please refer to Lifetime allowance and annual allowance planning for the high net worth client.

Is there a further benefit if the member pays?

If the member pays all of the tax charge themselves, it removes money from their estate that might otherwise be subject to Inheritance Tax (IHT), whilst leaving the full pension benefit earned in an IHT friendly environment (probably!).

Defined benefit pensions include dependent’s pensions after member’s death. Retaining the higher member’s pension will have the knock-on effect of keeping this too.

Reporting the annual allowance tax charge

The charge must be reported on Jason’s self-assessment tax return (even if the scheme pays the charge). You can read details of this process in our main annual allowance article.

Scheme pays – will they or won’t they?

On contacting his scheme, Jason learns they only offer ‘mandatory’ scheme pays so will only pay the part of his tax charge relating to the pension input amount exceeding the standard, and not his tapered, annual allowance. This means they will only agree to pay (52,800 – 40,000) £12,800 x 45% = £5,760, by reducing his pension. The amount of Jason’s pension that would be undone is (5,760/20) £288 pa pension.

It’s up to Jason whether he asks his scheme to pay this part of his charge or not, but regardless he must pay at least the remaining charge (£13,500) himself. One important point to note here is the different payment deadlines that will apply.

Tax charge payment deadline

The earliest payment deadline is the normal self-assessment date i.e. 31 January following the end of the relevant tax year. So for an annual allowance excess in the 2017/18 tax year, the tax charge must be paid by 31 January 2019.

This deadline applies where the client pays the tax charge themselves or their scheme have agreed to pay it on their behalf on a voluntary basis.

If mandatory ‘Scheme Pays’ applies, this deadline is much later. The client must give their pension scheme a notice stating (amongst other information) the amount of annual allowance charge they require their scheme to pay and the tax year this relates to. The deadline for submitting the notice is by 31 July in the year following the year in which the tax year to which the annual allowance charge relates ended. So, again using an annual allowance excess for the 2017/18 tax year, this deadline will be 31 July 2019. The scheme then administer the ‘Accounting for Tax’ process, which works on quarterly returns and specific set payment dates, meaning the tax charge may be paid as late as 14 February 2020.

You can find full details of the AFT process and timings here.

Jason decides to use ‘Scheme Pays’

What needs done and by when? Jason will pay £13,500 and he’ll send a notice to his scheme asking them to pay £5,760.

Date  Event 
5 April 2018 Tax year ended and pension input amounts (PIA) for 6 April 2017 to 5 April 2018 can be accurately calculated
6 October 2018 Scheme Administrator must automatically give Jason a PSS by this date as his defined benefit pension input amount exceeds the £40,000 standard annual allowance.
31 January 2019 Jason must submit his self-assessment tax return (showing the full annual allowance charge due of £19,260) and settle the £13,500 he has to pay with HMRC. At this time he will of course settle any other tax due.
31 July 2019 Jason must have provided his scheme with a completed notice requiring them to pay £5,760 of his annual allowance charge.
31 December 2019 This is the quarter end date relating to the mandatory ‘Scheme Pays’ notice received above
14 February 2020 This is the payment deadline relating to the quarter end date 31 December 2019. The scheme will report and pay the £5,760 tax charge using the ‘Accounting For Tax’ (AFT) process to meet this HMRC deadline.

As you can see, where the scheme pay the charge under the mandatory ‘Scheme Pays’ rules, the deadline is much later than for a client paying the tax charge personally. 

Reminder

The end of this month, 31 July 2018, will be the deadline for any members with an annual allowance excess for tax year 2016/17 to notify their scheme with a mandatory scheme pays request. This shouldn’t be any great surprise and has probably already been actioned where relevant - as we’ve covered here, the total AA charge amount should already have been reported in the self-assessment tax return made by 31 January 2018.

Final comment

Perhaps it’s not so much “can’t” pay, as choosing “not” to pay. No matter whether you are advising the most cash-strapped or the wealthiest of your clients, looking at the cost of paying the charge from their bank versus the value of pension funds / benefits they would have to give up has to be considered. If ‘scheme pays’ looks to be the right option, your client can elect this by notice to their scheme - no Bailiff required.

© Prudential 2019