Tapered AA - Salary vs Employer contributions

Hello,

I've had a number of scenarios since the start of the new tax year where I am being asked by the financial adviser to calculate whether a high earner (fully tapered) should carry on paying into their pensions via employer contributions, or try and ask the employer to pay the premium as salary instead to mitigate a potential Annual Allowance charge.

All of my workings so far have shown it to be cost/benefit neutral apart from a slight increase in employee NI, and large increase in employer NI if taken as a salary, so actually a better idea to take the tax hit. Has anyone else come across this situation and had any similar/different results?

Seems like a massive catch 22 situation!

Late to the party but looking to launch a new platform due diligence tool and consultancy business later this year - watch this space and feel free to message if you would like any initial info.

Comments

  • Unfortunately not, I should've mentioned the clients have used all carry forward available to them or I've calculated it in if not. The article helps outline the things to consider but isn't really getting to the crux of what I'm after.

    Late to the party but looking to launch a new platform due diligence tool and consultancy business later this year - watch this space and feel free to message if you would like any initial info.

  • Hi Jamie,

    Generic 'advice' is of course nigh on impossible for this area (isn't it always!).

    In simple terms let us assume that a client has the option of having employer only contributions.

    Let Employer Pension contribution = PCER

     Let member Annual Allowance = AA

     So the issue (obviously) arises when PCER > AA

     The extent of the issue is the excess contribution which is PCER - AA = XSERCont

     So if you have XSERCont paid into a pension, client will pay tax of a maximum of 45%. This results in overall gross wealth increase of 55% of XSERCont.

     If we then (for ease in what is a stupidly complex situation created by a Chancellor with little idea of what he has done in the pensions arena) ignore any investment growth, this contribution can, in the future provide:

     25% PCLS + income on balance (which we will assume is at 40%).

     Then net value of an excess contribution is (25% x XSERCont) + (75% x 60% x XSERCont) - (45% XSERCont) i.e. PCLS + Net Income - Excess Contribution Tax Charge

    = 0.25XSERCont + 0.45XSERCont - 0.45XSERCont

    = 0.25XSERCont

    Alternatively, negotiation with employer to have excess contribution as a salary (with employer insisting on a cost neutral basis) then you have:

    Additional Salary + Employer NI = XSERCont

     This then results in:

     Additional Salary = XSERCont / 1.138 = 87.87% of XSERCont

     As salary his will be subject to 2% client NIC and 45% income tax so net pay would be 53% of the salary = 53% of 87.87% of XSERCont = 46.57% of XSERCont.

     So, ignoring investment growth take it as salary.

     I'm working on the investment growth side of this, so more to follow. ( I think I've got this right so far!)

  • I follow your above thoughts, that's a really helpful piece. It is difficult as the client will likely leave the pension untouched for many a year (or forever), so the investment growth side could become incredibly relevant over time.
    To this point, I've used listentotaxman's income tax calculator to get the 'neutral' results so I'm going to try and build something into Excel to take all of this into account and different scenarios (might take a while!)

    Cheers

    Late to the party but looking to launch a new platform due diligence tool and consultancy business later this year - watch this space and feel free to message if you would like any initial info.

  • I've now done the excel calcs (attached)

    Unless you can deliver at least a pension investment return of 92% more than the personal investment (the time period is not relevant) then the client is better off overall taking he excess contribution as a salary.

    This increases to 153% if you sued an EIS / VCT.

    (Based on 45% income tax rate now, 40% in retirement and assumes you can run the investment portfolio without incurring CGT.)

  • used, not sued!!!
  • Cheers Richard, I let curiosity get the better of me so created my own calculator at the same time but have produced the same results, which is reassuring.

    Thanks for your help.

    Late to the party but looking to launch a new platform due diligence tool and consultancy business later this year - watch this space and feel free to message if you would like any initial info.

  • That is also reassuring for me!!
  • Nice work
    Outsourced paraplanner for The Paraplanners.  President of the Scottish Petanque Association
  • richallumrichallum Administrator
    Just had to do one of these and that spreadsheet very helpful.

    Was the 152% growth an arbitrary figure used or is there some more science to it that I'm missing? 

    Paraplanner. F1, Apple, Nutella, ice cream. No trite motivational quotes. Turning a bit northern. Republican.

  • Always (nearly) a science behind my figures!

    The 152% arises from a goal seek.

    Seek the growth rate needed in Cell B23 such that the value in B45 matches the value in B31. What this means is that in the 45% tax now, 40% tax alter situation a pension contribution would need to deliver 152% more, after charges, than a VCT / EIS (after allowing for the 30% tax relief) for client to break even.

  • A very useful discussion. I've not encountered one yet but when I do, I know what to do.

    Thanks!

    Andy
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