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Example tax considerations for breaches of tapered annual allowance

This article illustrates the potential tax charges relating to different options for a pension contribution that exceeds a client’s tapered annual allowance. This is designed to show the impact on income tax, national insurance (NI), growth and inheritance tax (IHT) in this scenario.

The table below illustrates the potential tax charges relating to different options for a pension contribution that exceeds a client’s tapered annual allowance. This is designed to show the impact on income tax, national insurance (NI), growth and inheritance tax (IHT) in this scenario.

In this example we have assumed the client has a reduced annual allowance (AA) of £10,000 and there has been a pension contribution of £40,000. We have also assumed a fund growth rate of 5% each year over a 10 year period until this benefit is taken.

Annual Allowance only

Annual Allowance then  Lifetime Allowance tax charge (LTA)

Full pension contribution as salary

Reduced pension contribution as salary after deduction of employer NI (13.8%)

£10,000 invested in the pension and £30,000 excess over the AA.

 

The excess will be taxed at the client’s highest marginal rate of tax (assume 45%) = £13,500.

 

Leaves £16,500 of £30,000 plus invested £10,000 = £26,500 in pension from day one.

 

As invested within a registered pension scheme, it is outside of the client’s state for IHT purposes.

 

Invested into tax relieved pension funds with assumed growth of 5% for 10 years = £43,165.

Follow on from the result of the “AA only” calculation

 

The fund of £43,165 is excess over the LTA and subject to an LTA excess charge.

 

Tax is either

LTA excess taxed as a lump sum at 55% leaving a fund of£19,425.

Or

LTA excess taxed as income so initial tax charge of 25% leaving £32,374 as funds available for income (if taken, taxed at the individual’s marginal rate).

 

In both cases the residual funds are outside of the client’s estate if paid within two years of death.

 

Tax free if client dies before age 75 or taxed at recipient beneficiary’s marginal rate if post age 75

£40,000 immediately subject to income tax (assumed 45%) and 2% NI leaving a value of £21,200

 

Funds invested into (e.g.) bond or UT. Assumed fund growth of 5% for 10 years = £34,532.

 

Inside the client’s estate for IHT

 

Available to client straight away for spending/gifting/ investing further.

 

Potential charges on the investments products if surrendered such as income tax or CGT, or PET/CLT if gifted.

£40,000 reduced by employer’s NI of 13.8% = £34,480

 

£34,480 immediately subject to income tax (assumed 45%) and 2% NI leaving a value of £18,274

 

Money invested into (e.g.) bond or UT. Assumed fund growth of 5% for 10 years = £29,766.

 

Inside the client’s estate for IHT

 

Available to client straight away for spending/gifting/ investing further.

 

Potential charges on the investment vehicles if surrendered such as income tax or CGT, or PET/CLT if gifted.

 

There are many other factors that need to be considered with the client as the above is only based on a one-off excess contribution. If it was a regular occurrence the tax charges would potentially be higher. In addition to the above considerations, it’s vital to take a holistic view of the client’s estate and assets as they may look towards other potential income options or to use capital for income as part of their estate planning.

For financial advisers only. Not to be relied on by consumers.

The information provided in this article is not intended to offer advice.

It is based on Old Mutual Wealth or Old Mutual International's interpretation of the relevant law and is correct at the date shown at the top of this article. While we believe this interpretation to be correct, we cannot guarantee it. We cannot accept any responsibility for any action taken or refrained from being taken as a result of the information contained in this article.

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