Lifetime pension allowance cut: Is ‘salary supplement’ the answer?
Pension savers have been hit with a raft of changes. Some have been hailed as very positive such as the Pensions freedoms allowing those aged over 55 unfettered access to their pension pots with the first 25% being tax-free. However, other changes have sought to reduce the maximum amount you can save into your pension both annually and over a lifetime.
Since April, the Lifetime Allowance – the maximum amount of pension savings you can build up without a tax charge – has been cut from £1.25m to £1m.
On top of that, for higher earners with an ‘adjusted income’ of between £150k and £210k, the Tapered Annual Allowance comes into effect, essentially reducing the limit by £1 for every £2 of income above the £40k annual pension contribution threshold.
Ian Price, divisional director of St. James’s Place Wealth Management, says this has meant more individuals facing restrictions on planning their retirement via pensions.
“As a result, we are seeing that more employers are paying a ‘salary supplement’ in lieu of a pension contribution for those individuals who are caught by either the Lifetime Allowance and/or the reducing Annual Allowance.”
What is salary supplement and how does it work?
It’s one for couples to consider, but you don’t need to be married.
The salary supplement reflects what the employer would have paid as a contribution to the employees’ pension but it’s paid as part of your income instead.
There’s no limit on the amount (this will depend upon your personal circumstances) but any salary supplement attracts both National Insurance contributions (NI) and tax at the highest rate the individual pays.
So, for example, if you have a salary supplement of £10k, you could end up with £5,300 after personal tax and NI are taken into consideration.
But Price explains that people are reviewing their spouse/partner’s pension arrangements to see whether they have scope for additional tax-relievable contributions, and if so, are funding their pensions instead.
You’re not passing over a tax allowance but you’re making sure that each individual within the partnership is making use of their own pension allowance as “it is very rare that both individuals in a partnership have used all of their pension allowance,” he adds.
For instance, a husband and wife where the husband has a salary supplement of £10k (which leaves him £5,300 after personal tax and NIC), could arrange to pay a net contribution of £5,300 into the wife’s pension. This contribution then receives £1,325 tax relief to give a gross contribution of £6,625.
Price says there will be scope for a lot of couples to redirect any salary supplement to increase the other’s pension provision. However, he cautions that “this is very much down to individual circumstances and it is important to take advice.”
This view is echoed by Steven Cameron, pensions director at Aegon, who very much supports couples planning their retirement finances on a combined basis as it offers tax efficiencies but is “also good for both parties to have an adequate pension in their own right.”
This is especially the case when couples have disproportionate amounts in their pensions and the amount of tax they pay differs.
However, he adds: “I would recommend the party considering asking for their employer to stop paying pension contributions seeks professional advice to make sure it’s the correct thing to do. They need to make sure they don’t inadvertently break the Lifetime Allowance in future years and they should apply for ‘protections’. If they change jobs, they need to make sure the new employer doesn’t pay in as this can lose them protections.”
Cameron also cautions that there are rules around how much can be ‘gifted’ to someone who is not your spouse without creating tax implications, particularly if the person making the gifts dies.
Also one further point to note is that the person contributing their salary supplement to their partner won’t have access to the pension pot upon retirement.
For tax reasons, the individual receiving the salary supplement will have the pension contribution in their name, meaning the original contributor won’t have any entitlement to the proceeds. “Though if you’re a married couple there’s an assumption that you would be sharing the joint income,” Cameron adds.