Scheme pays/excess annual allowance

[TaxCharge]

Good Afternoon

Ive been retired on Ill health. Due to an enhancement to retirement benefits I have exceeded the pension annual allowance.

The tax charge is approx 20k. Am I better to pay this upfront with savings as I am only in my forties so otherwise will be paying this money back for a very long time. My understanding is that Scheme Pays is basically an upfront loan and interest and inflation will continue to be added each year?

I am not aware that my health may reduce my life expectancy so could be receiving a reduced pension for a long time.

I’m assuming you are in a defined benefit scheme.

Firstly check that the ill health exemption doesn’t apply to you: www.gov.uk/hmrc-internal-manuals/pensions-tax-manual/ptm051200

Ask your administrator to confirm what the scheme pays debit would be in respect of that amount of tax. Then you will know what level of reduced pension you will be getting. The scheme pays debit itself doesn’t increase once your pension is in payment, but only the reduced pension will get annual increases added to it (again assuming you’re in a defined benefit scheme where pensions in payment t do increase each year!). So for example if your pension in payment is £100 and the usual annual increase is 10%, your pension would go up to £110. However if your pension is £100 and you have a scheme pays debit of £10, that leaves you with £90 and only that £90 gets the 10% increase leaving you with £99.

Unfortunately without a crystal ball to tell you when you’re going to pass away, it’s impossible to know whether you will be better off using scheme pays or savings. Personally I would go for scheme pays as I would rather keep my savings in the bank but it’s really up to you. If you think you’re likely to live long enough that the amount you pay back via scheme pays will exceed the level of the tax charge plus the interest you would lose from the savings, then using savings my be the better option but then there’s the risk of not having your savings to use if something else crops up.

It is the local gov defined benefit scheme with a Tier 2 pension. The offset factor is 1000 / 23.34. I think this means my pension is reduced by £43 for every 1k of the tax charge they pay, via scheme pays.

I understand it’s the reduced element that is subject to inflation linked annual increases but was unsure if the scheme pays deduction was subject to annual interest or inflation…from what you’ve written it appears the amount remains fixed & those set deductions continue for the rest of my lifetime.

It appears a decision between paying the charge upfront which would prove sensible if I survive another 30-50 years, against paying over 20k upfront and my estate losing money if I unexpectedly die early. Is that right?

A crystal ball would be useful!

Finally, can I just check that the excess annual allowance is to be treated like additional income for tax bracket purposes? So even though my income during the year I was retired was approx 35k, as the pension charge is around 70k, I will pay a 20% charge on the proportion under 50,270 and then 40% on the remainder? HMRC declined to confirm.

When the doctor completed the certificate confirming that you met the criteria for ill health, the certificate would have included a declaration of whether you met the criteria for the ill health exemption. In tier 2 cases it can go either way. I expect your administering authority has checked this, but it’s worth asking them to confirm you’re definitely not exempt if they haven’t already specifically confirmed this to you.

Yes, once pensions are in payment the scheme pays debit amount is fixed and won’t change.

And yes, it’s balancing how much you might end up paying via the scheme pays deduction versus losing out on the interest on your savings (and not having those savings available for anything else that might crop up).

To calculate the tax owed - your pensions savings statement will show the amount of pensions growth, and it’s the amount that this exceeds £40k that is subject to tax. So if your total pensions growth is £70k, deduct £40k from that and the remaining £30k is subject to tax. You may also have carry forward allowance from earlier years if you haven’t previously exceeded the annual allowance, which could then be used to further reduce the taxable amount.

And yes it’s taxed in the same way as income. So add the taxable pensions growth to your taxable salary to give your total taxable income for the year and it’s then taxed according to the tax bands so the first £12k or so is tax free, everything over that up to £50270 is 20% and everything over that is 40%.

Wow, you’ve been so helpful Chessie.

They’ve brought forward unused allowance from the previous 3 years and provided the amount by which I’ve exceeded the annual allowance.

The OH doctor did not tick the box for severe ill health.

That’s a shame but sounds like you’ve got all the information you need to make a decision now.

Yes I understand the tax charge now, thanks so much @ChessieFL . Do you know if I’m also liable for National Insurance on the excess annual allowance and whether Scheme Pays can pay that too?

No, there’s no NI due on annual allowance excess.

Brilliant @ChessieFL .

Thank you.