Overpaying A Pension May Offer Benefits To High Earners

Lisa Smith, BA (Hons), CeFA

The advantages of overpaying into a pension by high earners can outweigh the tax penalties, according to financial experts.

Anyone with an adjusted income of more than £150,000 have their pension contribution limit scaled down as a ‘tapered annual allowance’ – but for some high earners paying in more than the annual allowance could have financial benefits.

The taper whittles away the £40,000 annual contribution cap down to £10,000 at a rate of £1 for £2 of adjusted income.

But although the benefits may vary for individuals, 90% of advisers consider opting out of a pension to avoid paying over the annual allowance is a mistake for many retirement savers, said the Pru.

Meanwhile, eight out of 10 advisers felt retirement savers impacted by the tapered annual allowance would face unexpected tax bills, while 44% believed the allowance was unfair on wealthy savers.

Fiendishly complex

Technical expert for the Prudential Les Cameron said advisers should work out if the benefit of making extra contributions outweighed the cost of the additional tax.

“This survey provides a snapshot of how accountants and advisers regard the annual allowance, particularly the tapered annual allowance,” said Cameron.

“Most people find it fiendishly complex and unlike the annual allowance and money purchase annual allowance it’s generally not possible for a pension scheme to know their member has exceeded the limit.

“The key point is the overwhelming agreement that you should think carefully before opting out of any pension provision simply to avoid a tax charge. Sometimes the net benefit still makes it worthwhile.”

Unforeseen consequences

He went on to explain that many high-earners may not know they are breaking the tapered annual allowance rules because of the way their income was calculated.

Cameron argues the adjusted income calculation is complicated and some income, such as rental profits, dividends or interest may not become fully apparent until the tax year has ended.

Many advisers feel the adjusted income rules have unforeseen consequences as they work fine for the employed on fixed pay they are aware of in advance.

However, he believes the self-employed are hindered by the rules because their pay is irregular, and the figures are unworkable until after the tax year has ended with the taper penalties already applied.

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