New pension finalised

[Al R]

Roland,

I have done some examples which might help demonstrate how your tax could be calculated, and also, here is an old (wordy, sorry) blog entry about AFPS which might be useful. Yes, AFPS is unfunded, but you can in principle, take it elsewhere. Would you be mad to do so? Generally, yes, although not all client needs are prescriptive.
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Want to transfer out of AFPS into a personal pension? - Echelon Wealthcare

First though, tax on a 'mythical' pot. As you may know, the Treasury cut the annual allowance from £255,000 to £50,000 in April of last year, and at the same time cut the lifetime limit from £1.8m to £1.5m. Whilst it had the scalpel and red ink out, it also decided to increase the factor for valuing final salary benefits from 10 to 16. And it is that final Reg that is causing the problems for those being promoted to, invariably, Sqn Ldr to Wing Commander.

Once you have the promotion under your belt and your income smoothes out, the problem tends to go away, but in the year when you get that big hike, you may have a problem. The problem can be mitigated by using previous unused annual allowance (currently, you can capitalise on any unused allowance from the previous 3 years by calling it forward) and you can have it taken out of your final pot in some instances.

HMRC does have an online calculator but using it for AFPS is problematic because many SP have switched from 75 to 05, or been commissioned and the rate at which you build up your pension pot (the'accrual rate') has changed during your membership of the scheme. It also has issues with taking into account the lump sum. Thoughtfully though, you won'thave to pay an annual allowance tax charge due in a tax year if you die or retire and start getting a pension or lump sum from all your pension pots due to severe ill-health.

Bear in mind as well, that following a pension share on divorce there is a pension debit orcredit attached to your benefits which may affect you either way (in other words,you might get a tax break/swipe when your financial settlement is sealed by the court).

To calculate any taxcharge, I’ll use two examples; and assume we’re looking at someone who is a member of AFPS05 (1/70th accrual), has served for 24 years and firstly, gets a promotion and 10% pay increase from £60,000 to £66,000. The second example will consider the same person who is promoted and receives a new salary of
£72,000.

Example 1

First, the opening value of your benefits (ie; the amount of money that might be needed to provide the expected benefit, in other words, a notional ‘capital' or 'pot' value) is determined as follows. First, calculated by dividing the number of years of service at the start of the year in question by the accrual rate of AFPS05 and then multiply by the starting salary (24/70 x £60,000 = £20,571).

The closing pension entitlement is then calculated. If pension accrual continues, then the annual pension will rise to £23,571 (= 25/70 x £66,000) as a result of the extra year's service and the pay rise in the 25th year. The increase in annual pension entitlement is therefore £3,000. This is then multiplied by a factor of 16 (it used to be 10..) to give a deemed contribution of £48,006 (in other words, 2k under the annual allowance – good news).

However, because AFPS also gives you a separate lump sum in addition to your pension without having to give up pension, next, add the amount of the promised lump sum to that amount. To keep things simple and for the purposes of the examples, I’m going to leave that bit out, but remember, it is very important.

Example 2

Lets look at the second scenario. If you got a promotion from that 60k, to 72k, then, as before; first the opening pension entitlement. Situation no change - it is still £20,571 (24/70 x £60,000). Next, calculate the closing figure (this one is different); £25,714 (25/70 x £72,000). Next, subtract the opening balance (£20,571) and you have £5,143. Multiply that by the new factor of 16 and you end up with an annual contribution of £82,288. In other words, with that promotion you are exceeding the annual allowance by £32,288 and remember too, to add any lump sum.

Although SP don’t have the uncertainty of fluctuating investment and annuity rates to contend with, it does seem unfair that someone who has a final salary scheme that rises by a relatively modest £5,143 is exposed to a tax bill (many clients put that into their personal pension and the contribution is calculated far more benignly) - hence my comment earlier about Forpen fighting the case.

Once you’ve worked that out, the contribution can be tested against your annual allowance of 50k, taking account of unused allowance from the previous three years, and any charge due can be determined. The unused allowance is also useful for making contributions into your personal pension (if you have one) - and particularly useful for someone reaching retirement with capital to spare and who has less need for liquidity than he has need for income in retirement and wants to be as tax efficient as possible.

Generally, as ever, take specific advice that you trust to see if any of that applies to you.