September’s low CPI signals trouble for DB scheme members

 

The pension conspiracy theorists out there (oh yes, they do exist) will look to the conveniently low CPI figures for September (1.2%) and conclude that the Government has cooked the books to raise extra tax revenue. Without getting BBC’s More or Less involved it does seem to us that September is often the lowest month for the measure of inflation… we’ll let you make up your own minds. However, let me explain why this could increase tax revenues and the very real implications for those in DB schemes.

 

Briefly, the Annual Allowance is the Government’s yearly limit for an individual on tax relievable savings into a pension. Introduced in 2006 it has had a tumultuous existence (which we need not go into here) and currently sits at £40,000 (from 6 April 2014) down from the £50,000 allowed in the previous tax year.
 

For DC schemes this test is straightforward and values the contributions paid in for people by their employer or themselves.

 

For DB schemes this is a little more complicated and involves valuing the increase in the pension the member has earned over the year, with an allowance for inflation (CPI) to the starting pension.

 

The announcement of a low CPI of 1.2% for September which is the annual rate used for the next year means that members in DB schemes will have less scope for an increase in their pension resulting in a greater chance they will exceed the Annual Allowance.

 

Some people might be in a DB scheme that uses Career Average Revalued Earnings (CARE) basis. Many of these schemes increase benefits in line with salary AND inflation linking and where the higher RPI is used this could also increase the risk of exceeding the available Annual Allowance.

 

Any pension earned in excess of the Annual Allowance is added to the person’s income for the year and taxed at the highest appropriate marginal rate.

 

There may be mitigating factors:

-       Low salary inflation could restrict the increase in the pension

-       Individuals can carry forward unused Annual Allowance from the previous 3 tax years so may have scope to reduce the tax charge

-       Where the tax charge is over £2,000 people can ask the scheme to pay the tax. However, the reduction in their benefit can be complicated and must be understood.

People should contact their Trustees/providers to understand the carry forward they have and engage with their employer to understand the impact of any potential salary increases on their tax bill. Employers may also decide turn to the advice community for assistance in explaining these overtly complicated rules to members and the implications for their personal wealth.

David Brooks

Technical Consultant

Telephone: +44 (0)20 7893 3456

Email:  contactus [@] broadstoneltd.co.uk