Would your high earners be better off paying more tax?

‘You’ve got a massive tax bill? Lucky you!’ said no one, ever.

Financial planning has always been focused on making sure that as much as possible of someone’s hard-earned money stays in their pocket, rather than the tax man’s.

What’s the standard advice for most people? Use all your tax allowances, and plan ahead to make sure your income in retirement is as tax-efficient as is achievable. With good planning you can double, or even treble, the amount of income that can be earnt before tax needs to be paid on it. All very sensible advice.

An increasingly difficult strategy to follow

However, the reducing allowances for pension savings are making this strategy increasingly difficult to follow. The more complicated pension legislation gets, the more knots high earners tie themselves in, second guessing how to avoid the tax man. Employers are regularly warned about the perils of pensions for high earners, or those who already have substantial pension savings.

For those in their forties, with total pension savings of around £500,000 already, investment growth alone could mean they exceed the current £1million lifetime allowance. It makes sense to stop contributing, doesn’t it? Especially if a lovely employer will pay those contributions into a salary instead.

Perhaps not. Some high earners could end up paying more tax now than they would save later, particularly if an increase in salary meant they lose their personal allowance.

What if you have employees who have already stopped contributing to your workplace pension? Perhaps because they have one of the various forms of pension protection. Are they aiming to get to the limit and then move it all into cash? Or are they happy to continue to let it grow beyond the limit?

Their answer may depend on whether they are happy to accept the risk that the value of their fund might fall below the limit again. If they are solely trying to ensure they don’t pay the tax – why? They are essentially paying less tax by having less money; it just doesn’t make any sense.

Let’s say a fund value grew beyond the lifetime allowance by another £100,000. Even after the 55% tax charge they would still have an extra £45,000. Had they moved the money into cash, the value would have been eroded by inflation.

I’m not suggesting that we should just start ignoring the hefty penalties and tax charges that can apply when one goes over the tax-efficient pensions savings limits. However, when dealing with the complex area of high earners and pensions, we should remember that one size really doesn’t fit all, and sometimes a more unconventional approach could be wise. Providing you have the right advice, of course.

‘You’ve got a massive tax bill? Lucky you!’ – said me, now.

Gill Hibbard is compliance and operations director at Lorica.

This article was provided by Lorica.