If you are a member of a defined benefit pension like the NHS pension, you will need the CPI for annual allowance calculation.
It’s vital you use the CPI figure from the right date otherwise your calculations will be incorrect when working out your annual allowance. This could lead to a bigger tax problem than you thought.
Why you need the CPI for annual allowance calculation
The CPI (Consumer Price Index) is a measurement of the increase in prices across a range of goods and services.
You don’t need it for defined contribution pensions. That’s because working out how much has gone into your pension pot for an annual allowance calculation is easy. You just need to know the actual gross amount you and/or your employer have paid in to your pot over the last tax year.
For defined benefit pensions the calculation is very different as there is no pot, just a promise of an income in retirement linked to your earnings during employment.
Therefore for defined benefit pensions the calculation is based on converting your pension benefits into a capital value. Then looking at the difference in that capital value between this year and last year.
Over time your salary is likely to increase and therefore because defined benefit pensions are linked to your earnings, the pension income you accrue will increase. There is a good chance that your salary this year is more than last year. The bigger the increase in salary from last year to this year will mean the bigger the increase in capital value of your pension. This will mean more chance of you breaching the annual allowance.
In order to soften this potential blow, you are allowed to use CPI for annual allowance calculation. This means you can increase the capital value of your pension benefits from the previous year by the CPI, from the previous September before the tax year in question starts.
For example if you need the CPI for annual allowance calculation for tax year 2018/19 you will need to use the yearly CPI figure for September 2017 which is 3%.
You can find the CPI figure on the Office For National Statistics website.
How to use the CPI for annual allowance calculation
Here is an example of how to use the CPI for annual allowance calculation for defined benefit pensions.
To calculate the ‘opening value’….
- Use the annual pension benefit you have accrued up to 5th April for the previous tax year.
- Multiply the annual pension income by 16.
- Add to it any additional lump sum you are entitled to.
- Increase this final figure by the CPI rate (e.g. for 2018/19 tax year the figure is 3%).
To calculate the ‘closing value’….
- Use the annual pension benefit you have accrued up to the 5th April for the end of the tax year that you want to do the annual allowance calculation for.
- Multiply the annual pension income by 16.
- Add to it any additional lump sum you are entitled to.
Now you have the two values, you need to subtract the opening value from the closing value.
Closing value – Opening value = pension input for annual allowance calculations.
If this figure is over £40,000 then you may incur additional tax charges. You may even incur additional tax charges even if the figure is below the annual allowance of £40,000 if you fall foul of the Tapered Annual Allowance.
Using CPI for annual allowance calculation is complex and getting it wrong can have serious tax consequences. You don’t know what you don’t know. Why not let a professional expert do the calculations for you and potentially save you significant amounts of tax?
We have specialist knowledge of pension annual allowance rules particularly when it comes to the NHS pension scheme so please get in touch so we can carry out a full review for you.
Risk warning:
Stock market linked investments and any income from them, can fall as well as rise and is not guaranteed. Any figures quoted are for illustrative purposes and should not be taken as a forecast or guarantee. Past performance should not be seen as an indication of future returns and clients may get back less than they have invested.
