Defined Benefit Pension Scheme? That Electric Vehicle Might Not Be As Cheap As It SeemsThe drive for more carbon friendly methods of transport is pushing more employees towards electric vehicles (EVs) through salary sacrifice arrangements. Those in defined benefit (DB) pension schemes should be wary of taking the plunge as a big tax bill may await according to Private Client Manager at RSM UK James Ramshaw.
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The attractive tax savings that can be obtained by acquiring the latest EVs through salary sacrifice arrangements may be too tempting for some. However, not all individuals should be leafing through those dealership brochures, they should be quantifying the impact on their retirement plans instead.
Whilst on paper the salary sacrifice savings seem too good to be true, considerations should be given to the impact on pensionable earnings for anyone in a defined benefit scheme. As an example, a Tesla may equate to an annual gross salary sacrifice of £10,000, i.e. £833.33 going through payroll each month at a net cost for higher earners of around £405.
Whilst £405 a month for a Tesla may seem like a great deal, pension tax charges may arise when a lease comes to an end and the impact of the salary sacrifice can have a considerable impact on the pension scheme growth, as some doctors have been finding out.
Continuing the example above, the doctor giving the Tesla back at the end of the lease may see their salary go up by £10,000. Assuming they have been in the 1995 pension scheme for 27 years, this would equate to 27/80th x £10,000, a pension ‘growth’ of £3,375. The way pension growth is calculated involves a factor of 19x. At 19 x £3,375 this means an additional £64,125 of pension growth arises in that input period. Assuming that they have already utilised their available annual allowance, as well as that from the three previous tax years, they may face a substantial tax bill of as much as £28,856.
Alternatively, they could keep a salary sacrifice arrangement in place to mitigate the annual allowance charge. If they are aged 52 in 2022, and plan to retire at 60, in this example the £10,000 salary reduction would cost them a reduction in pension savings of £1,186 in the 2015 scheme (after the actuarial reduction) and £3,375 from the 1995 scheme. This would mean £4,561 less pension per year during retirement. Assuming they draw from the pension from age 60 to 88, this would equate to an estimated reduction in gross pension of £137,829 over their lifetime.
In summary, if an individual chose to lease and return an EV, they may incur a potential annual allowance tax liability of £28,856, or if over 36 months, an additional £801 per month of net cost.
Alternatively, if they chose instead to lease consecutive EVs for 8 years until they retire, they could be forgoing £137,829 of gross pension and lump sum – increasing the opportunity cost by £17,228 per year, or £1,435 per month.
Therefore, whilst entering a salary sacrifice arrangement for an EV may seem advantageous in terms of its immediate cost, consideration should be given for the potential pension tax implications.
For doctors that may be forecasted to exceed their pension lifetime allowance, the benefit of obtaining an EV via salary sacrifice may have an additional benefit of reducing a potential pension lifetime allowance charge.