UK Leasing

The electric car tax trap that could net you a £30,000 bill

You might think that buying an electric car has nothing to do with your pension. But hiring one through your company could cost you a tax bill of tens of thousands of pounds and reduce your income in retirement.

Many employers offer their staff the option of leasing a new vehicle through an arrangement called “wage sacrifice”. This means that the employee can pay for the car directly from their salary before deducting taxes and other contributions. It is a very tax-efficient way to acquire a car and has enabled many drivers to purchase an electric vehicle.

But a quirk of the tax system means many of those who opted for wage sacrifice and have a ‘defined benefit’ pension are now facing tax bills of up to £29,000 at the end of the lease.

This is because of the way pension growth is calculated for schemes that guarantee retirement income, including those held by public sector workers. Many doctors have fallen into this ‘car trap’ as they have long been victims of punitive pension taxes, financial advisers have warned.

For example, if a doctor hires a Tesla, it could equate to a gross salary sacrifice of £10,000 a year. This means their income appears to be £10,000 less than tax, said James Ramshaw of tax consultants RSM.

This can trigger huge tax bills when their salary suddenly increases by £10,000 at the end of the lease. Indeed, any salary increase can cause savers to exceed the annual retirement allowance and therefore to pay taxes. The £10,000 increase in taxable wages artificially results in pension growth over a year of £64,000.

Assuming they have already exhausted their annual allowance, the doctor would face a tax bill of up to £28,856, Mr Ramshaw said.

Anyone nearing retirement risks permanent damage to their pension by reducing the income they will receive.

If the doctor is aged 52 and maintains the wage sacrifice agreement until retirement at age 60, his annual pension income would decrease by £4,561 for each year of retirement.

This would represent a gross loss of £137,829 over their lifetime, Mr Ramshaw calculated.

Graham Crossley of Quilter, the wealth manager, said it was a “car trap” that many of his doctor clients sleepwalked into.

“It’s one of the questions we get on a regular basis and people don’t realize it, but the consequences are huge. Electric cars from the NHS scheme look very attractive at first glance because they are much cheaper than paying for them on after-tax income, but there is a sting in the tail,” he said.

Fortunately, there are ways to limit the damage. Pensionable salary is generally based on the best of the last three years of salary, which means that leases that only last one to two years will have no impact on a pension.

A couple, both NHS consultants, took turns taking two cars for two years each to avoid tax bills, Mr Crossley said.

Likewise, the exit penalty for returning a car before the end of the lease is far less than the tax bill workers incur, so many have ended the deal early, he said. added.

Others have renewed their leases several times in the hope that the government will fix the problem, he said. “At the end of the lease, they take another in the hope that the government will recognize how inadequate the system is, but it is a difficult game to play. Someone had a four-year car lease when he came to us and had no idea it would affect his pension. »

Private sector workers in their 50s or older could also be affected if they are affiliated to a defined benefit scheme. The same risk would apply to other company benefits that operate under the wage sacrifice model.

But the vast majority of young workers in the private sector will escape the tax trap because of the way their pension growth is measured. A worker with a modern ‘defined contribution’ pension who took out the same £10,000 Tesla lease would not risk a tax bill at the end of the lease.

The Treasury said 99% of savers would not be subject to a tax burden.