Higher earners prepare for pensions pain

Whatever is announced in the UK Budget on March 16, higher rate pensions tax relief looks to have had its day. How corporate pension schemes will react, however, is much less certain.


The government’s consultation, which closed in September 2015, put forward two proposals for reform of tax relief on pension contributions (see box, opposite): a flat rate of relief for all members (regardless of their tax band) or a complete revision of the pensions taxation, making them similar in treatment to individual savings accounts, which were introduced in the late 1990s and are known as ISAs. It has promised a response in the March 2016 Budget.

Few expect those in the 40% or 45% tax bands to retain full tax relief on their pension contributions, with these tax payers currently claiming more than two thirds of pensions tax relief, according to the government.

Adrian Boulding, policy strategy director of the Tax Incentivised Savings Association, said: “The Chancellor [George Osborne] has looked at the proportion of pensions tax relief going to higher earners and decided he will go on reducing that share.”

Regardless of the Budget, that move is well under way, said Boulding, with higher earners already facing significant reductions in their ability to save tax efficiently in pensions as a result of the last Budget in 2015, which reduced the lifetime pension savings allowance from £1.25 million to £1 million, and the new tapered reduction in the annual allowance. Unless overturned by next week’s announcements, both are due to come in force in April 2016.

Forecasting trouble

Both can cause significant problems for those running pension schemes, for members and particularly for higher earners, say experts. For a start there is the uncertainty and complexity they bring. It is difficult for individuals to know whether their pension fund value will stay under the lifetime allowance, above which it incurs an additional tax charge: for those near the limit, growth in existing investments could push them over – a situation former pensions minister Steve Webb describes as “perverse”.

Webb, now director of policy at life and pensions company Royal London, said: “It’s one thing saying you cannot put over a certain amount in and get tax relief, but to say what matters is the value of your pot so that if it is well invested you face a tax penalty seems wrong.”

That’s the experience at brewer Whitbread, which has about 26,000 members in its defined contribution pension scheme, having closed its final salary scheme in 2009.

Lesley Williams, group pensions director at brewery group Whitbread, said: “The problem with DC arrangements is you don’t really know whether or not you’re going to hit the lifetime allowance. Some people who hit it before the recent economic troubles are now well below, for example.”

The reduction to £1 million also means it is affecting a greater range of workers, she said: “It is not just the executives any more; it is also older people in top-tier middle management who are affected – people who might fill in a tax return but almost certainly don’t have a financial adviser.”

Wider and deeper

The tapered annual allowance is even more challenging, say some schemes. From April 2016, high earners face having the £40,000 they can put into pensions each year without a tax penalty reduced by £1 for every £2 they earn over £150,000. For the highest earners, on more than £210,000, the annual allowance is reduced to just £10,000.

The complication is that the £150,000 threshold includes not only the employer’s pay and pensions contributions, but a wide range of income the company may know nothing about: from rentals, investments, interest or other pensions.

John Chilman, group reward and pensions director at transport company FirstGroup, said it has written to about 120 people with salaries of £85,000 that it thinks may be affected. Of those, Chilman believes 40 are likely to be significantly affected, but for the remaining two-thirds it is much harder to say. “It is really difficult because of the definition of adjusted earnings used, which doesn’t just include the earnings we provide them,” he said.

Again, it is expanding both the number needing communications and the complexity of the messages. Outsourcing supplier Fujitsu Services, which has about 7,000 active members in its main UK pension plan, said up to 450 may now be affected by either the annual or lifetime allowances.

Paula Evans, head of pensions and benefits for UK and Ireland at Fujitsu, said: “When we started informing members a few years ago when the allowances came in we were talking about a handful of people. Now we are running quite comprehensive education campaign.”

The overall lesson being taken from the changes is rather simpler, however, according to Chilman, who said: “I think the message has been clearly understood for most higher earners, which is that they are screwed as far as saving as much as they have done previously in their pension.”

Stewart Hastie, pensions partner at KPMG, said: “You end up with a situation where you could be taxed three times; taxed on the way in, taxed at the lifetime allowance and then taxed in income tax in retirement as well.”

As a result, an increasing number of high earners are opting out of pensions. In the public sector, Andy James, head of retirement planning at financial advisers Towry, said his firm has been consulting with around 20 senior National Health Service employees hit by the changes.

He said: “The cost of contributions to those pensions has gone up significantly for them in the last few years as the government has tried to cut back its costs. As a result, they are paying a lot more in and suddenly find they are not even getting tax relief and that at the other end they’re going to get hit by a whacking great tax charge. They are just coming out.”

In the private sector, the worry is the same will happen, and that this will weaken commitment to decent pensions, since those setting the pensions policy will no longer be in the scheme.

Evans said: “It is inevitable that if you cannot use something you’re not going to be so interested in it. It’s increasingly going to be the case that the majority of senior executives in the UK are not going to be in the pension plan.”

Williams used to dismiss such fears, but is now concerned, too. She said: “It is not that executives are so mean as to not want to provide a pension because they cannot have one.

“It is more that if they don’t see pensions as a good thing, you are less likely to have market-leading contribution rates and a great focus on pensions communications. The chances are they will spend more time focusing on other types of benefits.”

Other options

One way around this may be to tailor benefits to take advantage of the other available tax reliefs for high earners. Kevin Wesbroom, principal consultant at Aon Hewitt, points to the US as an example. Its recent survey shows that as well as traditional pension contributions, 58% of employers make contributions to Roth 401(k) plans, which operate like ISAs in the UK, with contributions taxed, but withdrawals tax-free.

Wesbroom said: “They have come to terms with the fact that there are limits for a lot of people on what they can provide through pre-tax contributions and are offering something that is more flexible.”

The equivalent here would be to set up and offer contributions to corporate ISAs. Tom McPhail, head of retirement policy at independent financial adviser Hargreaves Lansdown, said it has already seen a greater interest in “wrap accounts” incorporating both pensions and ISAs as a result of the annual allowance.

For now, however, adoption remains limited. In a survey of 99 employers published in January 2016 following the announcement of the changes for higher earners, KPMG found just 5% were considering other savings vehicles, such as corporate ISAs, for those affected.

The rest would either offer employees a cash alternative or no alternative at all. Hastie thinks that might change in time.

For now, though, all eyes are on March 16 Budget and the challenges that it throws up, according to Nigel Roth, a senior partner at consultancy Mercer.

He said: “Companies are playing a wait-and-see game. No one is prepared to jump until they really see what is going to happen in the Budget.”

• CASE STUDY: Wolseley builds in contingency

Plumbing and building materials supplier Wolseley Group has about 5,750 active members in its defined contribution pension scheme.

This offers generous contributions from the employer on a sliding scale: if the worker puts in 1% of their salary, the company will contribute 2.5%; if they put in 9%, Wolseley puts in 12.5%.

It also offers a flexible benefits fund, giving all employees 1% of their salary to use in this. If workers are putting at least 4% of their money into the pension, and opt to put the flex fund into the pension, too, the company will add a further 1.25%.

Neil McCawley, group head of reward, has identified 50 employees who he thinks will be affected by the annual allowance taper, but is writing to all employees earning more than £70,000 to advise them to see an independent financial adviser. They can be divided into three groups: those on or more than £150,000 who will almost certainly be affected; those within 10% of that earnings threshold; and the rest.

He said: “Some on the face of it I don’t think are affected but because I don’t know their total income they need to be aware of what is going on.”

For those affected who have to stop contributing entirely, the fund aims to add to their salary the value of the employer contribution they would have received. Similarly, for those who stay in, but have to reduce their contribution, the company will pay the balance it would have contributed (based on their level of pension contribution in October 2015). This allows those who are unsure how much their allowance will be to check at the end of the tax year and potentially top up their contribution if they can, said McCawley.

He said: “We want to give them as wide a range of options as we can so that if they are still able to contribute, they can. Even if you are only able to pay in £10,000, that is still quite a chunk of money if you have 10 years to go. We don’t want to switch them off planning for their retirement.”

While McCawley said the company has considered options like a corporate ISA to keep higher earners involved, for now it is biding its time. He said: “We don’t think the government has finished mucking around with pensions, and we want to wait until it might have settled before we take another look at what we offer our senior people in terms of retirement planning.

“What I don’t want to do is introduce something now to find in two years time that the government is going to change the rules again.”

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