Reward professionals are looking at ways to ease the impact of this month’s tax increases for high earners, says Peta Hodge
This month’s tax changes for high earners have been exercising the minds of many professionals involved in the recruitment, retention and reward of key staff. The headline change is the introduction of a 50% income tax rate for earnings over £150,000, although the decision to include employers’ pension contributions in the definition of income effectively means the tax will bite at £130,000.
However, employees earning considerably less than this sum – even up to half – will also be affected by the tax changes. This is because the personal allowance for earnings over £100,000 is being withdrawn at a rate of £1 for every £2 of taxable income. This means that by the time taxable earnings reach £112,950, the personal allowance disappears. This change has the effect of pushing the tax rate on earnings between £100,000 and £112,950 up to an eye-watering 60% (see box right).
The impact of the tax changes will be felt a surprisingly long way down an organisation’s workforce hierarchy. Renu Birla, a director at KPMG, says: “In our experience, it really does start with people on £65,000 to £70,000 basic salary. That tranche of employees get other benefits, such as cars, bonuses and [share] options which, when added to personal income, are likely to take them over the threshold and into the £100,000 to £113,000 bracket.”
But she says employers are not, and should not be, instituting measures simply because of rising tax rates. “I think employers acknowledge tax rates are an external factor imposed by government and it is not really an obligation of the employer to mitigate and compensate in any way,” she explains. “It sets completely the wrong precedent.
How far should employers go?
“You never know when tax rates are going to increase in the future and if there are further tax increases, how far do employers go? There is always the difficulty that if they introduce something because of tax increases, will employees be prepared to see it reduced when tax rates go down?
“I am not seeing employers trying to help employees because of tax rates, I am seeing employers concerned about keeping key staff performing in this [salary band] by putting in incentive arrangements that provide sufficient motivation in terms of the ‘prize’ at the end and ensuring they get the reward for the hard work they are putting in.”
Employers should also bear in mind that there is only so much they can do. Graham Farquhar, partner at Ernst and Young, says employers will not even be able to identify all the members of staff that fall into the £100,000-plus income bracket because they will not know about the income employees earn outside of work, for example from private investments.
Instead, Farquhar says maximising the tax efficiency of affected employees “is very much about buy-in from the employees in this respect”.
Good communication is therefore vital. Employees need to be aware of how they may be affected by the tax changes and what opportunities exist within their employer’s reward framework for them to maximise their tax efficiency.
Salary sacrifice arrangements
Where earnings do fall into the £100,000 to £130,000 band, the opportunity to use salary sacrifice arrangements within flexible benefits schemes may be a useful tool, potentially enabling an individual to reduce his or her earnings to below the £100,000 mark.
Increasing pension contributions is an obvious first step, but Kim Honess, a senior consultant at Towers Watson, warns that regular contributions are probably the way to go. “There has been a trend in the last two Budgets to protect regular contributions,” she says. “Irregular contributions might work at the moment, but they are possibly riskier going forward.”
Employers should also look at offering other tax-efficient benefits via salary sacrifice, such as extra holidays. “If an employee is on £70,000 to £80,000, each day’s holiday is quite expensive, but it might be worth it if it keeps them below the £100,000 mark,” Honess points out.
Cycle-to-work schemes, buying additional life insurance, health screening and childcare vouchers are also worth considering. “For example, bikes for work might be worth only £1,000, but if an employee’s earnings are just over £100,000, it might be just enough to get them below the threshold, and give them the kick-start they need to start cycling to work,” she adds.
Employers should offer more choices
Although the onus is very much on the employee to make his or her own decisions, Honess says employers can help by offering more choices. Flex renewal is an ideal time to do this. She also thinks employers should be braver in what they offer.
“Instead of allowing employees to buy up to five days’ extra holiday, why not offer them 10, 15 or 20?” she says. “In the current climate, a lot of employers would like employees to cut back on their working time. This is a bit like offering a sabbatical, except that it smooths the impact.”
Similarly, instead of offering life cover of four-times salary, with the ability to reduce to two-times or increase to eight-times, employers could consider offering much greater multiples, such as 15- or even 20-times salary, says Honess.
As well as enabling employees to reduce their taxable earnings, flexible benefits can also be a powerful education tool. “Flex communication has always been about good news, choice and what people want, but it could also be used as a wake-up call,” says Honess. “For example, [it could ask] ‘Are you in this position? Should you be taking action? And where can you get more information?’
“It has not really been used like this in the past, but it could be a powerful education tool, especially as everything in a flex plan is person-specific.”
Beware of financial advice
But employers must ensure that if they are providing such education around benefits, they do not stray into the realms of financial advice.
For employees who will be affected by the tax changes, offering part of their remuneration in the form of share schemes where gains are taxed as capital gains at 18%, rather than as income, is another option for employers to consider. Company share option plans (Csops) are one such alternative. There has already been a marked increase in the number of employers bringing back Csops, or introducing them for the first time, in recent months.
This has been partly with the aim of offering high earners increased tax efficiency, in some cases because it is seen as a way of rewarding and retaining key staff without having to pay them in cash during difficult economic times.
Corporate individual savings accounts (Isas) could also be offered to help employees improve their tax efficiency in a general way. Farquhar says: “One thing you have to be careful about is that many of the employees in this salary bracket will tend to have their own personal Isas. Employers have to be careful that staff do not end up contributing to two Isas.”
Offering flexibility beyond the reward package can help, too, for example allowing employees to work fewer hours in order to take their earnings below £100,000.
Managing the impact of the withdrawal of the personal allowance on earnings between £100,000 and £130,000 is down to individual employees, but employers can do a lot to help through communication and by providing a benefits framework that maximises the individual’s flexibility and choice.
How staff earning £100,000-£112,950 will be affected
– From 6 April 2010, the £6,475 personal tax allowance will be withdrawn at a rate of £1 per £2 of extra income over £100,000.
– Every £2 earned will be taxed as if it was £3. This effectively turns a 40% tax into 60% for earnings between £100,000 and £112,950.
– This 60% tax rate stops at £112,950 because this is the point all the personal allowance has been eaten away (2 x £6,475 = £12,950).
– Those earning between £100,000 and £112,950 are hardest hit by the withdrawal of the personal allowance, so it makes particular sense for them to take action to get earnings below the £100,000 threshold.
– This group could include those with a basic salary as low as £65,000 to £70,000 if their remuneration includes benefits such as bonuses, cars and share options.
Case study: Roche helps to sweeten the pill
Pharmaceutical company Roche realised the tax changes for higher earners were going to affect a large number of its employees, so decided it needed to take action.
Its first step was to write to two groups: those whose remuneration would be in excess of £100,000 and would therefore be caught by the removal of personal allowances, and those who would be hit by the 50% tax rate with earnings in excess of £150,000. The letters not only highlighted this year’s tax changes, but also the pensions changes that will filter through from 2012.
Employees affected were offered one-to-one financial advice sessions to help them understand how their own personal circumstances would be affected, and 70% took up the offer.
One particular issue for Roche was making people aware of how the tax changes would affect them ahead of the company’s year-end, when bonuses are generally paid.
The company’s main concern was to retain and motivate key employees. It did not want staff to be demotivated by finding that, although their pay had gone up, they were going to be hit by a huge amount of additional tax.
Douglas Ross, corporate human resources manager at Roche, says: “We took the view that, while this is clearly outside the scope of the company, we did feel, as a responsible multinational employer, that we had a responsibility to make sure people were aware of these changes and they had an opportunity, prior to the end of the tax year, to do something about it.”
Ross believes a considerable number of affected staff have taken action because of the information received. For example, many exercised stock options ahead of the end of the tax year to ensure they were taxed at only 40%.
“Clearly this was only the first stage,” says Ross. “We have now moved on from that and are looking at bringing in some new benefits to reduce or mitigate the tax liability for these people.”
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