If you read nothing else, read this…
• From 6 April 2011, employees earning £150,000 or more each year will receive pensions tax relief only on contributions worth £50,000 a year, down from the previous £255,000.
• Employers are looking at alternative arrangements for their high earners.
• Possible options include cash top-ups and alternative savings plans such as corporate Isas.
• Employees also need to be made aware of the changes, and perhaps offered access to financial advice by their employer.
Case study: Bird and Bird will offer pension support
There will be no surprise tax bills at City law firm Bird and Bird, where staff will be supported through the new pension contribution limits.
Tanya Bohm, senior rewards and benefits officer, says: “It is important all employees are fully informed and aware of the limits surrounding pension contributions and the tax implications. We are meeting our pensions intermediary to talk through the communications.”
An important subject of the communication will be the ability to bring forward the allowance of £50,000 from three previous years, if it has not already been used. “This will need to be clearly discussed with employees who may wish to take advantage,” says Bohm.
Employees will also be able to consult pensions advisers. Total reward statements will include taxable earnings and allowances to help them make informed decisions.
Bird and Bird, which has 400 staff, is also reviewing its benefits offering. “With the new pensions legislation, including auto-enrolment from 2012, and the abolition of the default retirement age, we need to review our benefits and ascertain where we can add value,” says Bohm.
“One area we are reviewing is financial planning. We are looking at other savings options to run in conjunction with the pension. Many staff do not value pensions as highly as perhaps they should.”
Case study: BP oils the wheels for staff on pensions
BP has responded to the new pension contribution limits with a raft of education and support for employees.
Ronnie Murray, head of UK pensions and benefits, is keen to ensure all staff are up to speed on the new rules. “We recognise that BP can, and should, help employees understand the new pension taxation changes, so they are informed and able to help themselves,” she says.
The oil and gas company, which has more than 10,000 UK employees, is running everything from seminars to telephone clinics. As well as updating the content and tools on its pensions website to show the new limits, it will offer regulated financial advice for affected employees.
“We have confirmed that overall, the individual consequences of the tax charge is the employee’s responsibility, including any additional pension arrangements outside BP,” says Murray. “This includes the payment of any resulting tax charge, which means there will not be any compensation provided by the company.”
However, the company will allow affected employees to move to an accrual rate that is expected to result in a nil pensions tax charge (subject to agreement).
“All this will continue to evolve as the full details are published by the government and BP learns from the current activities,” says Murray.
Employers are seeking ways to compensate high earners for the impending reduced annual limit for tax-free pension contributions, says Jenny Keefe
On 6 April this year, the UK’s best-paid workers face a dilemma: pay top-rate tax on significant pension contributions or find alternative employment in Zurich. The high tax relief for high earners’ pension pots is coming to an end, with Chancellor George Osborne cutting the tax-free sum they can put aside for their retirement each year to one-fifth of its current size.
It has been possible for employees to put up to £255,000 a year into their pension and still qualify for tax relief, but this will drop to £50,000 when the new rules come into force. Staff must pay tax on any excess, and the limit applies to contributions from both employee and employer. Staff will initially be able to carry forward any unused allowance from the previous three years.
The Treasury’s bet is that the cut will affect 100,000 pension savers, 80% of whom will have an income of over £100,000. The new limits are likely to have a huge effect on high earners: many executives focused on mortgages and school fees in their earlier career, knowing they could throw in a large chunk into a pension later. Clive Fathers, head of employer solutions at Grant Thornton, says: “The pensions regime prior to April 2006 encouraged individuals to make significant contributions later in life, when they were in a more secure financial position. The new system will lead to higher earners spreading contributions over their working life.”
So how are employers dealing with the new rules? Clive Martin, investment director at Lorica Wealth Management, says: “Employers’ reactions to the changes vary from complete disregard and ‘it’s not our problem’ to a comprehensive education programme with individual advice for affected staff. The reality is most employers do not know, but when they do, they quickly request meetings for people earning over £100,000.”
Cash top-up offer
More than 80% of employers intend to offer a cash top-up above the annual allowance, according to Towers Watson’s January 2011 Executive pay poll. Sue Bartlett, director of consulting services at Towers Watson, says: “Most plan to offer a cash alternative to pensions, but many are still tussling with the level to set, especially if some of their executives are members of a final salary scheme.”
Organisations that want to ensure these make-good payments are cost-neutral will need to take into account employer national insurance contributions (NICs). They would not pay these when contributing to a registered pension scheme, but would pay NICs on cash sums. This is important because all NIC rates rise by 1% next month, with effective income tax rates as high as 60% on the band of income just above £100,000. It may be worth looking at salary sacrifice arrangements on tax-efficient benefits for higher earners who are under the annual limit.
Employers have few other options, says Bartlett. “Companies have very little time to decide what to offer their executives to replace part or all of their pension, against a backdrop of hostility from HM Revenue and Customs to anything that might be seen as tax avoidance. This rules out tried-and-tested alternatives such as Efrbs [employer-funded retirement benefit schemes].”
Efrbs are a type of offshore pension scheme. There is no limit on the amount employees can pay in, but the investments are taxable. Lorica’s Martin says: “Where alternatives for employees affected by the new limits are concerned, the market has been slow to move as yet. However, Efrbs may have been kicked into touch with the recent tightening of taxation.”
Another option is corporate individual savings accounts (Isas), which allow companies to pay in up to £10,200 a year for each employee. Tax breaks are the same as for a personal Isa, with no capital gains tax and no further income tax. Corporate Isas usually have cheaper annual management charges. Gary Wilkins, head of compensation and benefits at law firm Freshfields Bruckhaus Deringer, says: “In the few instances where an employee contributes more than the new £50,000 annual maximum allowed [to a pension], we will deal with it case by case. We are also looking at introducing a payroll-based Isa in addition to the regular pension scheme.”
Focus on communications
Other employers, such as law firm Herbert Smith, which has 1,650 staff, are focusing on communication. Benefits analyst Michelle Bassett says: “We are communicating the pension limit changes to employees and have sent out a webcast put together by our pension scheme administrators. We do not currently plan to add any other benefits [to compensate for the new annual allowance].”
The temptation is to leave staff to their own devices. Those that pass the £50,000 barrier will do so because of their own contributions. Even if employers do not want to tinker with salary and benefits, they still need to ensure workers are aware of how the changes will affect their retirement pot.
Clare James, a principal at Punter Southall, says: “Top of the list should be to communicate with all those affected. It is not just high earners – long-serving staff on more modest salaries could also be caught by the reduced allowance. There may also be some who will not be affected initially because they can benefit from the carry-forward provision, but they may well be caught in future when their carry forward has been used up.”
Closing time is approaching at the pension limit last-chance saloon, so employers must act. The worst-case scenario is leaving it until the taxman comes knocking. Grant Thornton’s Fathers says: “If a contribution exceeds the limit, the employee is unlikely to realise they are liable for a tax charge until almost two years later. If an executive paid £100,000 on 6 April 2011, they would enter it on their 2011/12 tax return, which they would not file until 31 January 2013.”
More changes on the way
High earners can expect even more changes next year. From April 2012, the government is cutting the amount people can save in a pension over their lifetime from £1.8 million to £1.5 million. Any pension contributions made after 5 April 2012 would make the protection invalid, so urgent planning is needed. Fathers says: “Unlike when the current regime was introduced in April 2006, there is only a one-year window in which to apply for protection against any additional tax being due on large pension funds that exceed the reduced lifetime allowance of £1.5 million.”
On top of this, many employers in the financial services sector are still trying to cope with the Financial Services Authority’s tough new compensation rules, which say banks must defer 60% of all large bonuses for staff covered by the code, with payment spread over three years.
One possible way around this is to hand out the deferred part of employees’ bonuses as contingent convertible bonds (Cocos). These bonds count as capital, do not rise in value like equity, but convert into shares if a bank gets into trouble. Swiss bank UBS has already introduced Cocos for some staff and Barclays has considered a similar move.
Adrian Lowcock, senior investment adviser at brokers Bestinvest, says. “The use of Cocos to pay top staff is an innovative and interesting idea. It will link in the employee with the overall strength and stability of the organisation. However, this is currently an issue only for banks, where there is a lot of pressure not to pay out large bonuses after the banking crisis. There is little indication this will spread beyond the banking sector at present, as there is no pressure to do so.”
As the coalition government seeks to reduce the UK’s deficit, it looks set to hit high earners for years to come, so employers must review their reward strategies accordingly. Lorica’s Martin says: “We have seen a significant increase in demand for highly specialised technical advice for high earners. The issue is getting clearer: companies are worried that the top end of the talent pool – employees earning over £100,000 – will move if they are not rewarded or looked after.”
How to prepare for the tax-free limit reduction
• Consider cash. Most employers are looking at cash options for employees who will suffer an additional tax burden.
• Do not forget national insurance contributions (NICs). Remember that if you offer cash, you may want to make an adjustment for NICs to keep the organisation’s costs the same.
• Do not disregard lower earners. The changes do not affect just the top people – the new limit could also catch long-serving workers on more modest salaries.
• Address individual problems. Remember each worker has different circumstances and may have other arrangements that they have not divulged but affect their pension’s tax treatment.
• Root out the data. Arm yourself with affected employees’ total earnings and pension contributions for the past three tax years (2008/9, 2009/10, 2010/11).
• Consider offering all workers on more than £100,000 a full review with an independent financial adviser.
• Cash in on salary sacrifice. The tax changes are unlikely to be a problem for most staff. Implement salary sacrifice by the start of the tax year for those who have not hit the £50,000 limit.