The pensions industry may have hailed the £50,000 annual allowance as a victory, but the new rules are not without their problems, warns Gill Wadsworth
If the cap fits
The industry, fearful of more draconian measures, breathed a collective sigh of relief as the government laid out a regime that is considered far less burdensome than the one proposed under the previous Labour government.
Indeed, Friends Provident ceo Trevor Matthews even went so far as to describe the regulations as an “elegant solution” which should be applauded.
But changes to the way in which pensions are taxed are not without criticism and while they might be easier for employers and individuals to stomach than previous proposals, they will undoubtedly cause upset and financial pain for some.
Marc Hommel, pensions partner at PricewaterhouseCoopers (PwC), suggests 200,000 people will be affected rather than the 100,000 estimated by the government. He adds that were inflation to accelerate while annual allowance limits remain frozen at the new £50,000 limit forend of the ranges previously suggested, substantial numbers of people could still be affected, particularly those in final salary schemes with long service and large salary increases,” Hommel says.
PwC figures show that an executive earning £150,000 a year with 20 years’ service in a final salary pension scheme will face tax of £12,200 on a pay rise of £9,000.
While the new tax limits are towards the less onerous end of the ranges previously suggested, substantial numbers of people could still beaffected, particularly those in final salary schemes with long-service and large salary increases
This amounts to a marginal rate of tax of 135 per cent on the pension increase plus 50 per cent income tax resulting in a staggering combined tax rate of 185 per cent on the pay rise.
The table on the next page demonstrates just how likely it is that a middle income earner will be hit by the new regime particularly if they have long payment history into a final salary scheme or if they receive a particularly generous pay increase.
Hommel notes that while some employees may bear the extra tax to protect their future retirement income, for most people such a decision would simply be unaffordable.
He adds: “Either way, affected individuals will look to their employers for help, advice and potentially some form of alternative savings vehicle.”
This puts tremendous pressure on employers to not only come to terms with the new regime but also identify affected employees and communicate the possible impact while coming up with suitable solutions, all well before April 2011.
Under the new regime, employers must provide members with their pension input amount within six months of the end of the tax year, information about employees’ pensionable salary, benefits and length of service and any relevant data at the member’s request within three months of asking or from six months to the end of the tax year.
“With less than six months until implementation, time is tight to engage with affected employees, manage the governance process with remuneration committees, and make the administrative and operational changes.
Employers need to urgently consider how they communicate with their employees and what adjustments, if any, they want to make in workplace pension provision,” Hommel says.
In some cases, employees will already be affected by the changes since pension savings are measured based on the benefits accrued within a pension arrangement during an annual pension input period (PIP), and for some individuals this has already begun for the 2011-12 tax year. So where the PIP started before 14 October 2010 and ends on or after 6 April 2011, the member’s pension saving in that part of the PIP on or after 14 October 2010 must not exceed the new annual allowance or a tax charge will be incurred.
Law firm Eversheds notes that these schemes in particular will need to ensure any necessary systems changes are made as soon as possible. Schemes will also need to consider adjustments to facilitate smoothing pensionable pay and accrual, adding that it may be preferable to wait until the legislation is finalised before completing such adjustments.
Employers need to prepare for an ever growing ’to do’ list: what alternatives to pensions can they offer; do remuneration packages need to be restructured; and should they prepare for yet more change in the future? Yet while companies may feel overwhelmed by an increasingly burdensome task list, for the financial adviser the business opportunities are obvious.
Param Basi, technical adviser at AWD Chase de Vere, says: “All high earners should now review their finances to consider what role pensions should play going forwards and to understand the most tax efficient way to hold their investments. We will be having conversations with high earning clients and their employers to consider whether remuneration packages will need to be restructured.”
Yet just as employers search for possible alternatives to pension saving, the menu of choices is likely to shrink considerably as the government focuses on removing any loopholes.
For example, the Finance Bill 2011 is set to make Employer Financed Retirement Benefit Schemes (EFRBS) and Employee Benefit Trusts (EBTs) much less attractive than they once were.
For the government to retain the industry’s positive support and to ensure that the new regime doesn’t undermine the good work already done by employers in offering workplace pensions, there needs to be a moratorium on further changes to the tax system
When the previous Labour government first touted changes to higher rate tax relief, EFRBS and EBTs were instantly shoved forward as a possible alternative to pensions.
Subsequently, a Punter Southall survey found that 25 per cent of employers were considering such schemes. However, the coalition appears to take a dim view of EFRBS which are now widely seen as on their way out.
Basi says he is not surprised EFRBS have been killed off, adding that he has warned clients off the products for some time. Similarly, Roger Breeden, principal at Mercer, said the consultant was in favour of closing loopholes on EFRBS and EBTs, claiming it had never understood why HM Revenue & Customs had ever allowed an “easy escape route” from the new regime.
Breeden adds: “We believe that funded EFRBS are dead; those that are unfunded may well remain but the volume will be low.
Unfortunately, some organisations will have spent significant amounts on establishing these plans and will now be looking to unwind their positions.”
Again, this presents advisers with an opportunity to assist employers with removing EFRBS and setting up viable alternative schemes, but the question still remains over what those solutions might be.
For PwC the answer lies away from traditional pensions in a likely combination of vehicles that not only tackle the need for long-term retirement saving but which also help to manage debt.
Jon Terry, PwC partner, says: “We could see greater use of share schemes, corporate Isas and other savings vehicles which are set to become more popular.
For some commentators the new pensions tax regime will drive the ’whole of life savings’ agenda where employees appreciate the importance of a long-term investment culture harnessed through a commitment to regular, frequent contributions.
Tom Stevenson, investment director at Fidelity Investment Managers, says: “A small number [of employees] may still need to think carefully about the tax implications of this change, but for the majority of people this new regime creates clarity and focuses attention on the need to think about saving for retirement each and every year.”
However, irrespective of the positive direction in which Stevenson believes the government is taking the industry, he concedes that people still aren’t saving enough and has called for some of the £4bn in anticipated savings from the new regime to be directed towards helping employers and their workforces make adequate provision for the future.
The fund manager proposes government introduces a single annual savings allowance covering both pension and Isa contributions as well as incentivising Isa saving via a cash bonus and subsequent payments on each anniversary for the life of the account.
While such proposals may sound optimistic, particularly the latter given the government’s desperation to preserve cash, Fidelity’s other demands for clarity on the state pension and a Child’s Isa to replace the soon to be defunct Child’s Trust Fund have both been met in the past month.
Stevenson says: “While we accept the need to reduce the deficit now with this £4bn per year in savings, we urge the government to consider channelling at least some of these funds in the future to help create a whole-of-life savings framework.”
The government is continuing to review this area and engage in consultation with the industry which, while leaving the situation somewhat uncertain for employers and their advisers, means the door remains open to alternatives to pension saving.
Of course, the danger then becomes the reintroduction of complexity as employers seek ways around the new legislation using sophisticated and intricate alternatives that might exploit any remaining loopholes.
Karen Goldschmidt, chairman of the Association of Consulting Actuaries’ pension taxation committee, says: “What is important is that, as individuals, employers and scheme managers grapple with the new rules in the particular circumstances of their arrangements, the positive consultative arrangements with the Treasury and HM Revenue continue so that we do not get too many complications when it comes to practical implementation to spoil the overall simple approach.”
For the government to retain the industry’s positive support and to ensure that the new regime doesn’t undermine the good work already done by employers in offering workplace pensions, there needs to be a moratorium on further changes to the tax system.
Companies are already grappling with the onset of auto-enrolment alongside coping with new regulations as well as myriad other concerns brought about by a challenging economic environment.
Employers will probably feel trepidation when it comes to putting any kind of alternative benefits package in place if they feel the government cannot be trusted to leave them alone.
Indeed, the temptation to simply offer the bare minimum and leave individuals to manage their own affairs could become overwhelming in the absence of consistency and clarity over the future of employee benefits.
As Hommel says: “For employers to be motivated to put durable savings arrangements in place, they need confidence there will be no further fundamental changes to the tax and regulatory pensions framework.”