I started my pensions career in the world of pension review, so many of you can imagine how I feel when people start talking about opting out of a final salary scheme.
For the majority of people back then, there was no reason to opt out of a final salary scheme, although many did. There was no test on the contributions or deemed contribution to the scheme because it was occupational. The test came when the benefits were going to be paid and these were relatively straightforward for most.
Fast forward to today and we have people considering opting out of schemes purely because they do not know what their annual allowance or pension input amount will be each year and they fear a tax charge. On top of that, a lack of trust that the lifetime allowance will remain the same or increase as promised gives rise to fears of tax charges at retirement too.
I know each case needs to be looked at on its own merits and calculations need to be made but even with a small annual allowance charge each year it would generally be better for someone to remain a member of their scheme rather than opt out and receive nothing. Even where the employer is willing to redirect some or all of the contributions that would have gone to the scheme into the member’s pay packet, unless they are severely hit by a lifetime allowance charge, they will still be worse off by opting out.
The benefits of remaining in a final salary scheme are obvious: guaranteed increasing income in retirement and the employer is taking the investment risk. Remaining in a money purchase scheme may not be as obvious to the member but they are still getting the majority of the contributions with tax relief, the growth will be tax-free and there will be 25 per cent tax-free at retirement up to the lifetime allowance. This all adds up and when you consider if the member does opt out, they will either receive nothing in exchange from their employer or an increased salary.
This increased salary will be taxed now, at the same rate as the annual allowance charge would apply in most cases. They would also be subject to National Insurance contributions on the increased salary and if they invest it, they won’t get tax-free growth unless they use something like an Isa, which may also already be maxed out.
One thing that would make remaining a member more appealing for some would be a change to the “scheme pays” requirements. Currently the scheme does not have to offer to pay any annual allowance charge unless the member has a pension input amount in excess of £40,000 with that scheme and the charge is £2,000.
This means that those who are impacted by the tapered annual allowance may find their scheme is unwilling to pay the tax charge out of the scheme benefits, so the member has to fund the charge themselves. The scheme can offer scheme pays to anyone, but because of the complexities involved, many a final salary scheme are not offering the option if not required by legislation.
The lifetime allowance is another issue entirely and if the member is over it, or perilously close, then opting out may seem a more likely option. Again, this will depend on the member’s circumstances, what type of scheme they are in, and what, if anything, the employer is offering in exchange for the member opting out of the scheme.
At the end of the day it should always be remembered that these are allowances and not limits, just like the personal allowance. I have never heard anyone turn down salary just so they do not breach the personal allowance and have to pay tax without something else in exchange. The annual allowance and lifetime allowance needs to be thought about in exactly the same way and the full picture of remuneration and retirement options considered carefully before anything rash is done.
Those taking advice in this area should be well protected. It is those that do not think they need to and see an immediate pay rise in exchange for something they see as wrong because a penalty is applied that will inevitably lose out in the long run.
Claire Trott is head of pensions strategy at Technical Connection