The government’s proposed changes to pension tax relief could result in a shake-up of high-level remuneration plans, according to experts.
In his Budget speech, Chancellor Alistair Darling revealed that pensions tax relief for those earning more than £150,000 will gradually be tapered from 40% until it is 20% for those who earn over £180,000 from April 2011.
Pensions less attractive
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Sue Bartlett, partner at Watson Wyatt, said that the change may make pension benefits a less attractive form of remuneration for senior executives and may have a knock-on effect on their willingness to maintain good quality pension arrangements for their staff. “It may be that some high earners want to opt out of the pension scheme because it will no longer be tax-efficient and more people may move into cash allowances as an alternative.”
Chris Noon, partner at Hymans Robertson, added: “Under the current proposals, it appears that pension saving for higher earners could become an inefficient retirement savings vehicle as these employees are most likely to be higher rate tax payers in retirement. The real danger is that once pensions become less interesting for senior managers, they may show less interest in them as a savings vehicle for employees.
“The income tax changes for employees earning more than £100k potentially introduces an opportunity for tax arbitrage. It may be possible for individuals to defer additional pension contributions this year and pay more next year at a higher rate of relief.”
Restructuring reward
Raj Mody, pensions partner at PricewaterhouseCoopers, said that the changes will force employers to consider the way they remunerate their highest paid staff. “Understandably, the government’s focus is on low to middle-income earners, but companies will be concerned about the impact on all employees – whatever their earnings level. Such a change might prompt employers to review the way they reward higher earners, in terms of the balance between pensions and other forms of reward.”
Salary sacrifice
Salary sacrifice may become more popular for higher-rate tax payers and employers looking to make savings on the tax and national insurance contributions.
Pat Wynne, director at Xafinity Consulting, said: “Higher income earners will look for alternatives to by-pass today’s announcement to restrict tax relief by reshaping their overall remuneration package. I predict that the likely outcome of the Chancellor’s plans will be an increase in work-place pension provision by salary sacrifice. This may circumvent the tax relief change – depending on the legislative detail. Using salary sacrifice would also result in a reduction in the amount of national insurance contributions (a tax by any other name) paid by affected employers and employees.”
However, despite the suggestion that the restriction on tax relief could be mitigated by making schemes non-contributory or by introducing “salary sacrifice” arrangements, pensions advisor Hamish Wilson said such steps would not work given that high earners will now be taxed on their employer’s contributions.
Top-ups
High-level earners who may have intended to top-up their pension pots with lump-sum payments will no longer benefit from tax breaks. The changes effectively prevent anyone earning more than £150,000 from changing their normal pattern of contributions between now and April 2011, or from increasing their total annual payments beyond £20,000 a year.
Bartlett said: “Some organisations will have been thinking of doing a bonus salary sacrifice this tax year into an employee’s pension scheme as an employer contribution. I think that this is going to be treated as a special contribution. So if someone earns more than £150,000, and if the total amount they contribute a year is more than £20,000, then there is going to be no point doing that. They can do it but it won’t be tax-efficient.”
Added complexity
Bartlett said the additional tax complexity may also make employers more likely to close their defined benefit schemes to future accrual if they have high earners in the scheme.
Wynne added: “Indeed, the announcement could be seen by the general public as a first step in abolishing pension tax relief entirely, or more simply as yet another anti-pensions message, at a time when government should be encouraging long-term saving. It is also the final nail in the coffin of the concept of pension tax simplification!”
Martin Palmer, Head of Corporate Pensions Marketing at Friends Provident said:
“One unexpected benefit of the latest budget is that it has highlighted that higher rate taxpayers are entitled to claim back their tax. In many occupational schemes this process occurs automatically through payroll, but in contract-based schemes such as Stakeholder pensions the emphasis is on the member to reclaim any tax over and above the basic rate in their tax return. This announcement should serve to encourage people to reclaim the tax that is owed to them – something which we feel many people without an adviser will forget to do.”
Matt Ellis, global employer services partner at Deloitte, commented: “With top rates of tax currently at 40% and relatively low Social Security contributions, the UK has to date been relatively competitive. For many, the hassle factor of leaving the UK has outweighed the marginal potential tax benefits. Whether this will still be the case following the Chancellor’s Budget announcements remains to be seen.”
In addition to a new 50% rate of tax, employees earning over £100,00 will lose the benefit of the ‘Personal Allowance’ from April 2010, as well as seeing their dividends on company shares taxed at a new higher rate of 42.5%. Furthermore, tax relief on pension contributions will now be restricted to 20% only and employer’s may be forced to develop more imaginative tax mitigation ideas to remain competitive and hang onto their best people.
Ellis said: “One obvious legitimate route for employers may be to reward employees using company shares which, when sold, are taxed at the capital gains tax rate of 18% rather than the income tax rate of 50%. Other ideas are likely to involve employees sacrificing taxable pay for tax favoured benefits such as cars with low CO2 emissions, extra holidays and discounted in-house benefits, all of which would mitigate the effect of the new increases.
“It shouldn’t be forgotten that employer’s themselves face increased National Insurance costs from 2011 with the headline rates going up half a percent to 13.3% and in 2012 will face the prospect of a 3% additional pension funding requirement for employees not opted out of their pension scheme.
“Whichever way you look at it the costs of UK employment are rising at all levels but with the remuneration packages of the highest earners under the most pressure. Careful planning may mitigate some of these costs and HMRC will undoubtedly be looking at this closely.
Commenting on the proposed Budget plans to tax anyone earning more than £150,000 on payments their employer makes into their company pension, Eleanor Daplyn, Associate, Sacker & Partners LLP, the leading specialist pensions lawyers, said:
“The Government has said it will be consulting on how the changes will apply to pension savings made by employers on behalf of their employees, but this feels a bit like shuffling deckchairs on the Titanic. Legally, the proposals can only lead to further complication and expense for trustees and employers alike at a time when the pensions industry faces more than enough challenges already.”
Martin Palmer, head of corporate pensions marketing at Friends Provident said:
“Treating employer contributions as a benefit in kind is a hammer blow to DB schemes, but it also drives a coach and horses through the principles of pensions simplification which applied a single lifetime limit to all people equally. This could be horrendously complex to administer, bearing in mind DB scheme contributions are not allocated at a member level. If this is being aimed at salary sacrifice, it is brutal means of closing the loophole.”