Could you help your higher earners save more tax-efficiently?

Employers are understandably dismayed at the disincentive to pension savings this gives, having collectively spent millions of pounds encouraging their workforce to save more in pensions following auto-enrolment.

The latest changes to the pension tax rules introduced an almost unworkable link between earnings and annual tax relief that no one in the pensions industry wanted to see.

In some banks, more than 50 per cent of staff are affected. This has caused them and many other employers to legitimately ask if there is a better way to provide pension benefits for their better-paid employees.

In short, there is.

Companies face two broad options: offer some form of cash alternative or provide benefits through an unregistered pension arrangement, called an employer-financed retirement benefit scheme.

For those familiar with the unapproved arrangements known as funded unapproved retirement benefit schemes and unfunded unapproved retirement benefit schemes that existed before 2006, the EFRBS is their modern-day successor.

EFRBS have attractive tax benefits on paper, but when are they a good idea for employers?

EFRBS are a perfectly legitimate and legal vehicle for providing pension benefits. More than 20 companies in the FTSE 100 report using them for their executives.

Quite simply, a pension provided through an EFRBS is not tested against the annual allowance or lifetime allowance.

In addition, if it is set up in the right way, national insurance contributions are not payable by the employer or employee, just as with a registered pension scheme.

A well-designed EFRBS allows employers to provide deferred pay to an individual subject only to their marginal rate of income tax in retirement.

Tax triple whammy

This is hugely attractive when considering how much tax is paid when an individual exceeds one or both of the annual or lifetime allowances.

In basic terms, an individual can face a marginal tax rate of 75 per cent on pension benefits that exceed both, reflecting the triple whammy of paying annual allowance and lifetime allowance charges plus income tax.

This is excessive when the top rate of income tax is 45 per cent, and gives employers a good reason to consider an EFRBS.

Many companies are committed to the idea of making sure their workforce has a decent retirement income and given the current changes, EFRBS should be an option for all employers.

They increase the real value for an employer by allowing more of their pension expenditure to reach the employees’ pockets.

EFRBS also ensure the employee’s eventual benefit resembles a pension in that it is accessed later in life.

Although employees impacted by the annual and lifetime allowances are, by definition, not at risk of an impoverished retirement, for companies the idea of simply throwing their hands up and giving employees cash to spend today goes against the savings culture that many have spent a lot of time and effort trying to instil in their workforce.

An EFRBS will not be right for every employer. Those with a small number of affected employees will quite often prefer the simplicity and transparency of cash to an EFRBS pension.

And the government has muddied the waters, holding an informal consultation on whether to tackle the tax advantages of unfunded EFRBS, having dealt with the tax advantages of funded EFRBS in 2011.

This has created uncertainty around their long-term viability.

But it does not seem fair that individuals should pay up to 75 per cent tax on their pension benefits, when the top rate is 45 per cent.

Employers should consider whether an EFRBS serves them better next year, when more individuals will find themselves caught by pension taxes that will see them receive a lot less retirement income than they were expecting.

Liam Mayne is a principal consultant at Aon Hewitt