Schemes face annual allowance rush to avoid fines

Industry experts have warned decreasing the annual allowance for tax-efficient pensions savings could catch middle earners as well as those on high salaries. 

Other schemes have put in place arrangements to put a cap on earnings

Schemes are obliged to send those that breach the allowance a pension savings statement for the two tax years of by October 6. According to HMRC, schemes that do not provide members with this information could face penalties.

The tax-free limit was brought down to £50,000 in 2011 from the previous limit of £255,000, and there will be a further decrease to £40,000 in April 2014. 

"Not only did the annual allowance drop, the way in which benefits are tested against it became more stringent," said Lucy Dunbar, associate at law firm Sackers.

The reductions have resulted in a wider category of people being affected. This could include long-serving employees in defined benefit schemes, or those that received a significant pay increase.

“You are not just looking at the fat cats which the annual allowance is meant to be targeting, it could very much be the middle earners,” she said, adding: “When the annual allowance was dropped to £50,000 in 2011/12, this requirement to issue pension savings statements was introduced.”

Some schemes may not be prepared or aware they have to inform members, Dunbar said. “Schemes that don’t think they have particularly high-earners or particularly good benefits structures may not be as attuned to these requirements,” she added.

Employees that exceed the limit can elect to have the scheme pay the tax on their behalf, under ‘scheme pays’ rules, in return for a drop in benefits.

“From the member’s perspective it has a lot of advantages – you will be able to pay from the benefit of your pension rather then raising your own money to pay tax on something you haven’t received yet,” said Ed Wilson, director in consultancy PwC’s pensions practice.

But this could have a negative impact on employer sponsors, who will ultimately have to foot the bill. “From a scheme’s perspective it will be relatively complex to run,” Wilson said.

“It is something for organisations to be wary of if they start to see a significant population affected by the annual allowance and it looks like a lot of those people will take scheme pays. They need to start thinking about how they will manage that process and its costs.”

Employers have taken different approaches if they think a group of members will be caught by the reductions.

"One choice is too leave the schemes as is and utilise scheme pays... other schemes have put in place arrangements to put a cap on earnings," he said. "This is a process the Treasury calls aiming off, you target people to not have more than the annual allowance and then provide some sort of compensation."