High-earner tax relief threat poses new challenge for employers

Participation in pension schemes has been decreasing for high earners since the introduction of the annual and lifetime allowances in 2006, which have since been steadily scaled back further.

A green paper was launched in the Summer Budget to examine the broader tax treatment of pensions and how best to incentivise pension saving.

But this week, pensions minister Ros Altmann told the Financial Times the government is considering also abolishing the remaining special tax relief for high earners as part of its wider review ofthe subsidy.

The government's options include keeping tax relief as it is, which would likely lead to high earners moving away from pensions; flat-rate tax relief, which could incentivise lower earners to save more; and taxing pensions at the point of contribution rather than withdrawal.

Freedom and choice was a real boost to pension savings. It generated a lot of interest and then this change pretty much contradicts that because it’s restricting how much they can save

Mark Jackson, LCP

Many believe the green paper signals plans to move to a system that taxes pension contributions when they are made rather than the current 'exempt, exempt, taxed' system, which gives tax relief on the way in and while invested, and is then taxed upon withdrawal – in a similar way to Isas.

Targeting higher earners

Some industry experts had already feared limit-tightening around the annual and lifetime allowances would lead to many higher earners leaving schemes altogether.

Earlier this year the chancellor announced further reductions to the annual and lifetime allowances, with the LTA falling to £1m from £1.25m as of April 6 2016, and the annual allowance to £10,000 from £40,000 for those with incomes above £150,000.

Consultancy LCP this week released its 2015 executive pensions survey of 284 individuals, which found a growth in executives finding more cost-effective ways to take benefits.

Cash in lieu of pensions, or 'salary supplement', is the route taken by more than a third (38 per cent) of executives, up from 27 per cent in 2013.

Tax-efficient pension savings within a defined contribution arrangement and/or cash, known as 'flexible pension compensation' is favoured by 31 per cent of executives, up from 26 per cent in 2013.

Seven out of 10 executives received a combination of DC and cash, or cash alone, while only one in 10 received a defined benefit pension.

Communication challenge

Mark Jackson, partner at consultancy LCP, said: “For trustees in particular they really need to get to grips with how they’re going to communicate to people what their allowances are, and how they’ll help them understand that and avoid tax surprises.”

The survey focuses on executive directors, but Jackson said the findings – such as the movement away from defined benefit schemes towards defined contribution – may signal what is to come for a wider section of the workforce.

He said: “What we’ll see now we’ve got even further reductions is what’s been happening for the people in the survey, extending deeper into the workforce for people with lower and lower earnings levels.”

He added that the continued tightening of the annual allowance goes against the direction of wider pension reform towards increasing participation and coverage.

“Freedom and choice was a real boost to pension savings. It generated a lot of interest and then this change pretty much contradicts that because it’s restricting how much they can save,” Jackson said.

Bhargaw Buddhdev, partner at consultancy Barnett Waddingham, said the tax changes would exacerbate the decline in overall scheme membership.

He said: “When the limits drop to £10,000 for high earners, it means they have very little they could save towards a pension.”

Vested interest

Jackie Holmes, senior consultant at Towers Watson, said reduced participation from high earners could have adverse effects for the rest of the scheme, especially where those people are senior within the company and make decisions regarding the scheme.

She said: “If the senior people are not involved, they have no vested interest in making sure [the scheme] survives.”

If the senior people are not involved, they have no vested interest in making sure [the scheme] survives

Jackie Holmes, Towers Watson

Holmes added that while schemes could adapt to the new lifetime allowance easily, the annual allowance would be a challenge “because it’s going to be an individual-based allowance, and it’s going to rely on something outside the trustee’s knowledge”.

The annual allowance will be based on an individual’s adjusted income, which can include a range of incomes, such as dividends and second salaries, that the employer may not be immediately aware of.

Many schemes are struggling to decide how best to communicate the changes to their members, Holmes said.

“Our clients are giving thought to that, but it’s not immediately clear how you do that other than to educate people as to the basis of the calculation,” she said.