Shifting sands for tax rules bring threat of mid to high-earner exodus

Both Labour and the Conservatives dealt a second blow to pensions saving for higher earners earlier this month when they each revealed proposals to reduce tax relief on pension contributions for those earning above £150,000.

The manifesto proposals came hot on the heels of the coalition government’s 20 per cent reduction of the lifetime allowance, which was capped at £1m in last month’s Budget announcement. 

Liam Mayne, principal consultant at Aon Hewitt, said employers will be challenged to provide alternative savings options as higher earners impacted by the changes move away from pension saving.

“I think it means that pensions will become quite a small part of your remuneration package,” said Mayne. 

He said the latest reduction would also impact a swath of middle-income employees and that this could present employers with new challenges.

“[Companies] may be more reluctant to treat them as special individuals," he said. "They’re not executives who you’re used to treating in a special way.”

Double hit

Alternative savings options currently offered by employers include cash in lieu of pension contributions, top-up arrangements into unfunded arrangements and corporate Isas.

Sue Waites, partner at consultancy Hymans Robertson, said the impact of the LTA reduction in isolation might not have been that significant because many higher earners could have been offered cash in lieu of pensions.

Companies may be more reluctant to treat [middle earners] as special individuals. They’re not executives who you’re used to treating in a special way

Liam Mayne, Aon Hewitt

However, she saw trouble ahead as savers are hit by the two policies in tandem.

“There’s not actually that much difference between getting cash and paying tax on it and going above the LTA and paying tax on it,” said Waites.

“But the thought of getting a tax charge on the way in and getting the lifetime allowance tax charge on the way out does make it pretty unattractive. Other investment products don’t work like that.” 

Pensions minister Steve Webb and shadow pensions minister Gregg McClymont have both previously spoken of the importance of getting the bosses back into pension saving. 

But Waites said the continued tinkering with pension tax is off-putting and could have a knock-on effect on how employers – where the key decision-makers are generally higher earners – value pension provision across the entire workforce. 

“Mostly that’s going to impact higher earners but the issue there is, if they get turned off pensions, they are generally the people making decisions about pension provision in companies,” she said.

Jackie Holmes, senior consultant within the financial planning division at Towers Watson, said there was scope for increasing current Isa limits.

“It’s gone up more than inflation to current levels but there is potential to move it even higher to allow those who have opted out of pensions to at least get the tax-efficient benefit within the investment, even if they’re not getting tax relief on it,” she said.

The new £1m limit means many savers may struggle to predict the point at which their pot exceeds the LTA.

Holmes added she had seen an increase in the number of employers requesting support in delivering guidance and information to their higher earners.

“It’s not generally as far as specific advice, but more generic support… to help higher earners understand the pros and cons and avoid a knee-jerk reaction to an increased tax charge,” she said.