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02 Dec 2015

How to respond to the pensions taxation conundrum for higher earners

A couple of weeks ago we shared with you the first in a two part article on the pension taxation changes for higher earners. This article focuses more on what we’ve seen so far from employers, in terms of how they’re reacting to the changes and provides some ideas for how employers can help support their employees.

Older workers

But first, here’s a quick recap on the changes, in case you haven’t read our previous article:

  • A reduction in the Annual Allowance for those earning over £150,000 from 6 April 2016.
  • “Pension Input Periods” (the time period over which pension savings are measured for comparison with the Annual Allowance) will be aligned with the tax year for all pension schemes from 6 April 2016. There are transitional arrangements to ensure that there’s no retrospective taxation when Pension Input Periods are brought into line with the tax year.
  • A reduction in the Lifetime Allowance to £1m from 6 April 2016, again with transitional protection available.

The response so far…

It’s still early days, but we’re starting to see various strategies which companies are employing in response to the Chancellor’s announcement:

  • Some are doing nothing;
  • Others are simply educating their workforce on what is an extremely complicated topic; and
  • Some are coupling an education campaign with changes in their remuneration policy designed to be more tax efficient.

For DC schemes, the obvious response is to allow employees to take their usual company contribution as cash (taxed at their marginal rate of income tax). However, this strategy is not as simple as it sounds. For example:

  • Who bears the additional NI cost where company contributions, which would be NI exempt, are paid as cash, on which NI contributions are payable?
  • DC contribution structures that have employer contributions conditional on employee contributions do not naturally lend themselves to such an approach.
  • Is it all or nothing? Or can employees choose to split their payment between pension scheme contribution and a cash supplement?

For defined benefit pension schemes the offering is generally a little simpler, since most are offering a cash alternative on opting out of the pension scheme. How much to offer is not straightforward though. The decision for employees is just as complicated and is even more important to get it right, since it’s likely to be an irreversible decision. We are not aware of any DB scheme offering members the chance to opt back in to future benefit accrual after leaving.

For some individuals a generous cash alternative may be attractive and may actually be more valuable than pension accrual or simply meet the individual’s immediate cash flow needs. However, companies need to be careful that their otherwise paternalistic intentions are not misinterpreted at some future date and seen as an inducement to members to opt out of valuable defined benefit pension accrual.

2667-1449065229_Slide1.jpg Supporting employees

Communicating the changes to employees together with the choices they need to make is very important. Employers must help answer the two most important questions members will have: am I affected and if so, what should I do about it? After an assessment exercise to establish the affected population and the extent to which they are impacted, some employers are opting to provide written communications including decision trees (such as the one shown). Some employers are going further for impacted employees, and providing webinars, individual consultations and/or online modelling tools, such as the AA modeller shown in picture.

This article was provided by Hymans Robertson.

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