How to educate high income staff on the complexities of the annual allowance

While they are likely to need to take professional advice, employers could play an important role in helping employees identify if they are impacted.

The tapered annual allowance

From 6 April 2016, the £40,000 pension annual allowance is reduced for a tax year by £1 for every £2 of 'adjusted income' the individual has over £150,000. The maximum reduction to the annual allowance will be £30,000, so that anyone with adjusted income of £210,000 or more will have an annual allowance of £10,000.

An exception is where net (threshold) income is not more than £110,000, the annual allowance is not tapered. Adjusted income includes earned income and non-earned income, so it’s not just salary. It includes other income such as dividends, bank interest and rental income and deductions such as trading losses. An added complication is that many individuals may not know if they are caught until it’s too late, after the end of the tax year.

An employer may not be able to identify which of its employees is impacted, or to what extent, so any guidance should ideally be made available to all employees. Of course, it’s important that communications are pitched at the right level for all different types of employee.

The result of some basic guidance may be that high income employees can identify whether they will have scope to continue with their current individual contributions and retain their employer contributions without triggering the tapered annual allowance charge, or whether they need to take advice.

For many there will still be plenty of headroom:

*assumes no other restrictions apply, such as income recycling anti-avoidance measures, or the money purchase annual allowance.

For high income individuals caught by the tapered annual allowance, full carry forward may still be available from the three previous tax years, so this is likely to provide a solution for many affected employees. These individuals may well need to take advice as carry forward can be complex.

Ensure employees are aware of carry forward

However, it’s important to make employees aware of carry forward. Otherwise they might reduce or stop their contributions unnecessarily.

Employees impacted by the tapered annual allowance in the 2016/2017 tax year can use carry forward from 2013/2014, 2014/2015 and 2015/2016 based on the standard £40,000 allowance; £50,000 in 2013/2014.

This may allow the employee and/or employer to continue contributions at current levels for up to three more tax years. Looking further ahead carry forward will still be very valuable particularly for those with fluctuating income.

An interactive tool that allows employees to try different scenarios may help with engagement. HMRC expects to update its annual allowance carry forward calculator in the summer, so it may be helpful to highlight this link with employees: http://www.hmrc.gov.uk/tools/pension-allowance/

Automatic enrolment

Employers also need to consider the interaction between the minimum pension contributions imposed by automatic enrolment legislation and the maximum tax-relievable contributions that the tapered annual allowance rules will allow, and what action can be taken to ensure that compliance with one set of rules does not cause an unintended breach of the other. Communication with employees on this is clearly essential.

The lifetime allowance

An additional complication for high earners will be the lifetime allowance, which reduced to £1million on 6 April 2016.

If an employee has more than £1million in their pension pots they may have to pay tax on pension savings above the lifetime allowance. The rates are:

• 55% if it is paid as a lump sum
• 25% if it is paid any other way, eg pension payments or cash withdrawals

Where both the tapered annual allowance charge and the lifetime allowance charge would apply, consideration must be given to whether it’s worth having a pension contribution at all. Whilst pension would be better than nothing, additional salary may be better.

An adviser is very likely to be needed to help the employee work through their particular case. However, some basic information may help employees in deciding where to start. There’s useful guidance on HMRC’s website, for example: https://www.gov.uk/guidance/pension-schemes-protect-your-lifetime-allowance

Employer support

The employee pays the tapered annual allowance and the lifetime allowance charges, so is it necessary for the employer to get involved at all?

It’s not a requirement. However employee financial education is likely to encourage staff retention.

Directing employees to support information created by professional advisers or providers, or getting professional presenters and advisers to convey information may help to engage employees and reinforce confidence in any messages.

Of course it’s important to use clear jargon-free language that can be understood by employees who are not experts on these topics and to ensure that all employees have access to information.

In addition, the recently announced increase in the amount available for employer-arranged pensions advice from £150 to £500, without a tax or national insurance charge, might go a long way in helping employees engage with their financial affairs. The new exemption will be available from April 2017 and could provide a valuable part of an employee benefit package for employees who need professional advice.

Sandra Hogg is senior tax and financial planning manager at Scottish Widows.

This article was provided by Scottish Widows.