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07 Nov 2019

Are your staff at risk of falling into the pensions annual allowance taper?

Introduced in April 2016, the tapered annual allowance continues to get negative press coverage.

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Its effects are limited to higher earners, who generally don’t get the sympathy vote. But when it starts having an impact (albeit indirectly) on us all, wider calls for change are bound to increase and this is now happening; most recently this impact has been felt within the NHS.

On advice from its own tax advisors, the government is now considering making changes to the NHS pension scheme or scrapping the tapered annual allowance all together – at least for public sector defined benefit pension schemes.

A consultation paper was issued by the government in July and updated in August this year. We’re now waiting for a conclusion, but with Brexit still not finalised and a general election in December, safe to say this isn’t top of the agenda at the moment.

So how does it affect us all?

In a nutshell, an increasing number of senior doctors are reducing their working hours or even leaving the NHS in order to avoid pension tax charges. With an already struggling health service, this is the last thing needed. A great example of unintended consequences.

Just a quick reminder

Tax relief on pensions costs the treasury around £21bn a year; so understandably if there’s an opportunity to cut this cost without negatively impacting most pension members, it’s going to be grabbed by the treasury with both hands.

Focusing on higher earners is a logical way to achieve this; hence the introduction of the tapered annual allowance. When it was first floated, the treasury estimated that it would affect only 300,000 people but would save £1.2 billion a year in tax relief by the end of this tax year.

We can all contribute up to £40,000 a year into a pension scheme; this is called the annual allowance. But if you’re a higher earner, your annual allowance reduces by £1 for every £2 you earn over £150,000, to a minimum allowance of £10,000. So, if you earn £210,000 your annual allowance is £10,000.

Not all is as it seems

The above explanation is a very simplified version. Just like all things pension, the tapered annual allowance is majorly over complicated and it’s the definition of earnings that is hard for anyone to get their head around.

But maybe the complexity is better left to the higher earners themselves and their advisers.

From an employer perspective, the bottom line is that the £150,000 starting point includes earnings from all sources, not just salary. You may look at your payroll breakdown and deduce that very few if any employees are affected. But this may not be the case.

With the best will in the world you don’t know what other earnings employees have eg rent from rental properties. Also, if anyone is in defined benefit pension schemes, this can complicate things even further.

For this reason, many employers assume that anyone earning close to £150,000 is likely to be affected. It’s probably the safest assumption.

What can you do?

I very much doubt that the taper will be scrapped for the private sector. Politically helping the struggling NHS is one thing, but helping a well-paid company executive is another. So, I think we should all assume that the tapered annual allowance is here to stay.

The problem with the NHS is its inflexible defined benefit scheme; to avoid a tax charge, doctors either must come out of it, reduce their hours thereby reducing their earnings or leave the NHS altogether.

For most other employers, the issue is a lot easier to deal with.

Err on the side of caution

There are many employers who have introduced a £10,000 cap on pension contributions for all employees earning over a certain amount eg £150,000.

Affected employees are then given the option of either receiving cash or having the difference between their employer pension contribution entitlement and £10,000 paid into an Individual Savings Account (ISA). The latter option arguably being the most sensible, as an ISA is a great alternative to a pension scheme for retirement funding owing to its tax efficiencies.

Employees recognise that the £10,000 limit is a tax limit not a retirement funding limit. A higher earner’s pension contributions might be limited, but they still need to build up an appropriate retirement fund so they can retire at some point. It just happens that unlike most people, their retirement funding might not just be about a pension scheme.

Then of course we have the Lifetime ISA which is an even better choice for any higher earner under the age of 40. They might not get tax relief on their contributions going in, but they receive a 25% government bonus up to £1,000 a year until age 50. Not a bad trade off!

If the funds are used for purchasing a first home or for retirement from age 60, any money withdrawn is tax free and penalty free.

Workplace savings

Regardless of what eventually happens with the tapered annual allowance, higher earners and pensions will continue to be an easy target for increasing the treasury coffers.

In other words, pensions for higher earners will never be enough. There must be a different approach.

Many employers are already adopting a different approach by introducing workplace savings and not just for higher earners. Workplace savings combine pensions and ISAs to give a more holistic approach to savings; pensions with tax relief in return for delayed accessibility and ISAs to supplement pension savings and allow access for other savings goals.

This article is provided by Smarterly.

Smarterly is sponsoring REBA’s Innovation Day 2019. Join us on 28 November in central London to future-proof your reward and benefits strategy.

In partnership with Cushon

Cushon is an online savings&investments platform provider, offering holistic workplace savings.

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