The Chancellor’s assault on pensions as a reward mechanism
for high earners might have seemed like a brilliant political wheeze in the wake
of public outrage over the pensions shenanigans of the ex-boss of Royal Bank of
Scotland, Fred Goodwin.
From the government’s perspective, the announcement of a partial withdrawal,
with effect from April 2011, of tax relief on pension contributions for high
earners and a phasing out of personal allowance entitlement for those earning
more than £112,950 effective from April 2010 must have looked like a solid win
from every angle. It was presented by Alastair Darling as simple fiscal justice
and fair play.
His comment, on announcing the rule changes in the Budget was: “I intend to
address the anomaly which sees a tiny proportion at the top taking a large slice
of the help we give people to save. It is difficult to justify how a quarter of
all the money the country spends on pensions tax relief goes, as now, to the top
1.5% of pension savers.”
Unfortunately, it now looks as if the rule changes are likely to bring the
law of unintended consequences into play. Before we get into the nitty-gritty of
what the changes mean for a spectrum of high earners, let’s look at the big
picture issue. Does “chilling” pensions for high earners threaten everyone
else’s pensions pot?
To put this question in context, let’s remember that the government is desperate
to limit the burden on the state that goes with having an ageing population,
where the proportion of working age people compared to retired people is
dangerously diminished. Encouraging those in work to provide for their own old
age through pensions and long-term savings is the only escape route for the
government from that problem.
And its gamble is that high earners will still want to take advantage of the
available on their contributions, plus the fact that the capital growth of their
pensions pot is free of tax (until, of course, pension benefits start to be
paid). However, advisers tend not to see things that way.
Neville Bramwell, tax partner at Deloitte, explains why the numbers do not
look even remotely attractive for high earners. “The key here is to look at the
post-tax value in the round,” he says.
He explains that if your employer pays you £100 additional of salary and you
are a 50% tax payer, then you have £50 post-tax in your pocket. If you invest
that money, you will pay tax on any capital growth annually, but not on the
original £50 investment.
However, if you put that £50 into a pension fund and the performance of the
fund turns out to be flat, the post-tax value of the pension comes out at the
equivalent of £39.
In other words, you have deferred your consumption of that £50 for a number
of years and you have lost 22% of its value purely through the Chancellor’s rule
“The point here is that you have to get a lot of growth for the pension of a
high earner to outperform other investment options. Even if the fund doubled
over 10 years, which would require it earning 7% compound, it is not clear that
you would be ahead,” says Bramwell. “Moreover, by investing privately, you would
have access to the entire pot (after paying capital gains tax). The holder of a
pension only gets access to a quarter of the fund. The rest vanishes into an
Instead of simplicity, we now have massive complexity, with the government’s
anti-forestalling regime designed to stop high earners massively upping their
pension contributions before the April 2012 start date creating new layers of
opacity. “What is not well realised is that it is not just those with a headline
salary of £130,000 that are affected by the changes. Because the provisions
relate to your whole taxable income, some people on £80,000 may find themselves
wobbling in and out of the £130,000 trap,” he says.
Anyone on that kind of income who sells, say, a chunk of shares, plus gets a
bonus, could find themselves suddenly getting hit with a surprise tax bill
relating to their membership of their employer’s final salary scheme. “This
throws into disarray the pension choices of thousands of people,” says Raj Mody,
a pensions partner with PricewaterhouseCoopers.
He anticipates that a likely outcome of the changes will be a sea change in
the concept of retirement savings. “We may well see the concept of retirement
savings replaced by the goal of general long-term savings, which will have the
great benefit of reintroducing flexibility of choice into the frame, something
we lost with compulsory annuities,” he explains.
Deloitte’s Bramwell believes the chancellor seems to have forgotten the tax
advantages of a pension are there precisely because it is a very inflexible form
of saving. “Because it is such a rigid structure, with a compulsory annuity,
people need to be incentivised to go into it,” he says. Take the incentives away
and why bother?”
Which brings us back to the question of whether, in an era where high earners
are not inclined to invest in pensions, we can expect high earners on corporate
boards to continue to want to include pensions in any form as part of their
total reward package.
We’re likely to see a complete rethink by employers on this. “If you remove the
tax distortion that created such an overwhelming case for pensions, then you
open the way for employers to consider a range of structures. We are currently
looking at schemes that create a single capital sum for employees, rather than a
pension, which, precisely because it is outside the pension rules, can be
delivered to them earlier than age 55,” says Bramwell.
Henry Denne, head of private client business at actuarial company Punter
Southall points out that the rule changes will be particularly hard on those in
defined benefit (DB) schemes. “To date, people have tended not to appreciate the
cost to the employer of these schemes. But when they find themselves hit for a
30% benefit-in-kind tax charge on their annual DB benefit we expect to see them
really questioning their continued membership of these schemes,” he says.
The exact mechanism behind the calculation of any revenue from the
benefit-in-kind tax will be the subject of consultation this summer. However,
Denne says that Punter Southall is working on the assumption that it will be
around ten times the increase in the pension. “If you accrued a further £1,000
of pension through the year, that would be deemed as a contribution of £10,000
and you would have a 30% tax bill raised on that, after allowing 20% relief as a
50% tax payer,” he says.
The consultation might tweak the multiple and it might end up being
age-related, but it will still hammer the taxpayer with a higher tax bill.
Of course, if this did disincentivise high earners from staying in DB schemes
it might, at a stroke, help UK plc to expedite the dumping of their own DB
schemes by removing a huge chunk of liabilities.
However, Deborah Cooper, pension strategy expert with Mercer, says that
companies should not expect to see any additional readiness on the part of high
earners to transfer out of the company’s DB scheme.
“It is far more likely that they will simply close their membership but keep
the accrued benefits, since those have a real value in the current environment,”
Cooper believes there is a very real danger that the government’s removal of
tax relief on pension contributions for high earners, coupled with its decision
to tax the employer contribution as a benefit-in-kind, will weaken the whole
fabric of UK pensions. “There is a concern that those in decision-making roles
will disengage from occupational schemes if there is no benefit in it for them.
It will accelerate the levelling down of UK pensions to the minimal contributi
on standards proposed for the government’s Personal Accounts scheme to be
introduced in 2012,” she says.
PwC’s Mody also believes the government’s move will do tremendous collateral
damage to UK pensions. “It has undermined the confidence of corporate management
in occupational pensions because of constant changes in the fiscal regime,” he
says. He finds it astonishing that the 2006 Pensions Simplification initiative,
which was very carefully consulted on and which still had elements bedding down
in April 2009 has been cast aside in an instant on what looks like a political
whim, or a piece of political expediency.
Adrian Boulding, pensions strategy director at Legal & General, says that
the loss of interest in occupational pensions on the part of UK board-level
management began in 1996 when ex-chancellor Nigel Lawson introduced an earnings
cap on pensions for those earning more than £65,000. “This latest attack by the
UK government is just another spin to the wheel,” he says.
Boulding adds that there is no point in anyone hoping a Conservative win in
the coming general election will restore tax relief on pensions contributions
for high earners. “We have asked the Conservative Party and it says that, while
it wouldn’t have gone about matters in the same way as the incumbent government,
rectifying the change is not top of its list of priorities so the changes look
like they are here to stay.”
Nest egg for Low earners
From 2012, workplace pension provision reform places a duty on employers to
automatically enroll eligible workers into a pension scheme that meets certain
criteria known as auto-enrolment, writes Paul Gilbody.
Finance directors should take note as the government will require employers
to make a minimum contribution to the scheme so that workers can eventually
expect a minimum pension contribution of 8%. This will be made up of a 3%
employer contribution, tax relief and the worker’s own contribution. The ov
erall package of reforms represents a significant change in the pensions
landscape and requires planning on the part of FDs of all company sizes.
For employees on low or moderate salaries, the government has mandated the
creation of the National Employment Savings Trust (Nest). It aims to be low
cost, easy to use and understand for both employers and members. The scheme will
be run by a not-for-profit trustee corporation and is due to launch on a
voluntary basis in 2011.
Currently, approximately 750,000 employers in the UK’s private sector offer
no pension to their employers, with a further 280,000 offering some provision
albeit with an employer contribution of less than 3%. More than half of those
earning between £5,000 and £25,000 do not contribute to a pension at all.
Under the Pensions Act 2008 employers will be required to enroll eligible
jobholders into any workplace pension arrangement that meets certain criteria.
Nest will be one of the qualifying workplace pensions available to employers to
meet the new duties that start to be introduced from 2012.
Anyone who becomes a member of Nest will keep the same retirement pot
throughout their working life. It will belong to the individual and travel with
them. This also means several employers can contribute into the same pot over a
member’s working life. If the member has more than one job, Nest will allow more
than one employer to contribute to their pot at the same time.