Employers can help members ease the pension tax squeeze
With pay increases returning to the agenda, those on the highest earnings will be wondering how to avoid losing their personal income tax allowance when their earnings go over £100,000 pa and fall into a 60% marginal rate of income tax. This marginal rate of tax applies on the band of earnings between £100,000 and £120,000.
In a defined contribution scheme, the solution is to give up salary or bonus and redirect to higher employer pension contributions. National insurance savings for both employer and scheme member increase the attraction, especially if the employer is willing to add a proportion of their savings to the increased employer pension contribution.
Even if the extra pension contribution pushes the member's total contribution above the £40,000 annual allowance, the tax burden suffered by the member is lower.
An extra £10,000 pension contribution in excess of the £40,000 annual allowance suffers a tax charge of only £4,000 – and the member can ask the pension scheme to settle the charge from their pension scheme benefits.
In summary, the tax burden is lower if the £40,000 allowance is breached compared with taking income over £100,000 and, for the member; the affect of the tax charge on the member's benefits is effectively deferred until retirement.
The same problem exists for those earning close the £50,000 pa threshold. They might want to take steps to minimise the high income child benefit tax charge.
Employers need to ensure their salary and bonus sacrifice arrangements are properly documented to satisfy HMRC requirements.
The problem is more complex for active members of defined benefit pension schemes because they are less likely to have any control over earnings that are 'pensionable.' In particular, if they have accrued a lot of pensionable service – a small increase in pensionable salary can lead to a tax charge to be settled personally or by a reduction in their benefits.
Giving up salary increases or bonuses to cap the annual increase in the value of their pension benefit may not be an option, especially if they are members of a pension scheme, for example, in the public sector, which does not recognise salary or bonus sacrifice arrangements.
Employers and trustees may not be willing to meet the cost of changing their scheme rules to recognise a salary sacrifice arrangement, although the abolition of contracting out from April 2016 will increase their attraction.
As an alternative, some employers are installing other forms of remuneration and benefits that would not be regarded as pensionable by the rules of the pension scheme but which remunerate the employee in a tax efficient manner.
Immediate tax danger
How many pension scheme members are aware of a tax charge of up to £137,500 on their pension fund or company life assurance benefit?
Employers and pension scheme trustees should make members aware that they might be able to make an application to HMRC to avoid this extra tax.
Simple and inexpensive changes can be made to the employer sponsored life assurance scheme to relieve this problem. The unfortunate scheme member may not thank you, but their dependants will.
Employers and trustees may feel sufficient duty of care to scheme members, or desire to avoid litigation from their dependants' representatives, to provide access to advice rather than direct them to guidance.
To deal with the increasingly complex pension taxation issues and complete pension flexibility at retirement, we envisage that demand for advice, as opposed to access to 'free' guidance, from members will increase.
Given what they face, members may be willing to pay for the advice if it helps arrange their affairs in a tax efficient way.
We have taken great care to ensure the accuracy of this newsletter. However, the newsletter is written in general terms and you are strongly recommended to seek specific advice before taking any action based on the information it contains. No responsibility can be taken for any loss arising from action taken or refrained from on the basis of this publication. © Smith & Williamson Holdings Limited 2014. code: 14/989 expiry: 28/02/15
