As tax relief on pension contributions for better-paid staff is whittled away, employers are looking for alternative solutions, as Pádraig Floyd explains
Ensuring that senior, high-earning staff stay engaged with pensions has always been regarded as an important component of workplace provision.
The reason is simple – if they themselves are not benefiting from the resources that their employer is pouring into the pension scheme, why would they support anything more than the bare minimum?
This has to be a concern for everybody, now that under auto-enrolment the bare minimum isn’t likely to be as much as employers with the flintiest skin used to offer in a group pension plan.
The latest limitations to tax relief, with the taper for those earning more than £150,000 a year, is not only revolutionary, but represents an outright attack on better-paid staff.
The green paper consultation on the future direction of pensions tax relief closed at the end of September, with the results due to be published in the Budget in the spring. Those earning a decent salary may well find further limitations on what they can save for the future, with some predicting that the government will move to a flat rate of tax relief.
They won’t even know if the member has other forms of pension contributions”
With the annual allowance reduced, employers will face a huge challenge, says Lucy Dunbar, senior associate, Sackers. “They’ll need to treat it person by person, but they won’t necessarily know which ones have other income from investments, rental property or even a second job,” she says. “They won’t even know if the member has other forms of pension contributions.”
The best thing to do is to determine who is in a pool of affected members, says Dunbar, but first you have to determine how to communicate and which parts of the membership you need to target.
What to do now
Some advisers are worried that clients may act hastily to prevent their employees from losing out. They may put in place something too robust, as the rules are highly likely to change again.
Chris Noon, a partner at Hymans Robertson says employers need to take a more considered approach to the future.
I suggest they keep it simple now, and wait for more clarity from the government”
For example, he has one client who only has 23 people affected in 2016-17 from a workforce of 600 – around 5%. However, this becomes a far bigger problem in 2017-18 as carry forward has gone. It may turn out all right, but it all depends on how earnings change.
“I suggest they keep it simple now, and wait for more clarity from the government.” says Noon, “Then they can be more robust in 2017-18. Because if tax relief on contributions goes and a TEE (taxed/exempt/exempt) system is brought in instead, we’ll have to fundamentally redesign the scheme.”
The authorities’ attitude towards anything offshore is one of all stick and no carrot”
So what’s the alternative? Well, there aren’t many, really. Group self-invested personal pensions (Sipps) might offer the freedom of flexibility, but it doesn’t allow for any greater amount of tax relief.
The good old days of employee benefit trusts (EBTs) are over and the authorities’ attitude towards anything offshore is one of all stick and no carrot, which rules out Qrops (qualified recognised overseas pension schemes).
The European incentive
The irony is the recent reforms make the UK the pension freedoms capital of Europe, says Robin Ellison, a partner at Pinsent Masons. He says: “Instead of pensions money going to Europe, providers will receive European money coming to the UK.”
This is because you pay local tax, but in some jurisdictions – such as Portugal – you pay no tax on pensions income. This creates an arbitrage opportunity for European citizens to use Qrops in exactly the way HMRC won’t allow UK citizens to access.
The Revenue has its knickers in a twist and has recently withdrawn approval from the Australian system”
“The Revenue has its knickers in a twist and has recently withdrawn approval from the Australian system,” says Ellison. “It’s in breach of European Union rules, but nobody is challenging it – yet.”
HMRC should take a less robust approach as the new pension freedoms make rules about withdrawing money irrelevant. There are, of course, exceptions for the use of overseas schemes, but the numbers eligible to make use of them will be very few.
In the short term, cash is the only option, says Noon. “Cash is the way because there are limited numbers of people affected and it has been the response since ‘anti-forestalling’ came into force in 2009.
Depending on what comes out of the consultation process, Noon expects a need for broader sources of planning and wealth creation.
The corporate ISA will rise like a phoenix”
“The corporate ISA will rise like a phoenix,” says Noon. “If an individual pays a maximum £10,000 to their pension, the rest can be automatically paid into an ISA.”
Employers can easily set this up and then negotiate terms as ISA rates are still significantly higher than pensions – eg 80 against 20 basis points.
“It offers the efficiency of delivery from the employee’s perspective and efficiency of pricing for the employer,” he adds.
We don’t want people with thousands of pounds in stock and have another RBS or Enron”
But actually, there is an alternative, says Noon, and that is the share incentive plan. It is highly tax efficient – tax free on the way in and on the way out. It is high risk as it offers less diversification than investing in a broad range of assets and as it is invested in only one stock for a five-year period.
But there’s no tax, so that’s a major benefit, and employers are looking at them as longer-term savings vehicles.
Noon says: “Some clients are thinking along this line and there is a lot of demand for managing risk in the round and in wealth in particular, because we don’t want people with thousands of pounds in stock and have another RBS or Enron.”
A leaf from the European book
There is another concept that works elsewhere in Europe, and Ellison has been working with industry stalwart Con Keating to get it up and running here.
It borrows from a Swedish/German model called the book reserve system and is designed for those earning more than £50,000 year who are caught by the lifetime allowance.
Ellison explains: “It’s an unfunded approach, with no tax relief, but the benefit for the employer is there are no frictional costs or levies, and 1,000 pages of legislation go out the window.
There is another concept that works elsewhere in Europe”
“Companies don’t have to pay out but make a reserve in their accounts and can use that for internal financing. Within 15 or 20 years, they can be free of the banks.”
Without an insurance underpin, if the company were to go bust, the pension would have gone too, but in Germany a company might pay 30 basis points on the liabilities to an insurance company – in Sweden, it’s to a mutual.
We haven’t needed them before, as the funded system has always been way ahead of Europe”
In the aftermath of bankruptcy, the insurance company pays the pensions – your own private Pension Protection Fund. If the company is solvent, it has to pay the pensions, but the fiscal freedom it provides is considerable, provided there are sufficient controls on the system.
“We haven’t needed them before, as the funded system has always been way ahead of Europe,” says Ellison. “But the time has come for book reserve.
Don’t be distracted
Don’t forget in all the excitement about tapers that auto-enrolment still applies to executives and that they may already have protection in place.
Sackers’ Dunbar suggests communicating with people who are earning above a certain level, and waiting to see what the chancellor’s next pronouncement on tax relief may bring. She believes the harder the response to so-called high-earners, the more likely the employer will be to avoid a “fancy solution”.
The Treasury’s message is that apart from the lowest-paid staff, it doesn’t care about workplace provision”
Noon agrees that potentially some schemes could be quite severely affected. Communicating the changes and introducing a modelling tool should help to flag up those with the problems.
“The Treasury’s message is that apart from the lowest-paid staff, it doesn’t care about workplace provision,” says Ellison. “It’s not that the government’s anti-pensions, but it’s giving out a message that sounds very like it.”
Noon hopes they will leave the structure as EET (exempt/exempt/taxed) and manage tax relief levels so higher paid staff pay a bit more tax on contributions. “The current position is unsustainable,” he adds, “and is not a fit for purpose solution for what they want to do.”