Cash is king for higher earners

EFRBS and EBTs are now beaten by cash as employers look to get round new pension limits says John Lawson, head of pensions policy, Standard Life


Employers with DC schemes and their advisers may need to implement changes to remuneration policies as a result of recently announced pension tax changes.

Let’s start with a summary of what has been announced. The annual allowance for tax relief will be cut to £50,000 from 6th April 2011.The annual allowance works on the basis of pension input periods ending in a tax year.

This means that contributions being paid now are potentially caught by the changes. It will be possible to carry forward unused annual allowances from the previous three tax years. For this purpose, 2008/09 to 2010/11 are deemed to have an annual allowance of £50,000.

Employer Financed Retirement Benefit Schemes (EFRBS) and Employee Benefit Trusts (EBTs) are to be made tax ineffective from 9th December 2010.

Any contributions going into these schemes on or after that date will potentially be treated as remuneration and subject to income tax and national insurance.

So what do employers and advisers need to consider as a result of these changes?

The annual allowance changes will have an impact on some employees within DC schemes. DB schemes are arguably more impacted but this is outside the scope of this article. Advisers should be aware that pension input periods are the new black. Higher earning employees should avoid paying in more than the annual allowance of £50,000 for any pension input period ending on or after 6th April 2011. The default start date for DC input periods is the date of the first contribution on or after 6th April 2006. If a scheme has chosen to alter its input period from the default, then the current input period may well end in 2011/12. For example if the input period is 1st August to 31st July, contributions currently being paid could already be subject to the £50,000 cap, and therefore a 40 or 50 per cent tax charge where the cap is exceeded.

It is possible to alter input periods retrospectively (this will not be possible after 5th April 2011). It is unlikely that a whole DC occupational scheme will do so, but individual members can if they wish. Care needs to be exercised for high earners who are likely to exceed this cap. Bonus sacrifice for the current season needs to be treated with utmost care.

Care needs to be exercised for high earners who are likely to exceed this [£50,000] cap. Bonus sacrifice for the current season needs to be treated with utmost care.

Employees in GPPs can also alter input periods on an individual basis.

Those with taxable income lower than £130,000 – lets call these ‘low earners’ – whose input period ends in this tax year can pay up to £255,000 between them and their employer into a pension. For those low earners whose input period ends after 5th April, the rule is that any contributions paid before 14th October 2010 must be aggregated with contributions paid in the same input period on or after that date and tested against the current £255,000 allowance. Contributions paid after 14th October cannot exceed £50,000 plus whatever can be carried forward from the 2008/09 to 2010/11 period. Those caught in this situation who still want to pay in more – up to £255,000 – for the 2010/11 tax year can open a new pension ‘arrangement’ independent of their existing one as long as care is taken to close the pension input period on it by 5th April 2011.

Those with taxable income above £130,000 – let’s call them ‘high earners’ – could see their post April 2011 contributions either rise or fall. Taking the potential fallers first, the anti-forestalling rules allowed those with contributions paid on a monthly or quarterly basis (typical of most members of DC arrangements) to keep paying at the existing level. This means that anyone paying more than £50,000 at the moment could be forced to reduce contributions from 6th April 2011.

Some high earners who didn’t benefit from the anti-forestalling protection for regular premiums may have been restricted over the last couple of tax years to annual pension contributions of between £20,000 and £30,000.

Their contributions can therefore increase and they may also have the opportunity to carry forward unused relief from 2008/09 to 2010/11 come April 2011.

How do employers remunerate those employees with contributions currently above £50,000 or likely to breach this limit in future? EFRBS and EBTs had been seen as the way to pension the top slice of earnings, but these have effectively been killed off by new rules that will tax contributions as income for both national insurance and income tax. These schemes now have no advantage over cash compensation but come with significant disadvantages attached, not least the fact that they are locked away until retirement. Cash, after the first £50,000 is paid into pension, is therefore king.