This month, two pieces of legislation relevant to the taxation of pensions are being published by the Government. One is already available, the other, called ‘scheme pays’ is expected at the end of the month. Scheme pays is particularly relevant, as it will make it much easier for individuals to meet any significant annual allowance charges that they may face. While this is good news for individuals facing the annual allowance charge, employers will need to be wary of the cost implications for the scheme.
The annual allowance charge will typically affect long-serving members of final salary pension schemes who earn more than £60,000 and people in Defined Contribution arrangements whose employer and personal contributions combined exceed £50,000. The charge results from the annual allowance for pensions tax relief being reduced from its current level of £255,000 to £50,000.
Many employers will need to rethink their response to the pension tax arising from this reduced annual allowance. They only have six weeks to do this, as the new regime, complete with scheme pays, comes into force this April.
The problem is that companies are expecting that employees due to be affected by the new lower annual allowance will opt for a cash supplement instead of their full pension promise and so not face an annual allowance charge.
However, due to the forthcoming ‘scheme pays’ legislation, a process will be available for a person to require their pension scheme to pay most of the tax bill for them. The pension scheme cannot, except in exceptional circumstances, refuse this request.
Scheme pays will take much of the sting out of the annual allowance charge by reducing the cashflow strain on the individual and also making the overall tax burden more manageable The current approach that most companies are adopting of offering affected people, particularly in defined benefit schemes, a choice of whether to maintain their full pension accrual and pay the tax (stay-and-pay) or take a restricted benefit with a cash top-up, will find that for their people stay-and-pay is the better choice.
This is an unwanted conclusion for employers, as both the cost of providing the benefits and the cost of administrating scheme pays will be significant. Draft legislation published on 10 February requires that such members must be given a Pensions Savings Statement, which accurately calculates the pension amounts for that tax year, and the three preceding years. Coupled with the difficulties of an annual ‘scheme pays’ event, the administration costs could well be thousands of pounds a year for each individual member involved.
Companies will need to change their plans to avoid this costly situation and have two, opposite approaches to choose between. The first is to reconsider their offer to make it more attractive. It could be that the cash offered simply is not sufficient to make this worthwhile for the individual, particularly given the high marginal tax rate of 52% that many people would pay on this. More thought should be given to how this top-up benefit is structured to make it more engaging, particularly considering investment options for the cash offered.
The second approach, relevant for those who have to reduce costs, is over the next year to remove the choice altogether. Given current economic conditions and the higher levels of inflation we are seeing, a compelled change to an arrangement that does not give more benefits than the annual allowance is a realistic option for many companies.
Ed Wilson is a pensions adviser at PwC
