Another way

  • Author : Matthew Pitcher
  • Date : June 2010
ABOUT THE AUTHOR: Matthew Pitcher is a Senior Client Partner at Towry Law

It has taken a full tax year for the dust to settle on the Budget 2009 changes to pension legislation. This is primarily due to tinkering by the government along the way, which has left many high earners confused as to where they stand. A year and a Pre-Budget Report later and the direction of travel is clear; the tax position for high income individuals looks set to deteriorate for some time to come.

Pre-Budget Report changes

In the December 2009 Pre-Budget Report the UK economics and finance ministry reduced the relevant income threshold from GBP150,000 to GBP130,000 per annum. This reduced threshold will determine whether the complex anti-forestalling rules will apply to pension contributions in the UK paid after 9 December 2009 in the 2009/10 tax year and in the 2010/11 tax year.

The combination of the reduced relevant income threshold and the increase in the effective income tax rate between GBP100,000 and GBP113,000 to 60 per cent (resulting from the reduction in the personal allowance), has meant that the definition of a high earner certainly starts at a lower level than we might previously have assumed. These levels may move further, with a further reduction in the relevant income threshold to GBP100,000 looking like an obvious amendment and simplification. After all, why continue to allow those with income just over GBP100,000 to gain 60 per cent income tax relief on pension contributions?

Remaining opportunities

The 2010/11 tax year is an important one because the complexity of the anti-forestalling rules does allow for some careful planning.

Those who have been making regular pension savings since before the changes were announced in April 2009 can continue with these contributions in 2010/11 and receive full higher rate tax relief. (However care must be taken over what is deemed to be ‘regular pension savings’ as the definition requires that contributions must be paid at least quarterly).

For those without regular pension savings it is still permissible to make a pension contribution of up to GBP20,000 with full income tax relief (known as the ‘special annual allowance’) and any high earners who are not taking advantage of this should seize the opportunity. In addition those with a history of lump sum pension contributions may qualify for a higher special annual allowance of between GBP20,000 and GBP30,000 and should maximise this potential for tax relief.

The anti-forestalling rules also allow the deduction of Gift Aid contributions from total income, for this tax year only. This potentially allows high earners to reduce their total income to below GBP130,000 by making sufficient charitable donations. By doing this, they can still achieve 40 per cent, or even 60 per cent, tax relief on their pension contributions and not be caught by the anti-forestalling rules. It might even be good advice for some high earners to make Gift Aid donations this year, which are equivalent to the value of the next few years’ planned gifts, to get the best advantage now.

With a doubling of high earner rates of employee national insurance from 1 per cent to 2 per cent, salary sacrifice arrangements for those whose income is below GBP130,000 look even more attractive. Salary sacrifice allows the employee to give up gross salary in exchange for an employer pension contribution. Whilst many employers will opt to retain some of the employer’s national insurance saving, many will past at least some on. It is possible to change an entire company pension scheme on this basis under the rules without giving high earning staff a tax headache.

Salary sacrifice is important to implement now as it has been challenged by the UK government recently, with the attempted withdrawal of its use for childcare vouchers, and the complete withdrawal for company provided phones and laptops.

Changing a group pension is only available though to those schemes with 20 or more members on the same basis. Unfortunately, the way the legislation was drafted, a change of company pension scheme could break an employee’s protected regular pension savings and render him or her only able to make contributions up to the special annual allowance, This means that an employer changing its pension contribution for everyone could trigger a tax charge for its high earning staff. In theory, a high earner receiving a company pension contribution for the first time could be financially worse off if the charge on his or her personal contribution was more than the amount given by the employer. To avoid conflict, companies (particularly smaller ones) with high earning staff will be seeking advice about their employee benefits packages.

Opportunities in the simplified world

It is without doubt that the anti-forestalling rules, in place between 2009/10 and 2010/11, are horrendously complex in practice. Indeed, we have seen many high-earning professionals make mistakes in their pension planning in the last year. From 2011/12, however, the situation becomes much simpler.

From 2011/12 anyone with income exceeding GBP180,000 will see the income tax relief on their pension contributions restricted to the basic rate. For those earning between GBP150,000 and GBP180,000, relief will be tapered away depending on their actual level of income. To add to the complexity, where income exceeds GBP130,000 but not GBP150,000, the value of employer pension contributions must be added to income to determine whether the GBP150,000 threshold has been exceeded and therefore tax relief restricted. Whilst exact details of the rules from 2011/12 have not yet been confirmed, it is clear that high earners will not have to be earning very much more than GBP150,000 before pensions become more of a burden than a benefit.

Most high earners will retire with effective income tax rates of 40 per cent to 50 per cent and, therefore, an income taxed at this rate from a pension on which you have only received 20 per cent or even 30 per cent tax relief does not look attractive. Pensions have always been criticised as being inflexible in terms of the withdrawal of benefits, but high earners have put up with that because of the tax breaks.

Inevitably anything that looks like a pension benefit or deferred salary may well be the next target of legislation

We have already seen an increase in attention being paid to tax-relieved investments, such as venture capital trusts (VCTs). These are likely to be one of the replacements for pensions for the very high earners.

The benefit of VCTs is that they give 30 per cent income tax relief but, unlike a pension for a high earner, they offer some access to capital. A carefully planned series of VCT investments, using the right providers, could help to build a rolling portfolio of tax-efficient capital. Indeed, each reinvestment within a rolling plan of VCT investments attracts a further 30 per cent income tax relief and so a series of tax breaks can be planned. This could include the use of the tax-free VCT income to fund ISAs. VCTs can be very illiquid and so for this to work the individual would need to carefully select those products that had robust plans for repayment of capital.

We would advise that tax-led products such as these, enterprise investment schemes (EIS) and others should only be for the very wealthy. In addition, they are only ever appropriate for individuals who understand, and are comfortable with, the risks, both investment and regulatory risks. Tax-led investments are best used as a small part of a person’s overall portfolio; 10 per cent is a good benchmark, depending on the client and his or her circumstances.

Problems for employers

Increasingly, as employees opt out of workplace pensions, employers will come under pressure to offer an alternative. It is conceivable that employees will simply accept more gross salary in exchange for a pension contribution from an employer, but many companies will come under pressure to offer something more interesting to retain their top staff. This may be in the form of increased equity in the employing firm. There has certainly been an increase in interest about employee benefit trusts recently as a way of holding this benefit.

How this is supposed to sit with the government’s own workplace pensions reforms heading down the line in 2012-16 is anyone’s guess. From 2012, employers will be forced to ‘auto-enrol’ staff in a workplace pension, but can expect conflict with their high earning staff, who will be resistant to this. Therefore in the future there is going to be pressure for advice and guidance not just from individuals, but also from corporate clients.

There is much talk at the moment about alternatives to pensions that are not caught by the new legislation. Inevitably anything that looks like a pension benefit or deferred salary may well be the next target of legislation.

Future financial planning

All of this means that the future for high earners is likely to look more complex. Gone will be the days when high earners contributed into one pension pot and this would provide the main source of income in retirement. Instead, it is likely that they will retire with a pension fund and a mix of other investments accrued over a working lifetime. This means that having financial, legal and tax advisors to hold their hands and keep track of what they have will become even more necessary.


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