The legislation around pension taxation continues to create challenges for employers and employees. Although the “simplification” proposed through the introduction of an Annual Allowance (AA) and Lifetime Allowance (LA) in April 2006 initially affected very few scheme members, subsequent changes to both thresholds have made the matter more complex, and lower “limits” are now affecting many more people.
The Chancellor has announced a reduction to the Annual Allowance to £10,000 a year for higher earners which will be particularly significant for Defined Benefit scheme members. This is in addition to the cut in Lifetime Allowance to £1m from 2016 which has already been announced and will impact those earning around £75,000 or more. Those earning over £110,000 are very likely to be impacted by both the Lifetime and Annual Allowances, which means that they may not get value back for their own pension contributions and will leave their scheme. The new rules will be effective from 6 April 2016 – but there is work to be done before then.
The Annual Allowance reduction will be tapered from the current £40,000 threshold down to £10,000 for those earning between £150,000 and £210,000. Earnings for this purpose is based on a new definition, “adjusted income”, which, for example, includes income from investments and property.
Crucially, it also includes the value of the employer’s contributions. The reduction is applied by removing £1 of Annual Allowance for every £2 of adjusted income. This means Local Government Pension Scheme (LGPS) members and those in the 1/60th Final Salary section of the Social Housing Pension Scheme (SHPS) above the threshold are very likely to see their Annual Allowance reduce. Others may also be at risk. Those affected will incur an additional Annual Allowance charge (or a new charge if otherwise they would not have had one), as well as a Lifetime Allowance charge.
Initial calculations show that employees in the LGPS or in the 1/60th Final Salary section of SHPS earning above around £170,000 will see full tapering of the AA down to £10,000. This means they may face an additional Annual Allowance tax charge of £13,500 a year – this is above the amount they may have paid anyway. At this earnings level, the budget changes could be viewed as a 10% pay cut. When viewed alongside the continued pay constraints it is anticipated that affected members may be seeking to understand their options – without options they may leave the scheme and potentially change employer. If the current pension schemes do not give sufficient flexibility (for example the LGPS), employers may need to consider alternatives or revise their reward strategy.
Reaction to the issue will require careful consideration. Employers could do nothing if they consider that this is a personal tax issue and it’s up to staff whether they stay in the scheme or not. More frequently however, employers are taking a more proactive role to engage their affected staff (especially as there are more of them) and help them understand the issue.
Employers need to understand who is (or could be) affected, what options exist for employers and staff, and how best to engage with affected staff. This can be summarised as analyse, manage and communicate. Only by doing all three stages will employers be in a position to recruit and retain key staff and ensure that a valuable piece of the reward puzzle continues to work for all.
If you have any questions please get in touch with your usual KPMG pensions contact or Steve Simkins.
This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG in the UK.