Recent changes in pension legislation and restrictions in contributions have brought about problems for those businesses who pay high salaries. Many employers will now find themselves paying pension contributions in breach of the restrictions brought in by HM Govt. This has brought about two problems now being faced by many employers. The first one is ‘How do I communicate the issue to those effected by the restriction in pension contributions?’ The second is ‘What options can I provide to them and how do I do it?’
Let’s be clear here. I am only talking about ‘Annual Allowances’ in this post. Lifetime Allowances are a whole different kettle of fish and specialist independent advice should be sought to help deal with any potential breaches in allowances.
The current annual allowance is a limit to the total amount of contributions that can be paid to defined contribution
pension schemes and the total amount of benefits that you can build up in defined benefit
pension scheme each year, for tax relief purposes. The annual allowance is now capped at £40,000 (although a lower limit of £10,000 could apply if you already draw a pension). Bear in mind also, that the annual allowance applies across all of the schemes an employee belongs to, it’s not a ‘per scheme’ limit. It includes all of the contributions that you or your employees pay or anyone else who pays on their behalf. Tricky eh? How do you know they don’t pay into a personal pension arrangement outside of any company scheme?
The problem becomes more complex for higher earners. New measures will restrict pensions tax relief by introducing a tapered reduction in the amount of the annual allowance for individuals with income (including the value of any pension contributions) of over £150,000. Where an individual is subject to the money purchase annual allowance, the alternative annual allowance will be reduced by £1 for every £2 by which their income exceeds £150,000, subject to a maximum reduction of £30,000. That means that those earning £210,000 or more, will have their annual allowance restricted to just £10,000.
If the annual allowance in a year is exceeded, the employee won't receive tax relief on contributions paid that exceed the limit and they will be faced with an annual allowance charge. The annual allowance charge will be added to the rest of their taxable income for the tax year in question, when determining their tax liability. If the annual allowance charge is more than £2,000, the employee can ask the pension scheme to pay the charge from their benefits. This means their pension scheme benefits would be reduced. However, there may be a way around this in some cases. If they have a money purchase annual allowance, they may be able to bring forward any unused annual allowances from the previous three tax years, to either reduce their annual allowance charge to a lower amount or reduce the annual allowance charge completely.
If the employee has taken benefits which include income, such as an ‘Uncrystallised Funds Pension Lump Sum’ or flexible drawdown
with income, and they want to continue paying contributions to a defined contribution pension scheme, they will have a reduced annual allowance of £10,000 towards their defined contribution benefits. The reduced allowance will apply if they have withdrawn more than the 25% tax free pension commencement lump sum. The reduced amount is known as the ‘money purchase annual allowance’ and includes both their own contributions and any other contributions paid on their behalf, such as an employer or a third party. Unlike the above, they cannot bring forward any unused annual allowances from the previous three tax years to warrant a higher contribution of £10,000 towards your defined contribution benefits.
So what are their options? Well you can give those employees who breach the allowance a number of options. They can accept the breach and pay tax on the amount over the annual allowance. If applicable, they can apply to carry forward previous year’s allowances. They can simply elect to have the excess paid as salary. They can divert the excess into a corporate ISA. They can divert the excess into a General Investment Account if they already have an ISA. They can divert the excess to be allocated to enhance or purchase other benefits.
These are all great, but how do you manage the communication, the assessment, the reporting and
the options? The issue is quickly being recognised by many employers, but those I have spoken to had not found a single solution. Fortunately, we already help many employers facing these challenges.
To discover how benefits technology can give employees access to the information they need to make the right pension choice for them, contact us on 0845 372 6644, drop us a line at email@example.com, or visit our website on www.staffcare.net!