There will be a number of factors for employees to consider in relation to their pension arrangements for the 2016/17 tax year, now that the reduced annual allowance has come into effect (see article here). Although it will be beneficial for employees to obtain independent financial advice on their pension planning, as the best course of action will depend on their individual circumstances, employers can also assist their employees by taking certain actions.
What are the pension changes?
The tax free annual allowance for pension contributions is £40,000 for the tax year 2015/16, however, from 6 April 2016 there will be a reduced allowance proportionately restricted by £1 for every £2 of adjusted income over £150,000. This will create a tapered allowance depending on how much an individual earns. For example, those earning £210,000 (including employer pension contributions) or more per year will have an annual allowance of £10,000, as the maximum reduction is £30,000.
The lifetime pension allowance will also be reduced from £1.25m to £1m from 6 April 2016. This is the maximum amount that can qualify for tax relief.
Following the 2015 Budget announcement, there were suggestions that tax relief on pension contributions could be removed entirely, making pension payments tax free. This was not implemented in the 2016 Budget as the Chancellor introduced another plan to encourage pension saving – a lifetime ISA (LISA) for those aged under 40 as of April 2017. There is concern that the LISA will undermine pensions and ultimately end up complicating the system further.
How will the new pension changes affect employees?
The new changes are likely to affect higher and additional rate earners the most (those earning more than £150,000), as their tax relief will be severely restricted.
Employees should consider two points in light of the new pension changes:
- Ensuring carried forward allowances from previous years are used up to benefit from the tax relief available; and
- Calculating their ‘Threshold income’ and ‘Adjusted income’ from the tax year 2016/17 onwards in order to determine whether they will be affected by the new changes.
Unused carried forward annual allowances
High earning employees potentially affected by the reduced annual allowance may want to make full use of any of the previous 3 years’ allowances carried forward while they still can. For each passing year, the previous years’ carried forward allowance is lost and replaced with the most recent years’ allowance, which could be only £10,000 from 2016/17 for some high earning employees. From the 2016/17 tax year, employees can carry forward up to £40,000 of unused allowances from each of the previous three years (2013/14, 2014/15 and 2015/16).
Calculating threshold and adjusted income
Threshold income is calculated to determine whether the employee’s annual allowance will be reduced. Broadly speaking, threshold income is the total income from all sources, less employee contributions to a personal pension, plus any income contributed towards employer pension contributions pursuant to a salary sacrifice arrangement. If it amounts to less than £110,000, the employee’s annual allowance will not be affected. If it exceeds £110,000 there will be a reduction, and the employee would then need to calculate his adjusted income to establish the amount reduced (i.e. £1 for every £2 of adjusted income over £150,000). Adjusted income is measured as the total income from all sources (with no deduction for employee contributions to a personal pension), plus the value of all employer pension contributions made.
How can you assist your employees with pension planning?
Employers might not have all the necessary information to identify how employees will be affected by the pension changes, but it is certain that employees will be affected, in particular higher earners. Even in circumstances where employees have an adjusted income of over £150,000, the possibility of using previous years’ unused allowances may mean that these employees could continue to have pension contributions in 2016/17 well in excess of any reduced annual allowance.
Many employers are issuing generic communications to employees outlining the pension changes coming into force on 6 April 2016 and its potential impact on employees. Employers could consider issuing targeted communications aimed at higher earners, who are most likely to be affected by the changes to ensure they understand how this will impact them and what they should consider. Although some employees might already have financial advisers, employers can also provide details for obtaining independent advice (such as the contact details of recommended financial advisers).
Limiting employer pension contributions
Although employees may not know what their annual allowance will be until shortly before the end of the tax year (for example whether variable pay, such as incentives or bonuses, forms a significant proportion of their remuneration package), they may want to ensure their pension contributions during the tax year do not exceed the minimum allowance of £10,000 until they can make the necessary calculations. Employers can consider limiting employer pension contributions in all circumstances to £10,000 per year (of which employee contributions are included), and replacing any contributions in excess of that amount with a cash payment (or a tax efficient alternative as mentioned below).
Given that employees may have some carried forward allowances in 2016/17, employers could make limiting contributions something employees could elect for in that year (higher earners will be less likely to have any carried forward allowance from 2018 onwards). Alternatively, employers could change the timing of employer contributions (i.e. make regular monthly contributions of up to £10,000 for the tax year (of which employee contributions are included), and then defer any further contributions until final remuneration for the tax year is known).
Should pension contributions be replaced with cash payments, there would be a National Insurance cost for both the employer and the employee, resulting in an additional income tax charge (as employer pension contributions are not subject to NICs even if they are above the annual allowance).
Other tax efficient forms of remuneration
If employer pension contributions are reduced, employers can consider other tax efficient forms of remuneration. Various tax efficient equity incentive plans are available in the UK that can provide significant benefits.
How can we help?
With expertise in law and tax, strategic HR consulting and communications, Abbiss Cadres offers a fully integrated consulting and advisory service.
Amongst other services, our highly experienced team of lawyers, consultants, pension and tax experts can assist with:
- Drafting and presenting employee communications surrounding the new pension changes;
- The legal risks of changing the timing of bonus announcements or payments;
- Whether to replace pension contributions with cash payments; and
- Alternative tax-efficient forms of remuneration.
If you have any questions, or to discuss how we can help you, get in touch.
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