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Pension Reform – hold your nerve and hope for stability

The recent budget announcements have yet again thrust pensions and tax relief issues into the spotlight.  From April next year, workers earning £150,000 and above will have their tax-free contributions reduced from £40,000 to £10,000 – effectively penalising those who can afford to maximise their pension provision. Yet average earners, who are more likely to struggle to reach their £40,000 tax-free contribution threshold, have no such cap in place. David Pugh, managing partner at employee benefits firm Lemonade Reward, questions the logic behind the plan, advising the proposed changes could have wider implications than first envisaged.

“The pension changes essentially means top earners – those who are invariably the key decision makers in a business – will at best slash their pension contributions to the £10,000 minimum and at worst, pull-out from the pension scheme altogether and either opt for a cash allowance, if such an option is available, or end up with nothing.

“There’s much talk about the cap mainly affecting those with ‘adjusted incomes’ of £210,000 but people with salaries below this figure should not be complacent; in this case, the devil is indeed in the detail.  As well as the basic salary, any additional perks, such as company pension contributions, bonuses, commissions, even private medical insurance premium payments and the company car may be included in the final calculation – pushing many who thought they wouldn’t be into the £210k and beyond ‘adjusted income’ earnings bracket.

“High earners typically pay between 10 and 20% of their salary into their pension, however the new budgetary cap of £10k means someone earning £200k is now limited to a 5% contribution.

“And if the business drivers from an employees’ scheme are reduced, employers will no longer have the appetite to improve them in the future.  Where’s the motivation?  I suspect better quality schemes will slide back to the minimum standards of Auto Enrolment. After all, if employers are only allowed to contribute the bare minimum, why shouldn’t they do the same for their employees?  I would never suggest leaders allow their personal circumstances to impact on their business decisions, but they could be forgiven for not having the same enthusiasm they had prior to the budget.

“What was hoped was going to be a period of stability is now a period of greater complexity, more change and grey areas, making it even harder for employers and savers to make long term decisions. Since pension simplification was introduced in 2006, there have been hundreds of changes to pension legislation – a lot of it small detail – but some big issues too (Retail Distribution Review, Auto Enrolment, annuity changes).

In the majority of cases, the changes prevent pension provision from being simple and transparent. The pensions industry itself is so busy changing its IT systems to meet Government requirements, I fear it’s losing sight of what actually is best for the customer.  Government is hindering progress, rendering what should be a crucial part of a remuneration package to something that is being increasingly seen as an irritation, a business distraction, a constant source of goal-post moving and so a disproportionate time consumer.

“This is why financial education within businesses is imperative; in order to embrace these constantly evolving changes and offer workplace solutions that benefit employees, we have to make informed decisions on what we know at the time. So how can hr directors and their colleagues maximise the current opportunities presented by the budget?

“There’s a window of opportunity to build-up those pension contributions before the cap comes into force in April next year; anything paid in before then is not subject to the reduced threshold. Because the pension input period (pip) is being aligned with the tax year, there’s an opportunity, between April and budget day, to boost your allowance to £80k in this tax year. Similarly, employees that haven’t contributed the maximum allowance over the past three years can carry forward any shortfall and use it to top up their pension pot this tax year by as much as £140k.

“These changes not only restrict what can be paid in, but employees will also be hit with a 55% tax charge if they manage to build total pension funds above a Lifetime Allowance. The Lifetime Allowance falls to £1m in April 2016, down from £1.8m three years ago. This creates a 100% tax charge on any contributions paid above your annual allowance; 45% tax going in and 55% coming out.

“Employers will have to decide what alternatives to give senior staff – on the one hand they could optimise the new allowances and allow employees to take any excess as cash, on other, they could view it as the employees’ problem.  A re-think is certainly needed for those facing an effective tax rate of 100%.

 “In order for business leaders to assess the impact of the budget on their firm they must quiz their financial planner, understand the intricacies – ask for detail as well as the top level findings – and  develop a strategy to cope with the 2016 changes (at the very least develop a High Earner Pension Policy).

“With further consultation in the pipeline (ISA-style pensions) I appreciate any strategy will have to evolve – so my message to HR directors and their peers is to hold your nerve, prioritise financial education, be informed, make the tweaks you need to and then, like the rest of us, pray for a period of stability which enables UK PLC to build upon what’s already in place.”

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