Following the Emergency Budget announcement that the UK pension age is to rise to 66 in 2016, pensions are again at the top of the agenda, for individuals and organisations.
Faith Dickson, partner at pensions law firm Sacker & Partners LLP, says, "We've learned this week the Government is reinstating the link between the state pension and earnings. But now we've also found out that many of us will need to wait longer to get it, and the default pension age is also likely to go.
“The promise of jam the day after tomorrow is no real surprise. On average, people are living longer, and the Government needs to make savings. The weekly basic state pension is currently higher than unemployment benefit or lower levels of disability allowance that people might end up claiming instead. The problem with averages is, there are always winners and losers. Fit and healthy 65-year-olds will welcome the opportunity to work for longer, but others won't be able to do so.
“Increasingly, it seems inevitable that retirement is going to happen later than we've got used to over several generations, and that requires a real change of mind-set. Employers need to start thinking about how their pension schemes can help employees retire when they want to, rather than when they have to. And as the state pension age gets pushed back, for the vast majority of UK workers, private pensions might be one of the few things that give them a real alternative to working as they get older."
Another law firm, Lane Clark & Peacock LLP (LCP), has welcomed the Chancellor's proposals to repeal the complex system of pensions tax on savings for high earners from April 2011 in place of an ‘annual allowance’ of pension savings for all.
The previous Chancellor had proposed that employees with income above £130,000 would have tax relief on pension savings limited to 20%, with a benefit-in-kind charge on employer contributions in addition. A consequence of this was that many of those affected were likely to opt out of tax-approved pension schemes to avoid having to pay tax both on pension savings and on the pension when received.
LCP had lobbied earlier this year for the relatively simple approach of reducing the current annual allowance from £255,000 to £45,000.
Mark Jackson, partner at LCP, says, "The Chancellor has proposed a much simpler, and fairer, system, because it allows a reasonable level of pension saving for all. Employers are much more likely to continue their sponsorship of tax-approved pension schemes for all employees if higher earners are not forced to opt out."
The Government has stated that it will work with the pensions industry to develop the proposals for use of an annual allowance, as long as it will raise the initial target tax revenue for the Treasury of £3.5bn proposed under the previous Government's more-complex proposals. The new Government estimates that the annual allowance would need to be set somewhere between £30,000 and £45,000 to achieve this.
The principle of the annual allowance is simple. Members of defined contribution (DC) schemes enjoy full tax relief on employer and employee contributions, up to a maximum of the annual allowance. Contributions that exceed the annual allowance are subject to a tax of 40%, payable by the individual. Members of defined benefit (DB) schemes need to think a little harder to work out the ‘value’ of their pension savings during the year. Currently, this is the increase in pension during the year multiplied by an HMRC factor of 10. The excess of this ‘value’ above the annual allowance is subject to tax of 40%, payable by the individual.
Mark Jackson adds, "Employers need to review their plans for April 2011 and assess the impact of a reduced annual allowance. Employers with defined contribution schemes can identify the level of annual pension saving relatively easily, but those with defined benefits schemes need to tread more carefully, because this level of pension saving can be reached more easily than expected."
LCP calculates that, under the current system, an employee earning £90,000 in a 60ths defined benefit plan has annual pensions savings worth £15,000. If the annual allowance is set at £30,000, then this employee faces no further tax. If the same employee has earned a full pension of two-thirds of their final salary, and receives a 7.5% pay rise, then the value of the pension savings triples to £45,000. In this case, the employee faces a new pensions tax of £6,000 ( = 40% of the excess over the annual allowance).
Mark Jackson concludes, "A tax will arise where an employee has enjoyed a significant, often hidden, increase in pension. Employers are amending their pension schemes to control, and limit, such increases because they ratchet up their pension liabilities. In this respect, the Chancellor's proposals are a good fit with the objectives of many employers."
