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Pension problems Osborne has given high earners

Lorna Bourke explains how the Autumn Statement's reduction in pension allowances leaves high earners in an awkward spot.

 

by Lorna Bourke on Dec 06, 2012 at 16:19

Pension problems Osborne has given high earners

Hundreds of thousands of high earning public sector workers and others in private sector final salary linked pension schemes have a very difficult decision to make following the reduction announced by the chancellor in his Autumn Statement in the annual limit on pension fund contributions to £40,000 and the restriction in the lifetime allowance to £1.25 million. 

Those in defined contribution schemes will be affected too but for them the decision is relatively easier. 

This is because the annual contribution limit of £40,000 for those in a final salary linked scheme is not related to actual contribution levels but to the deemed increase in the value of their pension pot. Given that most people still contributing to final salary schemes are those working in the public sector these are the individuals it will affect most adversely.

For all high earners saving in any pension scheme there is an important decision to be made and if they get it wrong it could cost them up to £62,500 in extra tax – the tax payable on the difference between a £1.5 million and £1.25 million pension fund – an expensive mistake. Many will need advice from their employer’s pension administrator and/or a pension consultant to determine whether they will benefit from the ‘transitional relief’ offered under the new limits.

Transitional relief

‘This is one of the most difficult pension decisions that anyone has to make,’ warns Chris Noon of pension consultants Hymans Robertson. Not everyone will be aware whether they are near the existing £1.5 million lifetime limit or the new £1.25 million limit. ‘It is up to them to find out from their pension administrators,’ says Noon.

But he points out that the administrator will only be able to tell them whether they are approaching the lifetime limit in their current scheme. Individuals will have to work out themselves whether the current scheme, combined with benefits from all the other schemes – both occupational and personal pensions – to which they have contributed, will bring them up against the lifetime limits.

The statement from the Treasury says, ‘a transitional "fixed protection" regime will be introduced for those who may be affected by the reduction in the lifetime allowance.’ The new £1.25 million limit is effective from April 2014 and people have until then to decide whether they want to go on contributing to their pension scheme – in which case they will opt for the new £1.25 million lifetime limit. 

Clearly those on lower salaries who are unlikely to be anywhere near the lifetime limit have nothing to worry about and should go on making contributions.

The alternative is to go for ‘fixed protection’ in which case the lifetime limit remains at £1.5 million – but no more contributions to the scheme can be made. This will affect older employees with long service and high earners who have already built up substantial pension pots.

Noon points out that huge assumptions have to be made about which to choose. ‘You have to decide when you want to retire, how the lifetime limit might increase in future and what your employer might offer as an alternative to being a member of the pension scheme.’

And for those with savings in a defined contribution scheme, personal pension or Sipp (self-invested personal pension), an assumption also has to be made about future investment returns which could, for example, push a current pension fund of £1 million over the £1.25 new limit if the individual is still contributing and has some years to go until retirement. Any excess over the lifetime limit is taxed at 55% so this could be an expensive mistake.  

‘Some people near the limit last time round [in 2006] when they had to make this decision on protection simply decided to retire.  But to do that you must be at least 55,’ Noon points out. Of course, this could be a clever ploy by the government to encourage high earning civil servants to leave without the costs of making them redundant or offering extra incentives. If they are unable to earn any extra pension, why carry on working?

Annual limits

There is an added complication which affects anyone thinking of taking advantage of the higher £50,000 limit for the current tax year – and 2013-14. Many who make additional voluntary contributions to a defined contribution or personal pension may find that contributions made as early as next spring could count towards their annual contributions in the following tax year. This is because the pension ‘measurement period’ does not necessarily coincide with the tax year so they could inadvertently exceed the annual limit.

It can affect members of final salary schemes and some people contributing to defined contribution schemes whether they are employed or self-employed. Noon explains that in 2006 when this complication previously arose around two-thirds of pension schemes changed their measurement year to align with the tax year. But if they didn’t, contributions are calculated from the tax year in which the ‘measurement period’ ends. For some this could be as soon as April 2013 so they will effectively lose the ability to make up to £50,000 of contributions a year early. This could catch out those who boost their contributions in an attempt to beat the cut in the annual limit.

It will also affect some self-employed people and others who make their own pension provision through Sipps or personal pensions.  Individuals may have their own ‘pension input period’ which, again, doesn’t necessarily align with the tax year. It may run from the anniversary of when contributions were first made to a Sipp or pension plan, it could be fixed by the pension scheme or it could be agreed by the saver with the scheme administrator.

Noon cites the example of a person with an input or measurement period starting in May. This means contributions in the year starting in May 2013 will count towards the lower £40,000 allowance in the 2014/15 tax year.

Given these ghastly complications it will clearly be necessary for high earners and those making pension contributions up to the maximum to take professional advice. Those most at risk are members of final salary schemes earning around £80,000 a year or more with 15 to 20 years’ service or accumulated pension contributions from former employers or personal pensions.

Noon reckons the cost of advice could be around £1,000 to £2,000 but it could be more. But it’s a problem most of us would like to have – and it’s good business for pension consultants.

32 comments so far. Why not have your say?

Jonathan

Dec 06, 2012 at 18:12

So long as the government don't have to support people with income support and other benefits when they get old why should they care?

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LouisV-W4

Dec 06, 2012 at 18:36

No sympathy for a high earning public sector worker worrrying about how to overcome the £1.5M pension cap. I'm I right in thinking that's a pension of some £70K per annum... and no risk? What a nightmare for them!

If £80Kpa is the indicative figure, I have earned as much per annum in the private sector as such high earning public sector workers over the years, but because my pension is not final salary, it is likely to be less than 25% of that due to pension raids by Brown, high admin costs and poor fund performance... and I will still have performance risk!

At least I will be able to draw down an extra 20% pa... that was stolen earlier!

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Roger Bailey

Dec 06, 2012 at 19:17

This article highlights just what a scam pensions are. You get tax relief on your contributions 20/40%, the government changes the goalposts and you end up paying 55% on anything outside of these goalposts. Isn't it time that pensions, except for State Pensions, were consigned to the rubbsih bin?Taxpayers should advise their political parties that they no longer want tax relief on pensions, want their employers contributions added to their salaries and then be free to invest as they feel fit. Isa allowances should be increased at the same time and allow investnment in cash or equities as per the taxpayers judgement.

The UK State Pension is the worst in the EU. It should be adjusted to include Local Housing Allowance so that nobody receiving a pension would need to claim any beneits such as Pension Credits/Housing or Council Tax Benefits.

The savings of £37 billion by abolishing tax reliefs on pension contributions would be far more than the cost of ensuring that pensioners had a minimum State Pension of the proposed Universal Pension of £155 per week plus LHA of say £125 per week. Those pensioners who already receive a pension made up from Employers Contributions should not receive the LHA in full, but have this deductedt to this extent.

Nobody would want to exist even on this enhanced State Pension as it is still below the poverty level, so there is an incentive to save either by buying your own home or investing in whichever way you want to and without the governments meddling. If people are able to save, they will save. If they can't or won't, they are destined to living their final years in poverty. It's up to them.

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Colston Hicks

Dec 06, 2012 at 21:31

I think capping contributions is illegal. A pension is deferred pay. As pensions in payment are taxed the contributions should be free of tax.Double taxation is unfair.

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Jonathan

Dec 06, 2012 at 22:51

Colston Hicks

I think you think wrong

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Colston Hicks

Dec 07, 2012 at 10:55

Jonathan

Why do think I am wrong to say double taxation is unfair?

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Jonathan

Dec 07, 2012 at 11:08

I didn't say double taxation is fair

The bit that is wrong is when you said "capping contributions is illegal" I don;t think it is.

But if you want me to take a view on double taxation then:

If you pay 40% tax if you took your pay as wages but no tax if you put it in a pension then only 20% on the pension income; overall the government is losing out on revenue collection by 20%. Is that fair?

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LouisV-W4

Dec 07, 2012 at 14:19

Jonathan, that's only part of the story.

40% tax relief going in, and assuming your pension is below the 40% tax threshold, only 20% coming out. So, in theory, 20% better off. However, with drawdown for most capped by the GAD (and only 'increased' by 20% on Wednesday), most will never be able to take out their full pension pot, and the remainder will be taxed at 55%. That sounds like a large net gain for HMG or, at best, breakeve, helping them fund their public sector pension black hole, and overly generous benefits payments for the fraudulent and workshy (let's hope it won't be too long before the DWP starts taking back control!)

I have always been in favour of the 40% relief, and a much more realistic GAD calculation would be best for me right now, but it's far too late for me, so I am now in support of a better way of tax-efficient saving for my children's retirement e.g. much larger ISA allowance with lower costs. I cannot do anything about having to give away huge amounts to fund the public sector and scroungers, but please, don't anyone tell me I am somehow ripping off HMG at others' expense.

.

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Jonathan

Dec 07, 2012 at 14:56

The 55% is the death tax on pension pots?

If you buy an annuity this doesn't count as the pension provider keep what's left.

The 55% tax is to account for the income tax that would have been paid plus death duty. This would need to be amended if the 40% relief on pension contributions were reduced.

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Jonathan

Dec 07, 2012 at 14:56

The 55% is the death tax on pension pots?

If you buy an annuity this doesn't count as the pension provider keep what's left.

The 55% tax is to account for the income tax that would have been paid plus death duty. This would need to be amended if the 40% relief on pension contributions were reduced.

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LouisV-W4

Dec 07, 2012 at 15:47

Tax + death duty! My kids will probably have enough left to them for an ice cream each. HMG gets you every which way...

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Jonathan

Dec 07, 2012 at 16:01

55% is arrived as it's what would be left after 25% income tax and 40% death duty by inland revenue by 100 - 25% (income tax) then - 40% death duty. can be expressed as (100 * 0.75) * 0.6) which leaves 45% hence 55% total tax.

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Jonathan

Dec 07, 2012 at 16:07

If you want to avoid any inheritance tax buy a farm or a forest. No death duty is payable on those and they fetch a high price as all the city boys are buying them for the same reason.

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RobtheFox

Dec 08, 2012 at 02:51

Oh dear, all this talk of capping and how one must try and plan to ensure that one's £ multi k pension does not become restricted by the government plans.

Nice problem for some to battle with and yet not one word about the most iniquitous capping that has been government policy on the State Retirement Pension for decades.

That cap is on 4% of all the retired UK citizens world wide and is simply because of the country they live in, or to be more correct because of the countries they don't live in, their UK State Retirement Pension is frozen at the rate at which it first becomes payable in the host country. Live in the UK, EEA or one of a select group of countries like USA, the Philippines or Israel and the annual uprating in April is automatic but have the audacity to go and live in Australia or, Canada, South Africa or one of around 100 other countries and your pension rate is frozen...forevermore...the price for some of wanting to spend the so called golden years with one's previously emigrated children and grandchildren.

There is no legal justification - the 2010 ECHR ruling did not make universal uprating illegal.

There is no moral justification - these citizens contributed to the NI Scheme when working under the same terms and conditions as everyone else but are denied, now in their retirement, similar equality in withdrawing from the NI Fund.

There is no financial justification - the current surplus in the "ring fenced" NI Fund is £33 BILLION. Pensions Minister Webb admits it would only cost £650 million to uprate...about half of the annual interest the government has to pay for "borrowing" from the Fund!

There is no administrative justification - pensions are already payable world wide; just a change of rate required.

It has been demonstrated in a detailed and comprehensively researched report by the Oxford Economic Group and ably supported by an equally reliable submission from the Runnymede Trust that it is to the UK's financial advantage to uprate universally eventually to the tune of £7.2 Billion a year. Failure to implement such a policy and maintain the status quo will serve only to exacerbate the problem; Steve Webb, the Pensions Minister naively dismissed them giving the distinct impression that he had either not read the reports or, perhaps, did not understand them.

So while you worry (and I do not criticise anyone for doing so) just remember Annie, a centenarian living in Australia and still receiving her UK State Retirement Pension at the FULL rate payable when she retired.................yes, £6.20 per week....and not the up rated £107.45 per week her contributions should entitle her to.

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HUFC

Dec 08, 2012 at 09:46

There's a lot of rubbish spouted about the contribution implications for these high earners, who are in the very fortunate position of already having accumulated substantial pension entitlements. The remaining 98% of the population would love to have such a problem.

The contribution limit has not been reduced, as there never was a limit to contributions. It is only the tax-allowable contribution limit which has changed. I have yet to hear of an IFA who spells that out to clients & delves deeper into the implicatons.

e.g. The individual who was paying contributions or accumulating pension benefits of £50k p.a. continues to do so.

As this will be £10k over the new limit, a 40% tax payer will incur a tax charge of £4k assuming there are no unutilised allowances to carry forward.

The individual asks the pension fund trustees to pay the tax arising under the government's Scheme Pays legislation.

The trustees pay the tax & reduce the member's pension entitlement accordingly - a typical pension reduction of about £200 p.a. from the date the pensions starts to be paid, depending upon the member's age.

Is that really worth all the misplaced indignation?

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Colston Hicks

Dec 08, 2012 at 14:57

HUFC

" The trustees pay the tax & reduce the member's pension entitlement accordingly" ??????

The member does not know his/her pension entitlement until he/she gets there.

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HUFC

Dec 09, 2012 at 09:48

Colston - agreed for defined contribution scheme members, but defined benefit scheme members are accruing pensionable service from which they can calculate how much pension has been accrued. The majority of the article relates to defined benefit schemes.

As the author said "for those in defined contribution schemes...the decision is relatively easier".

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Colston Hicks

Dec 09, 2012 at 13:28

HUFC- you are not quite correct.

Members can calculate how much pension has been accrued to present day, but they cannot calculate the pension that will be accrued at NRD.

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James O'Connell

Dec 09, 2012 at 14:12

Unless you can calculate your pension with some degree of certainty you don't have a 'pension' you have an 'investment'.

Those who can't see the difference may well be in real trouble in years to come.

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camerar

Dec 09, 2012 at 16:48

My first comment is that the lifetime allowance should be indexed in some way. In just three years it could be reduced in real terms from £1.25m to £1.14m at 3% inflation. Under previous A Darling proposals indexation of an earlier lifetime allowance may (and note - may) have been considered from 2016.

The second is that investment in a DC pension is subject to risk carried by the individual. Funding can go down as well as up. The annual allowance limit does not allow for this - the proposal appears written around the assumptions of the unfunded but guaranteed DB pensions of the civil service (not local government).

This means that it is very difficult to plan over years to avoid breaching the limit, which may or not be attained later in one's career, with consequent penal 55% taxation. It is fair enough to limit taxation relief on contributions, but not upon the reward of investment - that is just grabbing by the Treasury.

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camerar

Dec 09, 2012 at 16:50

I wrote annual allowance but meant lifetime. "The lifetime allowance limit does not allow for this - the proposal appears written around the assumptions of the unfunded but guaranteed DB pensions of the civil service (not local government)."

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Colston Hicks

Dec 09, 2012 at 17:14

Investment becomes pension automatically at NRD

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James O'Connell

Dec 09, 2012 at 23:59

Colston Hicks

Too late then, I'm afraid!!

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Colston Hicks

Dec 10, 2012 at 15:59

James O'Connell

You are absolutely right.

BUT, it worked pefectly for almost 100 years before 1997.

We MUST get back to sanity in investment.

First we must accept that pensions depend on good investment,and, that employers do not guarantee their employees' final salary pension scheme benefits.

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Colston Hicks

Dec 11, 2012 at 12:38

James O'Connell

Do you accept Q.E.D. ?

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James O'Connell

Dec 11, 2012 at 14:42

Colston (Is that really your name?)

I actually agree with your last comment about pension schemes working perfectly for a hundred years, BUT remember these were 'superannuation' schemes i.e. final salary schemes guaranteed by employers.

I've nothing against sound investment for the long term.

I'm in favour of the government setting up a 'model scheme' with sensible investment guidelines and no opting out by employees and no payment holidays by employers. This should ensure that there are no shortfalls or 'black holes'.

I am sure that employees would look favourably on paying a higher contribution for the security guaranteed by such a scheme.

Contributions used to be about 4% for employees and 12% for employers.

With regard to employers not being able to fund schemes, isn't there some form of indemnity scheme in place already? However, with sound investments and some regulatory framework in place (shades of Leveson?) such a scheme would be perfectly viable.

I repeat my previous warnings that defined contribution schemes will lead to disaster for employees. Remember that they are the vulnerable ones in all this.

Finally, I will ignore your latest jibe aimed at me. I wasn't labelling you as a fool or knave. There are plenty of other candidates!

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Colston Hicks

Dec 12, 2012 at 16:54

James,yes it is my real name. You are not the first to comment. in 1943 a snoozing Admiral at a court of enquiry into the collision between my ship and an aircraft carrier in Gibraltar suddenly woke up saying " that's an unusual name.

You say " these were 'superannuation' schemes". This term does not appear in the glossary of my Inland Revenue Occupational Pension Schemes Practice Notes, so I cannot comment. There is also no reference to " final salary schemes guaranteed by employers". Quite the reverse.

Part 14: Discontinuance of Schemes

General

14.1 Neither tax legislation nor Inland Revenue practice requires an employer to set up a pension scheme, or, having done so, to enter into an open ended commitment to continue to contribute

There are times, of course, when an employer guarantees the pension of a single high flying executive.

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James O'Connell

Dec 13, 2012 at 00:48

Colston

I think that we are at cross purposes here.

The early defined benefit schemes were most certainly called superannuation schemes. ('defined benefit' is recent terminology). My father (born 1899) who was a teacher, never called them anything else.

I know that employers were not required to set up pension schemes, although recent legislation has changed this (new government backed defined contribution scheme).

More modern defined benefit schemes, set up by almost all large employers, but now mostly closed to new members, were most certainly supported by employers. This was because they entered into a legally binding deed of trust i.e. by agreement of all parties concerned (employer, employee and retired member). They were, and indeed are still, governed by a committee of these parties who agree to appoint suitable trust managers to look after the investments. Why do you suppose that these employers are always grumbling about having to fund 'black holes' in their schemes. This is the very reason that they have closed schemes to new members.

Your quote 14.1 deals with the legal position which has been overtaken by recent legislation. The schemes to which I refer were voluntary.

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James O'Connell

Dec 13, 2012 at 13:09

Colston

A final note;

Since October this year all employers must provide a suitable pension scheme for their employees. Employees who are not already in a scheme will be automatically enrolled.

Full details can be found on the government website www.gov.uk/workplacepensions.

I am signing off from this particular blog for now.

I hope that you find my pensions information useful.

Have a good Christmas

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Colston Hicks

Dec 13, 2012 at 13:26

James

It would not be fair for me to let you sign off without pointing out to all that there is a huge difference between workers' schemes being " supported by employers" and workers' final salary pension scheme benefits being

" guaranteed by employers".

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RobtheFox

Dec 13, 2012 at 13:29

But although providing a scheme is mandatory and enrolment of the employee is automatic I believe the employee has the right to decline.

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Colston Hicks

Dec 13, 2012 at 16:20

RobtheFox

You are correct, the employee has the right to opt out. Referring to the comment

" employers must provide a suitable pension scheme for their employees", this is not correct, employers have to contribute but they do not have guarantee that the scheme is suitable,they do not have to guarantee one penny at retirement.

BUT, owing to the way the Pensions Regulator is set up the employers may be forced to guarantee workers' pension benefits !!! Absolutely ridiculous.

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