Articles & Updates

We can barely escape reminders that the government's finances are being tightened. The pensions of high earners are also being squeezed for more tax.

One of the methods chosen by the government to generate greater tax revenue is a reduction in tax relief on pension contributions for high earners from 6 April 2011. Additionally, so-called 'anti-forestalling' measures which trigger a tax charge when high earners seek to exploit the full tax relief currently available, are already in place.

Pensions tax relief from 6 April 2011

From 6 April 2011, those who earn at least £150,000 a year will have reduced tax relief on pension contributions. There will be a tapering down of tax relief between £150,000 and £180,000 a year, with those earning £180,000 or more a year only enjoying tax relief at the basic rate of income tax - 20%.

In determining whether an employee earns £150,000 or more a year, any employer pension contributions will be taken into account. This is subject to the proviso that the reduction in tax relief on pensions contributions will not affect those employees who earn less than £130,000 before taking into account any employer pension contributions. The reduction in tax relief will be recouped by means of a charge payable by the employee via self assessment. However, it is important to bear in mind that even with a charge of this kind a pension scheme has significant tax advantages over salary (which is subject to income tax) and other methods of remuneration, saving and investment.

The reduction in tax relief on pension contributions will apply in relation to pension schemes which provide 'money purchase' style pension benefits (such as small self-administered schemes) as well as to pension schemes which provide 'final salary' style pension benefits. However, because of the nature of 'final salary' pension schemes, the reduction in tax relief will reflect the growth in the value of the employee's pension rights in any one tax year, rather than the actual amount of employee and/or employer contributions.

Anti-forestalling

The 'anti-forestalling' measures now in force apply a tax charge in respect of significant one-off or irregular contributions by employees to pension schemes which provide 'money purchase' style pension benefits and in respect of significant one-off or irregular increases to pension rights in 'final salary' pension schemes. The 'anti-forestalling' measures do not apply to regular contributions or increases to pension rights (regardless of their total value).

Anti-forestalling applies if the employee:

• earns more than £130,000 per year (or has done so in either or both of the previous two tax years) and 
• changes their normal ongoing regular pension savings and
• has annual pensions savings which exceed £20,000 (in some cases, this figure increases to £30,000)

So, in the 2009-10 tax year, a charge of 20% of the amount by which any one-off or irregular contributions or increases to pension rights exceed £20,000 (or £30,000, as the case may be) will arise. This charge will almost certainly increase to 30% from 6 April 2010 for most of the affected individuals (to reflect the new 50% rate of tax on income over £150,000).

The 'anti-forestalling' measures also apply in relation to significant one-off or irregular pension contributions or increases to pension rights made by employers. Again, reduced tax relief will be recouped by means of a charge payable by the employee via self assessment.

A tax-efficient alternative: Employer-Financed Retirement Benefits Schemes

An Employer-Financed Retirement Benefits Scheme (an "EFRBS") could provide an alternative pension vehicle for high earners seeking to grow their personal wealth. Where high earners and employers co-operate, an EFRBS allows for contributions to a pension scheme to continue to be made in a tax efficient way.

An EFRBS is a type of pension arrangement which originally existed to provide more generous pension benefits than HMRC permitted under mainstream pension arrangements.

The key advantage of an EFRBS is that an employer can make contributions to an EFRBS on behalf of an employee which are not regarded as a benefit-in-kind for the employee. Accordingly, no employment income tax or national insurance contributions liability arises in respect of such contributions. Furthermore, the employer can potentially obtain tax relief in respect of its contributions to an EFRBS albeit not until the employee actually takes benefits out of the EFRBS. Having said this, it may be a price which employers are willing to pay in order to continue to provide attractive remuneration packages to key employees, and in any event a deal could be done with the employee to share the overall advantages of the arrangement.

An EFRBS is not affected by the reduction in tax relief on pension contributions and the 'anti-forestalling' provisions for the simple reason that contributions made by an employee to an EFRBS do not attract any tax relief. In practice, contributions to an EFRBS would only be made by an employer.

Case study

Jennifer is the Chief Executive of a FTSE 250 company and earns £200,000 per year. She makes regular pensions contributions of £50,000 per year to her employer's group personal pension plan. Her employer also makes regular contributions of £50,000 to that pension plan.

From 6 April 2011, Jennifer will only receive basic rate tax relief in respect of her contributions of £50,000 per year. As a consequence, a tax charge of 30% of that amount will arise (ignoring the effect of the tapered reduction in tax relief for the sake of simplicity). In addition, her employer's pension contributions of £50,000 will be regarded as a benefit-in-kind on which a further 30% tax charge will arise. Jennifer will be liable to pay both charges.

Instead of Jennifer herself making a contribution of £50,000 out of her salary and her employer making a contribution of £50,000 to her group personal pension plan, Jennifer could become a member of an EFRBS, her employer could make a contribution of £100,000, and she could accept a salary reduction of £50,000. As a member of an EFRBS, no charge to income tax would arise in relation to her employer's £100,000 contribution.

Conclusion

Although there is an immediate cost to setting up an EFRBS, for those employers who have a number of high earners that they wish to retain and incentivise it could well prove itself to be a good investment in the longer term.



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