The traditional pension, as a corporate benefit for high earners, has almost been taxed out of existence. The Tapered Annual Allowance rules for pension contributions mean that increasingly employers are opting-out of providing this benefit for high earning employees.
At best, employers are making the minimum permitted pension contributions to an employee’s pension pot.
Since April 2016, employees in the UK earning between £150,000 and £210,000 per year have been subject to a Tapered Annual Allowance for pension tax relief. The Tapered Annual Allowance starts at £40,000 and tapers down to £10,000.
So for employees earning more than £210,000 the total amount they can put into their pension pot, tax-free, is £10,000.
However even if someone earns less than £150,000 they could still be affected. This is because what is tested against the taper is both “threshold income” and “adjusted income“.
Combined, these two income calculations determine whether an employee is subject to a Tapered Annual Allowance.
Employees will be subject to the Tapered Annual Allowance if both of the following apply:
- Their threshold income is over £110,000 – this is income excluding any pension contributions.
- Their adjusted income is over £150,000 – this is income added to any pension contributions made by the employee or their employer.
If an employee’s threshold income is less than £110,000 then they immediately qualify for the full £40,000 annual allowance. Threshold income captures not just employment income but additional forms of taxable earnings such as dividend income, property income and savings income etc.
If an employee’s adjusted income is above £150,000 then the taper applies. Similar to threshold income, adjusted income captures additional forms of taxable earnings but also employer and employee pension contributions made from gross pay or through salary sacrifice.
So in practice the Tapered Annual Allowance rules have the potential to apply to an employee with a threshold income above £110,000 per year and will apply if an employee has adjusted income above £150,000 per year.
Any excess contributions above the Tapered Annual Allowance are taxed at the employee’s marginal rate of income tax, currently 45% for highest rate taxpayers.
The minimalist approach
The taper therefore applies to anyone who is a high earner and these individuals may have little idea what their correct taxable income is until after the end of the tax year, making it extremely difficult for them to calculate their Tapered Annual Allowance.
Given the complexity of these rules, employers are understandably not wanting to add to the confusion.
To ensure that employees do not unwittingly exceed their Tapered Annual Allowance, employers are increasingly restricting the maximum combined (employee and employer) pension scheme contributions to £10,000 – the minimum Tapered Annual Allowance.
Other employers are offering a cash allowance for any ‘excess’ pension contributions that would have otherwise been made to the pension scheme. Some employer’s use a cash allowance to replace the £10,000 pension contribution in any event.
A typical scenario at the moment is an employer who has contractually promised to make, say, 10% employer contributions to a defined contribution pension arrangement. If the employee earns £210,000, then the most that can be contributed to their pension pot is £10,000.
Unfortunately, 10% of £210,000 is £21,000, leaving an utilised “surplus” of £11,000. If the pension scheme cannot accommodate the surplus what else can? In an employee benefit context how should surplus earnings be put to best use?
If today’s senior employees do not have adequate retirement provision then they may not be able to retire at all. In the absence of an official retirement age, the Tapered Annual Allowance may limit companies from recruiting and nurturing the next generation of executive talent.
Moreover, financial well-being (or even its perception) can impact on productivity. Financial well-being is not necessarily determined by the level of somebody’s income, often it is the size of their existing “savings buffer” and their ability to contribute to future savings. Peace of mind from having a sensible savings strategy is rarely achieved by having a store of wealth sitting in a long-term deposit account.
Managing these issues will become ever more part of the challenge of attracting, retaining and motivating your best people.
Indeed, rather than delivering cash earnings, it may be more advantageous for employers to offer deferred earnings as a long-term savings solution (similar to pensions), as the table below attempts to illustrate.
|Cash earnings||Deferred earnings|
|Tax (PAYE/NICs @ 47%)||(47)||(0)|
|Return (say 7% compound for 10 years)||53||100|
|Tax (CGT @ 20% / PAYE/NICs @ 47%)||(11)||(94)|
*Effect: turns a “gross” figure into a “tax free” investment return