The introduction of pension freedoms in the UK has helped give individuals more choice and flexibility on retirement. But, as with all things, more choice can equal more complexity. And most would agree that pensions are anything but simple: from making the required saving and adhering to tax laws, to ensuring a pot big enough to last a lifetime - it’s a minefield out there.
In short, it makes sense to provide pension support because employees trust their employer to make good decisions on their behalf. Perhaps even more importantly, not providing support can only lead to a downward spiral. The impact of poor financial wellbeing on employees is well documented in terms of worries, stress, absenteeism and presenteeism, which costs the organisation.
The reality is that if problems do occur, the finger is likely to be pointed at the employer regardless of where the responsibility officially lies. So, proactivity truly pays in multiple ways.
Lay a strong foundation
After the pension plan is in place, member booklets are (hopefully) up to date and this year’s auto enrolment (AE) minimum contribution increase has been communicated to everyone - what more could or should be done? Well, the fact is that helping employees become engaged savers is an ongoing commitment. It’s probably fair to say, however, that most companies just do the basic essentials.
If the goal is to provide more support to employees - helping to build trust and value - a communication programme tailored to employee demographics will go a long way. And topics to include are things like pension pitfalls to avoid. Good communications may also identify savings that can be reinvested in the benefits programme.
Pension checklist: the basic package
- Well-managed default fund that delivers good returns - communicated to employees
- Up-to-date trust schemes with no exposure to uninsured liabilities
- Regular suitability assessments of registered group life and/or excepted group life arrangements
Pension checklist: upgrades for better mileage
- Potential help from an audit and design service to ensure core pension benefits for each employee demographic are relevant and compelling
- Easy-to-understand and timely employee communications about pension legislation and other changes that affect future savings and entitlements
- Employee access to independent, no-obligation, scheme specific advice that’s checked for due diligence
- Staff guidance on the Pensions Advice Allowance and the tax-exempt limit on employer-funded advice for employees
The lifetime allowance now affects more people
The lifetime allowance (LTA) is the limit on the amount of pension benefit that can be drawn from pension schemes - whether lump sums or retirement income - and paid without triggering an extra tax charge. In 2006, this limit stood at £1.5 million when the LTA was introduced and viewed as something that only affected a few higher earners. Over the years it increased to a high of £1.8 million, then steadily decreased to a low of £1 million.
The start of index linking raised the LTA to £1.03 million for the 2018-2019 tax year, a slight increase brought about by inflation. At this level, it now has the potential to catch many of the ordinary majority - not just the fortunate few. And it has also become a political tool with politicians from all sides unable to resist tweaking and changing the limit.
Although government figures suggest that only 4% of people will be affected, it’s difficult to quantify the actual number. But as a general rule, if someone is, say, in their 30s and paying around £1,000 a month into a pension, they’re likely to hit the allowance at some stage in the future.
There’s no onus on an employer to communicate changes to the LTA. But doing so can help build employee trust, which has a knock-on effect on reputation.
Watch out for future LTA developments
It’s still possible for some members of schemes to register for either fixed or individual protection, which effectively sets the LTA at £1.25 million. However, this comes with consequences, so it’s not an easy or straightforward choice.
Another potential concern is that benefits from a registered death-in-service (DIS) scheme would be added to pension benefits when tested against the LTA. There’s also the chance that individual protections could be lost for someone who moves from one employer to another. To prevent this happening, individuals shouldn’t join a new pension scheme or a registered DIS scheme. This device, sanctioned by Her Majesty’s Revenue and Customs, is called pension transitional relief.
There are solutions to help avoid breaching the LTA, and/or invalidating any LTA transitional protection, including alternative kinds of DIS arrangements and a carefully structured audit of any insured benefits.
Communicate the pitfalls of contribution limits
For the 2018-2019 tax year, the standard rule is that UK taxpayers will get relief on pension contributions of up to 100% of their earnings or a £40,000 annual allowance - whichever is lower. Or, for those with no relevant earnings, such as a non-working spouse, tax relief on contributions up to £3,600 are allowed.
Any pension contributions in excess of these limits have to be made in the year the earnings were made. And it’s here where things might get a little sticky. Since the introduction of tapered annual allowance, the potential for breaching the annual allowance has increased. This could become more relevant in the 2018-2019 tax year as the ability to go back three years and carry forward will start to coincide with the legislation changes - making breaches likely.
Defined benefit schemes serve as an example. They provide a pension based on a formula related to the number of years in the scheme. It’s easy to breach the limits when calculating contributions and making use of unused allowances if, say, a big pay rise or promotion applied in any of those years.
What does the future hold?
The cost of subsidising UK pension tax relief has reached almost £55 billion a year.1 Further and substantive changes to the existing regime are therefore expected. For example, it’s been rumoured over recent years that the government will scrap the higher-rate tax relief available on pension contributions - and replace it with a flat rate of, say, 30%. All taxpayers would get the same level of tax relief no matter how much they earn. Some may say this change is fair, but it would benefit the majority of workers who pay into a pension scheme whilst higher rate taxpayers would take a considerable hit.
Finally, it’s worth pondering that although auto-enrolment has helped get more people saving for the future, it’s far from being the pension panacea. Most employees and companies are paying the minimum allowable contributions, which will inevitably result in a funding gap on retirement for anyone who doesn’t have other savings.
This risk needs to be clearly communicated. It could even be argued that auto-enrolment has actually reduced the amount that companies put into pensions — as everyone races to the minimum and away from more substantial contributions and greater retirement security.
Pitfalls and ways to avoid them at a glance
- Flexi-access drawdown in 2017-2018 This option entitles individuals over 55 to draw a pension whilst still working, but limits their pension addition to £4,000pa total for this tax period
- Tapered annual allowance in 2017-2018 Catching a lot more people overall and requiring higher earners to factor a lot more calculations, this rule limits the standard annual pension contribution to £40,000 and tapers the allowance for higher earners
- Inform employees that they may be able to maintain the full allowance by reviewing contribution levels and transferring other income sources to a spouse
- Provide alternative benefits, such as a cash substitute
- Carry forward unused pension allowances from the last three tax years
- Make sure employees know that pensions currently sit outside of their estate, so money within their annual allowance can be gifted to spouses, civil partners or children
1. HM Revenue and Customs, ‘Personal Pensions Statistics — PEN 6: Cost of Registered Pension Scheme Tax Relief’, September 2018