A raft of UK firms are rushing to set up arrangements that allow wealthy staff to "bust" the new lifetime pension allowance without paying punitive tax. They are offering high earners pension top-ups that don't count towards the allowance, which the government is slashing from £1.5m to £1.25m in April this year.
Around 120,000 workers on medium to high wages will be hit by the new ceiling, according to HM Revenue & Customs (HMRC). They will be forced to stop pension saving and apply for protection, or pay a 55 per cent tax bill on pension money that exceeds the threshold.
The top-ups are being designed to directly replace the retirement income savers could have accrued by paying into 'gold-plated' defined benefit schemes. They provide the same guaranteed, index-linked pensions.
But because the government wants to reduce the overall cost of pensions for taxpayers, these top-ups, formally known as Unfunded Employer-Financed Retirement Benefit Schemes (unfunded EFRBS), are being "closely monitored" by HMRC.
In the past, such benefits have only been enjoyed by directors of large listed companies, but lawyers, actuaries and accountants have all told Investors Chronicle that because the lifetime allowance is about to become "so restrictive", a surge of large, small, and medium firms, have had to take alternative measures to ensure high earners are given a level of comfort in retirement that meets their expectations.
In the past around one in ten large listed firms have used unfunded pensions to remunerate staff, according to Mike Smedley, partner at KMPG. But one lawyer we spoke to said he'd set up new arrangements for five FTSE 100 schemes just in the last few weeks.
| FTSE 100 FIRMS USING UNFUNDED PENSION ARANGEMENTS TO PAY DIRECTORS •BP (Shell promised to pay its former CEO, Peter Voser, a total of 9,287,315 Swiss Francs (£6.3 million) through an unfunded pension arrangement, according to its 2012 annual accounts.) |
Rajesh Jiwani, an accountant at Charterhouse Accountancy, said: "Middle and high earners expect a pension of two-thirds of salary, but from April, even small, privately owned firms won't be able to use traditional pensions to provide that level of income.
"It's tempting for workers in this position to take early retirement, which is why a growing number of employers are incentivising them to stay on by promising them these pension top-ups for the rest of their life."
Someone with a final salary pension could accrue benefits worth around £62,500 a year before hitting the £1.25m lifetime allowance, although experts say you should opt to take protection well before your guaranteed income reaches this level.
Are these so-called EFRBS too good to be true?
Unfunded pension top-ups could dramatically improve your wealth in retirement, but before you snap them up, you should know there are some major catches.
Experts say HMRC is "relatively relaxed" about unfunded EFRBS, but none of them are sure whether it will end up taking a dim view of them and taking preventative measures.
We do know that HMRC is watching these schemes closely, though, to check that a) they don't make the UK pensions system significantly more expensive for taxpayers, and b) that they don't break disclosure of tax avoidance scheme rules.
A spokesperson told the IC: "The disclosure of tax avoidance schemes provides us with early information about these tax arrangements. EFRBS [pension schemes] were specifically mentioned in the January 2014 guidance and EFRBS exhibiting those hallmarks are disclosable.
"The Government wants to create a more affordable pensions tax regime through restricting the tax reliefs for pension savings. We are closely monitoring the use of unfunded EFRBS to ensure they are not at odds with this goal. The new employment income hallmark is an important tool supporting this work."
But Colin Woreby, managing director at Heritage Pensions, says it's sometimes impossible for HMRC to tell if a company is using an unfunded pension scheme from its annual accounts.
However, he added that firms with schemes in place can use them to conceal "a number of things", including chunks of company profits on annual reports.
Another consideration for anyone presented with the opportunity to join an unfunded pension scheme is the fact that there are no guarantees that you will ever see the money you've been promised if your employer goes bust.
Ros Altmann, independent pension consultant, says the safest choice is accepting cash from your employer.
"Of course, they can be very generous and let you get round the cap, but they are not secure. Because the benefits are unfunded, if your employer goes bust, your benefits aren't protected."
A better alternative to continuing with pension saving and paying punitive tax might be to ask for in lieu of pension payments instead, and invest the money in an Isa or a normal account for your retirement.
Unfunded pension top-up schemes explained Pension top-up arrangements are offered by employers as an individual trust arrangement between employee and employer, where the employer acts as the trustee. Paying into one does not affect your fixed or enhanced pension protection on the lifetime limit. They were originally called Unfunded Unapproved Retirement Benefits Schemes (UURBS), but they are also known as 'EFRBS' - Employer-Financed Retirement Benefit Schemes. However, they are not to be confused with funded EFRBS, the tax-efficient trusts companies used to reward employees for years before the government introduced new legislation to prevent them from "leaking tax" in 2011. The key difference that sets unfunded EFRBS apart from funded EFRBS, is that no funds are put aside to provide the benefits. This means neither the employee nor the employer pays any contributions to the scheme. It's essentially just a promise of a future payment. It means you don't get any tax relief by being a member, but you can avoid paying tax on any contribution by your employer, and your employer can only get tax relief once the pension starts being paid. If you choose to take the benefits after you reach state pension age, you don't have to pay national insurance (12 per cent) on the money - an incentive not to retire until age 65. You can choose to swap the pension for a lump sum, but there is no option to take a 25 per cent tax free lump sum, unlike a regular pension that comes with that option. And if your employer goes bust there is no actual guarantee that the pension will be paid. |
