Higher earners have a bigger problem than you might imagine

According to recent research by Employee Benefits, nearly half of employers do not offer any alternative to a pension for higher earners restricted by the annual allowance, and a third just pay cash as an alternative.

Facing restrictions on how much you can pay into a pension because you earn too much may sound like a nice problem to have, but the reality for those impacted could be a pretty hard landing when they come to retire.

What compounds the issue is that there is seemingly little planning around the issue from both employees and employers alike. The apparent complexity seems to discourage both from looking for solutions that might be a win-win for both the employee and the sponsoring employer.

Take for example a senior employee, aged 45 with total remuneration of £300,000, who’s already built up a healthy pension of £400,000. If prior to the introduction of the Tapered Annual Allowance, they were putting in their full £40,000 allowance, but they now find they’re restricted to just £10,000 per year, the result could equate to a halving of their eventual retirement income if they make no alternative provision.

To find out more about the Tapered Annual Allowance, see our factsheet here:

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There is no doubt that many affected employees have continued to blindly save into pensions oblivious of the financial penalties, though that may change as they exhaust any available ‘carry forward’ and brown envelopes from HMRC shock them into action. Their consternation at such a hefty tax bill (potentially up to £16,200) will inevitably be aimed at their employer; and more specifically, those in HR and Reward.

The Tapered Annual Allowance is a complex, but very effective piece of legislation that limits tax relief on higher earners, but it also creates challenges for employers. Bonuses paid late in the tax year (February and March) may not give enough time for affected employees to plan and besides the so-called ‘taper-tantrums’, it dampens the effectiveness of your pension scheme, turning something that was a benefit, into a source of annoyance. It can drive pension engagement down among the senior team which can trickle through to other employees despite them not being affected.

While some employers have consciously cited this as a change to personal taxation and have chosen to make no alternative arrangements, others are keen to offer flexibility. However, that often translates to the most administratively easy route out – cash in lieu of pension. This might sound like a solution, but the reality is that few individuals might use that cash for what it was designed - long-term savings. Rather they may treat it like cash and spend it like cash, leaving the retirement pot short.

One solution that will ensure that long-term saving is maintained is to divert the cash in lieu via payroll, into an ISA or general investment account that sits alongside the pension. While these contributions don’t attract tax relief, they do ensure that the employee continues to invest for the long-term, and they can manage the account in the same way as their pension. Employers could also assist those affected with webinars or individual meetings with a pension specialist. As the sponsoring employer, you can be confident that you are supporting your senior staff and comfortable that your pension spend is being used in the manner it was designed.

Remember tax rules can change and the value of any benefits depend on individual circumstances.

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