Helping your employees with the pensions trap tax
At a glance
The ‘pensions tax trap’ has received a lot of press recently for its effect on the NHS, but the problem affects many employers.
There are two key limits which, if breached, can trigger a tax charge:
- The Annual Allowance – the amount you can
save each year; and
- The Lifetime Allowance – the amount you can
The standard Annual Allowance is £40,000 a year, but reduces to as little as £10,000 depending on total taxable income.
Taxable income includes things such as overtime pay and rental income, so employees may have a lower Annual Allowance than their basic salary indicates.
In the NHS this put higher earning staff in a difficult position where working overtime could create a tax charge with no increase in their pension.
What are employers doing?
Our survey showed that among employers that offer an alternative to high earners, the most common option was reduced DB benefits, similar to the proposed NHS solution.
What causes the pensions tax trap?
The graph below shows how the Annual Allowance reduces based on taxable income. Other forms of income (e.g. overtime) can push earnings over thresholds, reducing allowances.
Actions employers can take
While the government is looking at options for the NHS, there are are actions employers can take now to help affected members.
1. Offer other pension options for high earners, such as those outlined on the next page.
2. Allow members access to a comprehensive ‘scheme pays’ option to allow their tax bills to be paid through their pension scheme.
3. Provide support to members to help them understand their options before problems arise. This could be through written communications, seminars or guidance sessions.
Alternative pension options for higher earners
Alternative pensions options were often previously offered only to the highest level employees. Since the tax limits have reduced over time, more employees are now affected and alternative options can be explored for them.
Liabilities are likely to have increased significantly compared to the previous year end due to recent large falls in corporate bond yields.
Investments should have increased significantly too, with increases in the equity market as well as in bonds.
Overall, companies reporting at 30 September with well-hedged pension schemes are likely to see an improvement in balance sheet positions. However, for schemes that are not well hedged, the overall balance sheet is likely to have deteriorated as increases in liabilities exceed the increases in assets.
For more information see here