The Revised Annual Allowance has received a cautious welcome from the industry in a KPMG survey. But communication with affected employees is crucial says KPMG pensions partner David Fairs
As readers will be well aware, the Treasury has published its response to consultation on reducing the annual allowance. It has concluded that this would be a more effective and less complex way of achieving their primary objective of raising £4bn of revenue than the previous government’s proposals.
To the Treasury’s credit, its document received a generally warm welcome. In an online survey of employers conducted by KPMG the day after the proposals were announced, 46% of respondents said the proposals were better than they had expected.
However, there are clearly some compromises compared to what some lobbied for, and the implementation timetable will create headaches for many employers.
Firstly, the good news. An annual allowance of £50,000 pre annum and a flat factor of 16 for valuing defined benefit pensions were much better than had been feared.
With defined contribution arrangements now commonplace and good arrangements providing perhaps 15% of salary as combined employee and employer contributions, an annual allowance of £50,000 is only likely to have an impact on those with earnings comfortably in excess of £300,000. Even a very generous contribution of 20% of salary is only likely to affect those with earnings over £250,000.
Where individuals are affected it seems relatively straightforward to allow any contributions in excess of £50,000 to be taken as salary.
However, care needs to be taken on how this works for schemes with matching contributions as it can lead to some perverse outcomes. Consider a pension scheme that offers a one for one match and the employer agrees to pay any pension contributions over the annual allowance as a salary supplement.
One employee might make a contribution of £25,000 and receive a matching employer contribution of £25,000, taking him to the annual allowance. However, if another paid £30,000 and received a matching employer contribution of £30,000, the employer would pay a salary supplement of £10,000. In effect, this employee would be paying £20,000 for a £30,000 employer contribution while his colleague paid £25,000 for a £25,000 employer contribution.
In the online survey, 17% said they would make a salary supplement available. Perhaps not surprisingly, given the timing of the survey 42% were not sure what their policy would be and 32% thought there would be no change to their pension arrangements.
The £50,000 annual allowance is likely to be more of an issue for defined benefit schemes. However, the Treasury did announce a three-year carry forward of unused relief against a notional annual allowance of £50,000 for the previous three years which will mitigate the impact of the reduced annual allowance for moderate earners.
The announcement at the same time as a reduction in lifetime allowance to £1.5m came as a surprise for some. Its effect however seems to have been to allow the government to raise the annual allowance to a level where it was highly unlikely to hit those on moderate incomes.
But it leaves a difficult decision for those with large pension savings. Do they accept a reduced lifetime allowance of £1.5m, or opt to retain a fixed £1.8m allowance but give up future pension provision? This is a more challenging decision that many will require help with.
Not surprising then that the survey indicated that 25% of respondents would provide a significant level of communication for employees, and 55% would make some available; perhaps because 46% of employers thought more than ten of their employees would be affected by the changes, and 27% thought more than 50 would feel the impact.
Of course the big challenge for employees and employers will be getting to grips with pension input periods, which probably deserves an article in its own right!
