Pensions tax shift will see FDs feel the pinch

Finance directors face a cash crunch whichever government is in power but, instead of National Insurance being the big issue, as it has been in the election campaign so far, it will instead be pensions that causes the greatest headache.

A Labour government will restrict income tax relief on pension contributions for people earning between £150,000 and £180,000, taper­ing it from a rate of 50% to 20%.

But key for FDs will be a much-maligned part of new pensions legislation. Employ­ees will be able to have their pensions tax bill paid by their company in exchange for a reduced benefit when they draw their pension.

Com­panies will have to stump up the tax far in advance of when they will receive the benefits of reduced pension responsibilities. “The scheme will be forced to pay the tax for the individual,” said Eleanor Dowling, Retirement Resource group principal at pension advisory experts Mercer.

And as if that wasn't enough for FDs to deal with, the situation will be compounded by the Baby Boomer generation beginning to draw their pensions from 2011, just as the restrictions to pension reliefs kick in, putting even more pressure on making payments into pension funds.

FDs can also look forward to a reporting headache because the government wants to align the start of a company’s pension year with the tax year.

Businesses prefer to run their pensions year alongside accounting periods when new salary and earnings data is available.

But advisers say there will be an added workload and cost for obtaining and proc­essing the information to calculate the benefit accrued over the tax year. “It’s a complete mess,” Dowling added.

The CIoT has slated the compliance costs for businesses, which will have to shoulder the added burden just when the economic recovery is supposed to be fully under way next year.

Colin Ben-Nathan, chair­man of the CIoT’s Employment Taxes Sub-Committee, said: “Even the government’s own figures indicate that the compliance cost on business will be in the region of £1bn in the scheme’s first year alone.”

The Conservatives do not agree with Labour’s policy – but have stopped short of reversing it. The Liberal Democrats proposed an even more drastic change by capping all reliefs to the basic rate. This would mean all taxpayers only receiving relief at a basic rate of 20%.

A larger base of workers impacted by the relief restrictions could force even more of them to ask their employer to foot the tax bill up front.

“We’re sitting on a pensions’ timebomb,” said Mike Warburton, tax partner at Grant Thornton. “For the next 30 years this problem will just get worse as these people cash in their pensions on an increasing basis.”

In a briefing note, HMRC insisted the government's changes do not affect the vast majority of ­individuals. “They affect only those who have a total annual income of £150,000 or higher in the current tax year or in either of the preceding two tax years.”

NIC tricks

While Labour and the Lib Dems line up pensions changes, the Tories have focused on National Insurance instead, trumpeting the fact that staff would be better off by £150 in some cases.

But advisers have stripped out the Tories figures to show how employers and employees still lose out.

Smith & Williamson worked out that under Tory proposals employers make the biggest saving – £140 – at a threshold of £6,807. From there it tapers down to zero until £20,785, at which point NIC increases by 1%.

Employees making £43,875 will be worse off by £231, according to the firm. Those paid above this threshold will lose £231, plus 11% made above this level.

“These are the figures they didn’t want you to see,” said David Hewison, employment taxes director at the firm.

in our view

In additon to the extra costs being shouldered by the FDs, the legislation changes have been described as “clumsy” and “disappointing”. The government needs to consult again with stakeholders including the accountancy institutes on this. There is also the public policy issue of
high earners turning their backs on employer-sponsored pension saving, resulting in the closure of high quality schemes for all employees.

Further reading

NAPF: Pension tax reform ten times more expensive than expected