Our work at Employee Benefits Collective involves helping HR and payroll professionals understand pension rules and regulations. It also involves getting employees engaged with their workplace pension. This isn’t always easy, even though modern workplace defined contribution (DC) schemes are, by and large, simpler and more accessible than pensions have ever been.
Understandably, one deterrent for many employees in the complexity of pensions legislation. Layer upon layer of legislation has been enacted because successive governments — governments of every stripe and hue — are ambivalent about pensions. On the one hand, it is vitally important to encourage people to save into their pension so that they can enjoy a comfortable retirement without expecting too much from the state. On the other, the wealth saved in personal pensions (£6.1 trillion in 2016, according to the ONS) represents a colossal cash cow, a source of potentially huge tax revenue. So, there are two opposing forces here. Pensions must be attractive, tax-efficient savings vehicles; but tax breaks must be modulated so that a limited amount is given away.
Lifetime allowance (LTA)
The LTA is effectively a limit on the total value of an individual’s pension savings.
For various reasons, including auto-enrolment and a decade of unprecedented market growth, an increasingly large minority of employees need to be aware of the LTA. In the 2010/11 and 2011/12 tax years, it hit an all-time high of £1,800,000: an irresistibly huge cash cow to the coalition government. The LTA then diminished in substantial increments to £1,000,000 in the 2016/17 and 2017/18 tax years. In 2018/19 it was linked to the Consumer Prices Index (CPI) and has since risen by relatively small, variable amounts each year. It currently stands at £1,073,100.
No wonder people are confused.
The substantial reductions in the LTA led to HMRC offering a series of protections to people, to allow them to maintain tax advantages on pension values higher than the diminishing maximum. Two forms of protection still exist: Fixed Protection 2016 and Individual Protection 2016. Details of them can be found on the government’s website: www.gov.uk/guidance/pension-schemes-protect-your-lifetime-allowance. You need to apply to HMRC to obtain protection.
Very importantly, protections are revoked if you continue making contributions into a DC pension.
Benefit crystallisation events
In simple terms, whenever you withdraw a lump sum from a pension, or convert pension savings to a form from which income is, or can be, taken, a ‘benefit crystallisation event’ (BCE) occurs, and the money is tested against your LTA.
If the BCE means that you exceed the LTA, a tax charge of 55% is normally applied to the excess money if it is taken as a lump sum. If it is taken as income, 25% tax is payable on top of income tax.
If you phase your retirement and/or have more than one pension, multiple BCEs will take place.
Employees and the LTA: what to do
Employees should be keeping an eye on the value of their pension — or more likely pensions, plural. With modern workplace schemes, this is easy. You go onto the pension provider’s website and register. Not only will this enable you to track contributions and monitor the value of your investments, it will allow you to access a range of educational resources and projection tools. Alternatively, you can download the app that most modern providers have now launched. This lets you check your pension details as easily as you can check your bank account balance and transactions.
If your pension savings are getting near the LTA, you should be sure to let your employer know.
These are areas we invariably cover in presentations to and 1:1s with employees.
Employers and the LTA: what to do
Employers should always ask new employees, especially high earners, if they have LTA protection in place. If they do, they are exempt from normal AE procedures. It is essential that no pension contributions are made so that the protection isn’t lost.
In order to treat employees fairly, many employers we work with have a 90% rule in place as regards the LTA. That is to say, if employees’ pension savings reach a value of around £900,000 and they can prove it, the employer will offer to discontinue making pension contributions and pay their equivalent as an addition to salary instead. Using the term loosely, this requires the employee to opt out — to make his or her policy paid up. The main reason employers ask for proof of the value of pension savings is to avoid any charge of seeming to advocate opting out, which is a breach of regulations.
If contributions are converted into a component of salary in this way, they will be subject to income tax and National Insurance. There is no getting away from the fact that income tax will be payable one way or another, and indeed some employees decide against the salary increase. They would rather keep contributing and take a hit when they crystallise benefits.
How EBC can help
It seems that whenever a new stratum of pension legislation is created, conflicts with previous strata occur. AE regulations can be at odds with the LTA. (Similarly, tensions between AE contribution minima and the pension annual allowance have arisen, but that’s another blog.)
Our view, generally speaking, is that personal prerogatives should override scheme-level rules when they have the effect of penalising people — but this is often difficult territory for employers to navigate. If you are an employer and would like our assistance in operating your workplace scheme efficiently and fairly, please feel free to get in touch.