Form

55187

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056129

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A4

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5pp

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Spot Red & Black

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NOV 15

Operator Info 1

KP

18.11.15

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FINANCIAL PLANNING UPDATE

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THE TAPERED ANNUAL ALLOWANCE & AUTOMATIC ENROLMENT

CREATIVE SERVICES CHECKLIS

ON A PERIODIC BASIS WE AIM TO PROVIDE YOU WITH AN OVERVIEW OF RECENT INDUSTRY TECHNICAL DEVELOPMENTS, LEGISLATIVE CHANGES OR PROVIDE A REFRESH ON TOPICAL ASPECTS OF PENSIONS AND/OR TAX ISSUES. WE WILL ALSO USE THIS MEDIUM TO UPDATE YOU ON RECENT ADDITIONS TO OUR TECHNICAL LIBRARY.

If there is a particular topic you would like covered in future updates, please email thomas.coughlan@scottishwidows. co.uk. This month we will look at the interaction between the minimum pension contributions imposed by automatic enrolment legislation and the maximum tax-relievable contributions that the forthcoming tapered annual allowance rules will allow, and what action can be taken to ensure that compliance with one set of rules does not cause an unintended breach of the other.

THE AUTOMATIC ENROLMENT STATUTORY MINIMUM To comply with automatic enrolment legislation, an employer must ensure that certain employees benefit from pension contributions of at least a fixed percentage of their qualifying earnings. The percentage is currently 2% with at least 1% paid by the employer, but will rise to 8% with at least 3% paid by the employer by 2018 when the current ‘phasing in’ period ends. Qualifying earnings are broadly total earnings but only those between £5,824 and £42,385 (2015/2016 tax year rates) are pensionable. This is the statutory default, but many employers will use a different definition of pensionable pay for convenience and can certify that the scheme meets the minimum contributions under one of three permitted ‘sets’ as detailed in the table below. The bracketed figure shows what part of the minimum contribution must be met by the employer.

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Before 1 Oct 2017

1 Oct 2017 – 30 Sept 2018

On or after 1 Oct 2018

Set 1

3% (2%)

6% (3%)

9% (4%)

Set 2

2% (1%)

5% (2%)

8% (3%)

Set 3

2% (1%)

5% (2%)

7% (3%)

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Whilst these three certification options afford employers a degree of flexibility over pensionable pay, the outcome remains a minimum contribution of a percentage of some or all of a worker’s earnings.

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The actual contribution due under the scheme will be determined by the employer, they do not have use the statutory minimums. For example, an employer may provide an automatic enrolment scheme that enrols eligible jobholders (UK workers, aged 22 and over who earn at least £10,000) into the scheme with an employer-only contribution of 10% of basic pay.

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THE TAPERED ANNUAL ALLOWANCE

THE SOLUTIONS

In potential conflict with the minimum contributions imposed by automatic enrolment is the tapered annual allowance for high earners from 6 April 2016. These new rules will introduce a restriction in the annual allowance for those with income greater than £150,000. Above this threshold a 2:1 reduction in the annual allowance applies: the tapering halted when the allowance falls to £10,000, which is achieved at income levels of £210,000 and above. The technical details are covered in my July Techtalk article: Fading Away – The Tapered Annual Allowance.

There isn’t a single solution to this problem, because of the many factors at play. Nor are the options limited to those discussed below. The best outcome for each individual should be arrived at by careful consideration of their circumstances, involving discussion with the client, the employer and their financial adviser. A broad-brush approach will not work.

A consequence of these two separate pieces of legislation coming together is that complying with the minimum contribution under automatic enrolment could result in a worker exceeding their tapered annual allowance and suffering a tax charge. There are a number of scenarios where this could occur: Example 1 Alena has salary and investment income totalling £220,000 in 2016/2017. £120,000 of this is salary. She is a member of her employer’s qualifying scheme on a set 1 basis, which she joined by contractual enrolment. The contribution basis for the scheme is 10% of basic pay, which is met entirely by the employer. She has no other pension provision in the year. Alena’s annual contribution is £12,000 (10% x £120,000). She has no carry forward allowance available. Her employer has met the minimum auto-enrolment contribution on a set 1 basis, however in doing so has created a £2,000 annual allowance excess. This results in Alena being subjected to a £900 annual allowance tax charge (45% x £2,000) in 2016/2017.

Example 2 Bernard has total income from employment of £300,000 in 2016/2017. He was automatically enrolled in 2012 into a scheme certified under set 3 and in 2016/2017 benefits from employer contributions of 5% of total earnings. Bernard’s annual contribution is £15,000 (5% x £300,000). He has no carry forward allowance available. Again, his employer has met the minimum autoenrolment contribution, this time on a set 3 basis, however in doing so has created a £5,000 annual allowance excess. This will result in Bernard being subjected to a £2,250 annual allowance tax charge (45% x £5,000) in 2016/2017. Clearly, for certain high-earning individuals, a tax-issue can arise. What options are available to those caught in this way?

Perhaps the most important factor is that it is the employee that suffers any annual allowance charge, not the employer, so any decision about pension provision following consideration of this issue should be motivated towards an improved net outcome for them. Another key consideration is the existing contractual entitlements of the affected employee. This could be to a certain level of pension contribution which the employer is obliged to honour - precluding any action that simply reduces the entitlement without offering a replacement benefit. It also can’t be assumed that the employee wants to avoid the annual allowance charge at all costs, as an employer pension contribution less an annual allowance charge will in most cases provide a higher net benefit than no contribution. Keeping these factors in mind, some of the potential solutions are as follows: 1. Utilise carry forward. The amount of unused annual

allowance that can be carried forward from 2013/2014, 2014/2015 and 2015/2016 is unaffected by the tapered annual allowance. Carry forward from a year in which the annual allowance is tapered to a later year will be restricted in relation to the client’s income in that year. Whether restricted or otherwise, carry forward will continue to be available. Clients that have sufficient carry forward available to cover any excess over their tapered annual allowance caused by pension contributions to a qualifying / automatic enrolment scheme will not need to take immediate action. What they should do is check how much carry forward is available and for how long this will cover the likely excesses above the tapered annual allowance. 2. Pay the annual allowance charge. Where sufficient carry

forward is not available or has since been exhausted, affected workers will have a decision to make. This decision may be to do nothing. Whereas the automatic enrolment minimums are enforced by law, the annual allowance is not an absolute limit. Pension scheme members can exceed the annual allowance – many do, particularly defined benefit members – but must pay the resulting annual allowance charge. If the member is happy to pay the annual allowance charge, because the overall benefit is better than if contributions are reduced below their annual allowance, then the simplest solution of taking no action may be the most appropriate. Clients who decide to simply pay the annual allowance charge should be made aware that the excess (that isn’t covered by carry forward) will need to be declared on their self-assessment tax return.

3. Reduce contributions and offer an alternative. Those

who are in a position to negotiate their remuneration package could have a discussion with their employer to consider exchanging part of the pension contribution for some other benefit, such as increased salary, a bonus or perhaps a non-cash benefit such as a company car. If this has the effect of reducing the pension contributions below the automatic enrolment minimum for the scheme, it would become non-qualifying for that member. In this instance, switching from a certification basis to an entitlement check – where the employer checks that the monetary amount of contributions is at least equal to the minimum required for schemes that calculate contributions on a qualifying earnings basis – may ensure that there is no breach for that member. The highest minimum contribution on a qualifying earnings basis is £2,925: 8% x (£42,385 - £5,824), which is well below the minimum tapered annual allowance of £10,000. An entitlement check is specific for each member. If there are a large number of workers in this position, then instead of many individual entitlement checks, the employer could segment the group and certify a section of the scheme as receiving contributions that are at least as good as those calculated on the qualifying earnings basis. This is informally referred to as ‘set 4’. 4. Switch to Qualifying Earnings. If a worker affected by

the annual allowance is happy to have their contributions reduced - because they would rather avoid the annual allowance charge or because some other benefit has been negotiated - removing the client or clients from the certificate and calculating their contributions on qualifying earnings could help to solve the problem. This is a similar approach to that covered in 3) above - the highest minimum contribution being £2,925, which in itself will not lead to an annual allowance excess. Switching to a QE basis would in most cases reduce the scope for AE minimum contributions causing an annual allowance charge, but it has to be remembered that all contributions and accrual are aggregated for the annual allowance test, so contributions on a QE basis could still contribute to an excess tax charge.

Example 3 Continuing with Example 1, Alena asks her employer and financial adviser what her options are. She is advised that her income is sufficiently high to reduce her annual allowance down to £10,000 and that her lack of carry forward means that continuing the current level of contributions will lead to a £900 tax charge in 2016/2017. Her IFA suggests that the employer reduce the annual contributions from £12,000 to £10,000 per annum and offer a replacement benefit of £2,000 (e.g. bonus). The scheme in question will now no longer be qualifying for Alena. The employer can deal with this by noting Alena’s position on the certificate and carrying out an entitlement check to ensure that the monetary amount of Alena’s contributions are at least equal to those she would receive if her contributions were calculated on a qualifying earnings basis.

When the tapered annual allowance is introduced from 6 April 2016, it will result in a small proportion of earners being caught by this tax trap. Those that are will be high earners and probably not the intended beneficiaries of the automatic enrolment reforms. The rules, however, don’t exempt such individuals, so employers should highlight those with high levels of contributions to an automatic enrolment or qualifying scheme and discuss the options available. As mentioned, financial advice is crucial because of the complexity of the issues involved. And as the potential tax liability at stake is the individual’s, the final decision on any action should be theirs based on their discussion with their own adviser.

FINANCIAL PLANNING’S PENSION TECHNICAL LIBRARY AT A GLANCE

ADVISER EXTRANET CORPORATE PENSIONS

INDIVIDUAL PENSIONS TECHNICAL MASTERCLASSES & PODCASTS • Lifetime Allowance Protection http://www.scottishwidows.co.uk/extranet/business/ adviser-online-hub/webinars • Pension Death Benefits – Estate Planning With Your Pension • Fading Away – Tapered Annual Allowance And Pension Input Periods http://www.scottishwidows.co.uk/extranet/business/ adviser-online-hub • Summer Budget - 8 July 2015 http://www.scottishwidows.co.uk/extranet/business/ adviser-online-hub/SWinsights-masterclass

CORPORATE PLANNING SUPPORT MATERIAL

RETIREMENT PLANNING SUPPORT MATERIAL

• Fact sheets

• Essentials & FAQs

• Presentations

• Technical Guidance

• Articles

• Case Studies

• Thresholds

• Presentation

• FAQs http://www.scottishwidows.co.uk/adviserautomaticenrolment

• Quarterly Updates http://www.scottishwidows.co.uk/extranet/financialplanning/pension-planning/retirement-income-planning

CORPORATE PLANNING TECHTALK ARTICLES http://www.scottishwidows.co.uk/extranet/literature/ category/215

PENSION ACCUMULATION TECHTALK ARTICLES http://www.scottishwidows.co.uk/Extranet/Literature/ Category/627 PENSION DECUMULATION TECHTALK ARTICLES http://www.scottishwidows.co.uk/Extranet/Literature/ Category/628 PENSION FAQs

http://www.scottishwidows.co.uk/extranet/financial-planning/techtalk/frequently-asked-qandas TOPICAL NEWS Lifetime Allowance Protection 2016 – 5 November For the latest developments please see: http://www.scottishwidows.co.uk/extranet/financial-planning/techtalk/news BUDGET ANALYSIS http://www.scottishwidows.co.uk/extranet/financial-planning/budget TAX CARD http://www.scottishwidows.co.uk/Extranet/Literature/Category/219

FINANCIAL PLANNING’S PENSION TECHNICAL LIBRARY AT A GLANCE

EMPLOYER HUB EMPLOYER CORPORATE PLANNING SUPPORT • Quarterly Legislative Updates • Budget & Autumn Statement Analysis • Tax Card http://www.scottishwidows.co.uk/corporate/employers_and_trustees/index.html EMPLOYER AUTOMATIC ENROLMENT FACTSHEETS http://www.scottishwidows.co.uk/corporate/employers_and_trustees/eh_business_factsheets.html EMPLOYER TECHTALK ARTICLES Workplace pension schemes and employer consultations http://reference.scottishwidows.co.uk/docs/15964a.pdf Pension freedoms: educating employees http://reference.scottishwidows.co.uk/docs/15964b.pdf Age discrimination, retirement and pensions: changing patterns at work? http://reference.scottishwidows.co.uk/docs/15964c.pdf Automatic enrolment: scheme certification http://reference.scottishwidows.co.uk/docs/15964d.pdf TUPE, pensions and automatic enrolment: understanding the interactions http://reference.scottishwidows.co.uk/docs/15964e.pdf

Every care has been taken to ensure that this information is correct and in accordance with our understanding of the law and HM Revenue & Customs practice, which may change. However, independent confirmation should be obtained before acting or refraining from acting in reliance upon the information given.

Scottish Widows plc. Registered in Scotland No. 199549. Registered Office in the United Kingdom at 69 Morrison Street, Edinburgh EH3 8YF. Telephone: 0131 655 6000. Authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority. Financial Services Register number 191517. 55187 11/15