As time rolls on and the date for the beginning of the possibly the biggest ever changes to our pensions system, I thought it was a good time to speak out to all you employers and employees out there who will be effected by this.

Make no mistake about it, employers are going to face additional cost and administration burdens under this new pension regime. However, the good news is that there is time to plan and prepare, but time is running out.

There are four basic steps that can help employers plan.

1. Find out when the staging date is

This will give employers a deadline for implementation and a point to work back from. The staging date will be based on how many workers an employer has or, if there are less than 50 workers, the last two characters of the employer’s ‘Pay As You Earn’ reference.

There are more than 40 staging dates spread over four years from 2012. Larger employers will go first, smaller employers last.

You can find out your corporate client’s staging date by using this handy staging date calculator from Scottish Life.

2. Find out the duties that are likely to apply

Every employer will have some duties to perform but the duties will be different depending on the types of worker they employ. As a rule of thumb, any worker over age 22 and under state pension age, and who earns more than around £7,500 a year, will be treated as an ‘eligible jobholder’.

These workers will need to be automatically enrolled into a pension scheme by their employer. As long as these workers stay in the pension scheme, the employer will have to pay contributions. Those workers who don’t fall within this category will still have to be offered a pension scheme by the employer, and in some cases the employer will have to pay into it.

3. Review pension provision

Employers who already offer some form of pension provision will need to make sure that their existing scheme meets a minimum standard. This generally means that there must be a minimum contribution rate, made up of both employer and employee contributions.

If the scheme isn’t up to scratch contributions will have to increase. Building up these contributions to the minimum standard slowly could be preferable to employers rather than waiting until the last minute and facing a high up-front bill.

Employers who don’t have a pension scheme will have to set one up sooner or later. Again, starting to do this as early as possible would help employers to build the scheme up at their own pace.

4. Consider the impact on the business

There is no doubt that automatic enrolment will have cost implications for every employer, large or small. Employers will need to consider how they will meet these costs.

• Can they simply absorb the costs, potentially reducing profits?

• Will the costs of their goods or services need to increase?

• Will staff remuneration structures have to change?

• Will HR processes and systems need to change?

• Will business plans need to be adjusted to reflect the increase in costs?

These are just some of the questions that finance directors and business owners will need to address. Planning ahead, well before the staging date, could help smooth any cost increases, avoiding last minute shocks.

It’s clear that employers will face a major challenge when their employer duties start. With the economic climate as it is, it is probably even more important to plan as early as possible. It won’t be easy but help is out there. If you wish to have a free initial consultation with us please just get in touch and we’ll be more than happy to have a chat about your situation.

The newly published seventh report on the state of retirement savings from Scottish Widows has just been released and it doesn’t make particularly pleasant reading. Whilst there does seem to be a slight increase in consumer understanding of pension provision, particularly in the public sector, the sad fact is that we are still a nation where around half the population still does not contribute adequately to a pension and around one-in-five is actually doing nothing at all.

Here are some of the main findings:-

• Only 51% are making enough provision for their retirement. This is up from 48% in 2010, but below the 54% in 2011.

• 20% are saving nothing in 2011, compared with 21% in 2010

• The gender gap between men and women has fallen to the lowest on record. 53% of men compared to 50% are preparing adequately.

• The age gap has widened, with 59% of over-50s preparing adequately for their retirement, compared with 47% of those between 30 and 50.

• The income group which currently appears to be preparing best for retirement is those earning between £30,000 and £50,000. It appears that high-income groups are not as focussed on retirement provision.

• London is the region currently preparing worst for retirement, while Wales and the West Midlands are best-placed this year.

Characteristics of different savings groups

• Most people who are saving adequately are typically, male, married and in the latter part of their career. They are also relatively modest earners. They are likely to expect a decent company pension but may also have significant savings of their own.

• Those who are somewhat under-saving (6-12% of income) are often younger than adequate savers. Generally they work in the private sector and have more than one pension arrangement.

• Those who are seriously under-saving (up to 6% of income) are largely mid-career and may well earn a relatively decent income. They may well have high levels of debt and are self-employed or work for a small company.

• Common characteristics from the non-savers include having relatively low income, being single or divorced and are likely to change job frequently.

These type of reports may well be packed full of statistics and mumbo jumbo, but I do think they perform a vital role in helping us understand how we can begin to implement change in a nation that appears to be largely indifferent to the concept of planning for a financially secure retirement.

The report goes onto look at the likely impact of automatic enrolment and NEST which will begin to get rolled out in October 2012. Support for automatic enrolment does appear quite strong with only 11% expected to opt out.

This is a subject I will be covering a lot in the coming months, primarily because it is such big news in the pension world. However if any employer or individual needs any more info at this stage please don’t hesitate to drop me a line.

  As promised here is an article on the changes to Unsecured Pensions( also known as drawdown).
 
 Summary of the proposed changes
 
 The age 75 rules on annuitisation, value protection lump sums, pension commencement lump sums (PCLS) and trivial commutation lump sums will be removed.
 
 The age 75 rules on contributions and Lifetime Allowance checks will remain.
 Pension funds will be able to remain in an Unsecured Pension (USP) indefinitely. This is referred to as “capped drawdown”.
 
 Alternatively Secured Pensions (ASPs) will cease to exist.
 
 The USP maximum withdrawal limit may be reviewed. The current limit of 120% of GAD rates is regarded as probably too high at older ages and may have to be less than 100% to avoid the risk of people exhausting their funds.
 
 A USP customer will be able to access additional flexibility through “flexible drawdown” provided they have met a minimum income requirement (MIR). This minimum income will need to be a secure pension income for life and escalate by the lower of 2.5% or inflation. The customer would then be able to withdraw up to 100% of the remainder of their fund. This will be taxed as income.
 
 The minimum income required is not set out in the consultation paper. However, it is expected to take account of not just current means-tested benefits, but also potential health costs and future expenditure needs.
 
 Lump sum death benefits will be taxed at 55% to counteract tax relief given – this includes value-protection payments. The only exception is for pension savings where no part has been used for an income when the saver dies before 75, where the fund will be tax free.
 
 Importantly, the Government has already announced on 22 June 2010 that in
 anticipation of the drawdown rules changing, clients may remain in USP until
 age 77 as an interim measure. At present any Pension Commencement Lump Sum
 (PCLS) must be taken by age 75.
 
 The main things that will cause concern to existing Drawdown customers is the extra 20% charge on lump sum benefits from the scheme. This will automatically change in April so it is vital that you review your situation. The changes to maximum income are not so straightforward because if you are in an existing contract and taking maximum income (120% GAD) then you can continue with this until your first review date which is normally 5 years after the contract was taken out. Again though it is probably wise that you do contact your adviser to discuss these changes.
 
 
 CONCLUSION
 
 As I have already alluded to it is vital that if you are in a drawdown contract that you regularly review your situation because it may not be the contract for you anymore. Decline in health for example means that you may want to purchase an impaired life annuity and the 10 year guarantees offered by annuities may be more appealing, given the 55% tax charge on death in USP. Your attitude to risk may also have changed as there is obviously an investment element to these contracts, so reviewing your options here is vital.
 
 If you require a review of your situation or if you are considering drawdown for the first time please just drop me an e-mail or give me a call on the free

Well probably not but there has been enough changes in the last few months to cause more than a few heated debates amongst the many interested parties. Pensions are headline news and trust me that is not going to change anytime soon!

Over the next week or two I’m going to be putting up a series of articles which will highlight stuff that could well be relevant to you. Changes such as the scrapping of the need to take annuity by age 75, the limits to how much you can put in a pension, proposed auto-enrolment, the big changes to drawdown contracts etc etc etc.

I’ll start tomorrow with the changes to drawdown and this effects those who are currently in an unsecured pension and those considering entering into drawdown.

Maybe not the new rock’n’roll but these changes are going to effect each and everyone of us. Until next time…

There was positive news on pensions today with the release of a document explaining new rules which will do away with the need for people who have defined contribution (aka money purchase) pension schemes to purchase an annuity by the age of 75. This proposed change is aimed to come into force in April 2011.

Effectively this will mean that those of you with defined contribution pension pots, such as Personal Pensions, will now be able to continue with income drawdown arrangements (where you draw on pension savings keeping the pot invested) for as long as they choose beyond the age of 75. The one drawback to these changes is that tax on unspent pension funds levied on death will be higher (at 55%) after age 75 than the rate (35%) that applies before the age of 75.

The changes will also mean greater flexibility for those people who have a secured income of at least £20,000 a year. Where people are in that position, and clearly will not ever fall on to the State for support, the flexibility of income drawdown that they have on additional pension pots is to be greatly extended.

This additional flexibility (drawdown or similar) will, of course, be of real use only to people with higher than average levels of pension saving. However I have to say that I don’t think that it is a bad idea to make it more attractive to people to make more provision for retirement. The indication from Whitehall seems to be that while the Government is working to make pensions more flexible ‘the more you save, the more flexibility you will get’.

The following is a link which explains the changes in greater detail for those of you who like a bit more meat on the bone.

http://www.hm-treasury.gov.uk/d/pensions_annuitisation.pdf

So, to conclude; the age-75 rule is being removed; all DC pension savers will have the right to income drawdown indefinitely; a new form of flexible drawdown is being introduced for people who already have a secured retirement income above a certain level.

This has to be a step in the right direction. As ever if you need more information just drop an e-mail or give me a call. Until next time…

Pension Tax Relief Changes Post 2011

Regulation & legislation focus

The Treasury and HMRC recently announced their future plans for the restriction of pension tax relief. In this article I provide a summary of the Government’s draft regulations. 

Annual Allowance and Tax Relief

The annual allowance determines what level of pension contribution can be paid by an individual for tax relief purposes. The changes specific to the annual allowance are as follows:

> Annual allowance will be reduced to £50,000 (from £255,000) for the tax year 2011-12. The Government plans to review the rules and consider options for indexation and apply to both Defined Benefit(DB) and Defined Contributions (DC) pensions. Tax relief will continue to be available at the individual’s highest marginal rate of tax.

> The annual allowance tax charge to recover any undeserved tax will be tailored according to the amount of tax relief the individual has received.

> A flat factor will continue to be used to value Defined Benefit pension accrual, although this will being increased to £16 for every £1 of additional pension (an increase from 10:1).

> Unused annual allowance for up to 3 years may be carried forward where pension contributions/savings for the current year exceed the annual allowance. This will include being able to carry forward from the tax years 2008/09,2009/10 and 2010/11 using an assumed annual allowance of £50,000 for each of those years.

> The new ‘carry forward’ facility will be available to members of both DB and DC schemes.

> The Government will consult on possible options, for those who see a very significant increase in pension savings in a year, for the annual allowance tax charge to be paid out of their pension entitlement rather than their current income. This could include the scheme paying the tax charge on the individual’s behalf(commonly known as ‘scheme pays’) or the liability being rolled forward and paid out of pension benefits once they are taken at retirement.

> Increases in deferred benefits under DB schemes will not be tested against the annual allowance.

> For active members of DB schemes, the previous year’s benefits will be re-valued with the aim of ensuring that only pension benefits arising from salary increases and additional years’ service are tested against the annual allowance (the rate of revaluation has not been confirmed).

> No annual allowance test will take place in the year of a member’s death or where serious ill-health benefits are paid.

> In addition, exemption may be given in certain circumstances where ordinary ill-health benefits are taken(details on how this additional exemption will operate will be published later in 2010).

> Measures will also be taken to include unreasonable increases in pensions in payment to the annual allowance assessment (further details are awaited). However, there will be no other exemptions from the annual allowance test – this means the current exemption for the tax year in which benefits are taken will no longer apply and there will be no exemption for redundancy situations.

Pension Input Periods

The pension input period determines the timescales for an individual’s annual allowance. The changes specific to the pension input period are as follows:

> The existing rules regarding setting:- Pension Input Periods will not change – i.e. pension schemes will generally continue to determine the period and it does not need to be aligned with the tax year. For money purchase arrangements, members will still continue to be able to determine their pension input periods.

> Transitional rules will be put in place for those schemes where the period started prior to 14 October 2010 and will end in the 2011/12 tax year, to reflect the reduced annual allowance for the period from 14 October 2010.

> Those whose pension input period starts on or after 14 October 2010 will be subject to the reduced annual allowance of £50,000 for the whole of the input period.

Lifetime Allowance (LTA)

The lifetime allowance is the maximum pension accrual that can be accumulated without additional tax charges ordinarily applying. The changes specific to the lifetime allowance are:

> It will be reduced from £1.8m to £1.5m, intended to be effective from April 2012.

> The valuation factor for DB accrual will remain at 20:1 (25:1 for pre A-Day benefits in payment).

> The LTA tax charges will remain unchanged – i.e. 55% where the excess is taken as a lump sum and 25% where it is taken as an income (with the income subject to tax at the individual’s own rate of tax).

> Maximum tax-free cash (pension commencement lump sum) will remain at 25% of the member’s available standard lifetime allowance.

> The link between the LTA and trivial commutation will be removed from April 2012 – instead of the limit being 1% of the LTA, it will instead remain at £18,000.

> Protection will be given to those who have ‘already made pension savings decisions based on the current level of the LTA’.

> Government will consult on the detail of the protection regime, but proposes that:

>Those with pension benefits in excess of £1.5m receive protection (subject to a cap on protection of £1.8m).

>>

Anti-Avoidance

The Government are keen that alternative pension arrangements are not used by higher earners to avoid paying tax where appropriate. In this regard legislation will be published,later in 2010, to ensure that Employer Benefits Trusts (EBTs) and Employer Financed Retirement Benefit Schemes (EFRBS) are ‘less attractive than other forms of remuneration.

In summary

In general these rules are more straightforward than the previous method of restricting tax relief, and the annual allowance is more generous than w perhaps thought it woud be. The reintroduction of ‘carry forward’ to pension legislation will please many but will help both DC and DB members to avoid tax charges when there is a spike in contributions/accrual.

>Individuals who currently have Enhanced Protection or Primary Protection (or both) should continue to benefit from that protection.

>It is not currently clear as to how protected tax-free cash will operate post 2011.

>Those with primary protection, and thus who have higher personal lifetime allowance will not lose out as a result of the reduction in the standard lifetime allowance.

>Some form of protection (referred to as ‘pension growth protection’) might be afforded to those who have planned on the basis of their pension fund growing to £1.8m (the current LTA) between now and retirement.

>‘Pension growth protection’ could take the form of a personalised LTA set at £1.8m, in exchange for no further pension savings being made.

If you’re concerned about how these changes might affect you please just get in touch by e-mail or phone and we will try and make sense of it all.

For further information consult the following:- HM Treasury press release – www.hm-treasury.gov.uk/press_52_10.htm

Pensions and Divorce

If you are currently going, or already have gone through a divorce and you and your ex-spouse are looking at dividing up your assets, then the Court will be required to take your pension rights into account.

The options that the court can offer are as follows:

• balance the pension rights against another asset, such as the matrimonial home (this is known as Pension Offsetting); or
• arrange that when one party’s pension eventually comes into payment, a portion of it will be paid to the other party (this is known as Pension Earmarking); or
• split the pension at the time of the divorce to give both parties their own pension pot for the future (this is known as Pension Sharing).

The first step after contacting a solicitor is generally finding out what both you and your former spouse’s pensions are approximately worth. This will mean contacting your pension providers for valuations of whatever pensions you may have. It should be noted that your former spouse will not have any right to know what your pension value is without your consent.

You should really attempt to understand what the implications of each of the three methods of taking pension rights into account in a divorce settlement.

 However one thing you should be aware of is that transferring from a final salary or career average scheme to a money purchase scheme (or personal pension plan) can carry a number of risks.  You should seriously consider taking independent financial advice before sharing a pension so that you understand whether you are likely to lose out financially.

The Court can issue a Court Order to the following types of pensions:-occupational pension schemes (funded and unfunded, approved or unapproved), personal pension schemes, retirement annuity contracts, and Section 32 Buy-out Plan.

The Court can consider pension plans that you and your former spouse are currently paying into, plans that have been frozen in the past and plans that are currently paying you an income.

Arrangements that are outside the scope of the processes covering pensions and divorce are state benefits, Equivalent Pension Benefits earned between 1961 and 1975, and any pension rights a person is in receipt of by virtue of being a widow, widower, or dependant.

Pension Offsetting

All the couple’s assets are taken into account and pension benefits are offset against other assets (e.g. the family home). The party with the pension rights keeps them for him/herself and the other party is given the benefit of other assets, such as the right to live in the matrimonial home or an equivalent lump sum.

Achieving a fair share of a couple’s total assets by offsetting a pension pot against other assets can often be a fraught process. This may be because pensions do fluctuate in value more often because they tend to invest in assets such as shares. If it turns out to be difficult to achieve offsetting, one or other of the alternative bases is then likely to be used.

Earmarking

Pension Earmarking was introduced by the 1995 Pensions Act, for divorce petitions filed on or after 1 July 1996 (or 19 August 1996 in Scotland).

The pension scheme, on instruction from the Court, pays a specified amount of the member’s pension and/or lump sum (in England, Wales and Northern Ireland) or a specified amount of the member’s lump sum only (in Scotland) to the ex-spouse. The amount is ascertained at the time of the divorce but as with all periodical payment orders, either party can apply to the Court to have the amount varied. The payment is made when the spouse with the pension pot decides to retire, say, or when they die.

Earmarking has not proved entirely satisfactory in practice. Mainly because it does not achieve a ‘clean break’ and does not enable the ex-spouse to receive retirement income until the spouse with the pension pot retires.  An additional drawback is that if the Divorce Order is for the regular payment of a pension, those payments will stop when the spouse with the pension pot dies or if the party receiving the earmarked pension remarries (for reference, the right to a lump sum under an Earmarking Divorce Order does not stop on remarriage).

Pension Sharing

The Welfare Reform & Pensions Act 1999 gave powers to the Court to split pension rights between husband and wife on divorce. This legislation is not retrospective and only applies to proceedings for divorce or annulment filed on or after 1 December 2000.

The basic concept is to separate the ex-spouse’s benefit entitlement (as specified in the Court Order) from the pension scheme member’s, so that there is a ‘clean break’. A Pension Sharing Order is issued that creates a Pension Credit Member (the ex-spouse) and a Pension Debit Member (the member).

The Pension Credit is based on the member’s Cash Equivalent Transfer Value (CETV). The Credit will be a percentage of the CETV, not a fixed sum of money. The CETV is calculated as of the day before the Pension Sharing Order takes effect, so it can be higher or lower than the value disclosed at the start of the divorce proceedings. The Pension Sharing Order takes effect from ‘the date on which the Decree Absolute of Divorce or nullity is pronounced or if later, either (a) 21 days from the date of this Order, unless an appeal has been lodged in time, in which case (b) the effective date of the Order determining that appeal’.

As you can see this is another area which is laden with pitfalls. If you are currently in this situation then please just get in touch and get some valuable advice.

Pension reform
There will be more pensioners in the future and those pensioners will live longer. This will put a massive strain on the State pension system.

To alleviate this burden, the Pensions Acts 2007 and 2008 make changes to the Basic State Pension, the State Second Pension and introduce new employer duties for pensions.

The employer duties
From October 2012, employers will be required by law to:

• automatically enrol all their eligible employees not already in a good quality pension scheme into a Qualifying Workplace Pension Scheme (QWPS) on the day the employee becomes eligible, and
• pay contributions for every employee who does not opt-out of the QWPS.

Timetable
The employer duties will be staged in over 4 years from 2012. Larger employers will have their duties imposed first, smaller employers last. Any employer with less than 50 employees will have their staging date set depending on the last two digits of their PAYE reference number.

The costs
The amount of contributions that must be paid in order for a scheme to be treated as a QWPS is being phased in as follows:

The contributions will be based on a percentage of band earnings between £5,035 and £33,540 (qualifying earnings) at 2006/2007 levels. These amounts will be increased in line with earnings to 2012 and beyond.

*  The minimum difference includes tax relief available on employee contributions.

Quality Qualifying Workplace Pension Scheme (QQWPS)
Employers can avoid much of the administration burden associated with automatic enrolment by setting up a QQWPS where:

• the total minimum contribution is 11% of qualifying earnings, of which
• at least 6% must come from the employer,
• there is no option to phase in contributions, and
• automatic enrolment dates can be postponed up to 90 days allowing a ‘sweep up’ of eligible employees all at once at the employer’s convenience.

Eligible employees
All employees will have to be auto-enrolled unless:

• they are already in a qualifying workplace pension scheme,
• they are under the age of 22,
• they are over the State Pension Age, or
• they earn less than £5,035 a year (in 2006/2007 terms).

Employees can only ‘opt-out’ once they have been auto-enrolled.

Non-eligible employees must be given the option of opting in to pension saving.

Auto-enrolment is the responsibility of the employer, not the Government or the pensions industry. The Pensions Regulator will oversee employer compliance and has the power to fine employers for non-compliance.

National Employment Savings Trust (NEST)
Employers who do not have, or who will not set up, their own QWPS will have the option of using NEST. This scheme is designed to be low cost and is specifically aimed at low to medium earners. There will be certain restrictions applying to NEST:

• there will be a general ban on transfers in or out,
• there will be an upper contribution limit (currently £3,600 each year),
• limited retirement options and
• limited investment options.

Remember these reforms are less than 3 years away so it is important to start addressing this issue by getting sound advice as soon as you can.

The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice. The information provided is based on our current understanding of the Pensions Acts 2007 and 2008.

General questions about salary exchange
With the proposed increase in National Insurance contributions currently causing a political storm I thought it would be a good time to revisit one of my favourite subjects in relation to pensions. That of salary exchange. An already attractive proposition has just become even more so.

These questions and answers cover some of the most common issues on salary exchange. If there’s a question that you have that isn’t covered here, you can check HMRCs Salary Sacrifice Guidance or Salary Sacrifice Q & As Alternatively, you can e-mail me with your question. I’ll do my best to find out the answer and may post it on this website

What is salary exchange?
In basic terms:

• an employee agrees to give up some salary or bonus
• the amount given up is used by the employer to provide a non-cash benefit to the employee
• because the employee is being paid less salary or bonus:
  • the employer makes National Insurance Contribution (NIC) savings
  • the employee pays less tax and NICs.

What type of pension plan can salary exchange be used with?
It can be used with any type of UK registered pension plan – i.e. individual or group personal pension/stakeholder or occupational money purchase/final salary schemes. The main point to remember is that there must be an employer willing and able to make payments to the scheme after the exchange is made.

Can the self-employed use a salary exchange arrangement?
As there’s no employer to make a pension payment on their behalf, the self-employed cannot set up a salary exchange arrangement.

How can salary exchange be set up with a pension plan?
The employee exchanges an amount of salary that they would have otherwise paid to their pension plan. The employer then pays the amount exchanged to the pension plan as an employer payment. For example:

Employee earns £20,000 gross yearly
Employee currently pays 5% of salary to a pension plan – that’s £1,000 yearly
Employee exchanges £1,000 of gross salary
Employer pays this £1,000 (plus any employer payments) to the pension plan.

Can pension payments be increased just by using salary exchange?
Yes. Depending on how the NIC and tax savings generated are used, there are several options available. Our calculator can deal with the following four options:

1. None of the tax and NIC savings generated are used:

• Employer saves as they pay less NICs on a reduced salary.
• If it’s the current employee pension payment that’s being exchanged their take home pay increases as they are paying less tax and NICs, albeit on a reduced gross salary.
• Pension payments remain the same.

1. Employee take home pay remains the same:

• Employer saves as they pay less NICs on a reduced salary.
• If it’s the current employee pension payment that’s being exchanged, they can exchange slightly more so that their take home pay remains the same.
• The pension payment increases by the extra amount the employee exchanges.

1. The employer reinvests their NIC savings into the pension plan:

• Employer reinvests their NIC saving into the pension plan.
• If it’s the current employee pension payment that’s being exchanged their take home pay increases as they are paying less tax and NICs, albeit on a reduced gross salary.
• The pension payment increases by the amount of the NICs savings that the employer makes.

1. Employee take home pay remains the same and the employer reinvests their NIC savings into the pension plan:

• Employer reinvests their NIC saving into the pension plan.
• If it’s the current employee pension payment that’s being exchanged, they can exchange slightly more so that their take home pay remains the same.
• The pension payment increases by the extra amount the employee exchanges plus the amount of the NICs savings that the employer makes.

Higher rate and additional rate taxpayers can claim additional tax relief. Does this affect the salary exchange calculation?
This depends on whether the exchange is being set up in a personal pension/stakeholder pension plan or an occupational pension scheme:

Personal pension/stakeholder pension (relief at source)
In the vast majority of these plans, pension payments are deducted from net pay – i.e. after tax has been deducted. These pension payments are then grossed up by the pension provider at basic rate only. The amount that can be claimed back depends on the individual’s tax position and their total taxable earnings.

Occupational pension scheme (net pay arrangement)
In these schemes, payments are normally deducted from gross pay i.e. – before tax – this has the effect of giving full tax relief on any pension payments paid. Our calculator will show this where the individual is a higher rate or additional rate tax payer by showing the payment before the exchange as being deducted from gross pay.

Will HMRC restrict or remove salary exchange arrangements in the future?
Whilst there’s no straight answer to this as it’ll depend on Government attitudes going forward, HMRC have published guidance together with questions and answers on salary exchange. So it seems likely that at least in the short term, salary exchange will continue to be available.

How can any employer NIC savings generated through salary exchange be used?
The NIC savings the employer makes can be used in many ways. For example they can be used to provide other employee benefits, increase pension payments, shore up deficits in a defined benefit schemes, or the employer may simply keep the savings. Remember however that the actual amount of salary that the employee exchanges MUST be used to provide a non-cash benefit to the employee, such as childcare vouchers, or pension plan payments.

Setting up a pension salary exchange arrangement

Can salary exchange be used with existing pension plans?
Yes, salary exchange can be introduced into existing plan as well as new plans.

How do employers set up a salary exchange arrangement?
Salary exchange is a change to the contract of employment and so there’ll be some paperwork required to set up an arrangement. We can provide guides to salary exchange, guide for employees and personal calculator have more detail on this. Also, more information can be found in HMRCs Salary Sacrifice Q & As.

We’ve also produced a sample joiner pack where the employer can introduce salary exchange for all employees, however employees are given the option to opt-out of the salary sacrifice arrangement.

It’s important that any salary exchange arrangement is set up before the right to the salary actually arises to the employee. As an example of how this may be done:

November
Employer advises employees that they’re introducing a salary exchange arrangement and gives them the option to join or opt-out.

December
Employer deadline for receiving all completed joining or opt-out forms.

January
Salary exchange arrangement starts.

Is salary exchange suitable for all employees?
As salary exchange reduces gross salary, this can affect certain state and other benefits. I can cover this in more detail on request  and further information is available from HMRC’s salary exchange guidance.

HMRC guidance on salary exchange states:

“For most employees paying less NICs may not adversely affect your benefit entitlement…”

However there are potentially two groups of employees who may be more adversely affected by salary exchange than others. We would recommend that the employer considers carefully:

• Employees who earn less than the NIC lower earnings limit (LEL) – £5,044 p.a. for 2010/2011 tax year. Those earning below this level will not accrue certain state benefits. Employers may want to restrict salary exchange to those employees earning over a certain amount. This is sometimes known as a Pay Protection Limit. There’s no hard and fast rule as to what level of salary should be set as the Pay Protection Limit – it’s up to the employer to decide. Note that it’s not possible to reduce an employee’s salary to a level which after the exchange is lower than the National Minimum Wage.
• Women who are pregnant and about to take maternity leave. Because some maternity benefits are based on the salary after exchange, employers may want to restrict pregnant women from entering the salary exchange arrangement. Note however that it’s possible for the employer to top-up any loss of benefits due to salary sacrifice so that pregnant women can still benefit from the arrangement.

Do HMRC have to be told about salary exchange arrangements?
The only occasion where HMRC would want to look at a salary exchange arrangement is where it’s set up for less than one year. Otherwise, as salary exchange constitutes a change to an employee’s contract of employment, it’s not within the remit of HMRC and they do not have to be advised.

However HMRC are concerned that tax and NICs are deducted correctly. Employers have the option to contact HMRC if they want to make sure that they’re deducting tax and NICs properly after the salary exchange arrangement is in place. Details of how they can do this can be found in the Salary Sacrifice Q & As.

Can a salary exchange agreement be altered or terminated?
Not normally. The change to the employee’s contract of employment will normally last for the duration detailed in the agreement letter, usually 12 months, although this may be longer depending on how the agreement letter is drafted. A sample agreement letter is available in our guide to salary exchange.

However, certain ‘lifestyle events’ may allow the agreement to be terminated earlier than this. Lifestyle events are significant changes to an employee’s circumstance and are defined by the employer. Examples may include the birth of a child, divorce, a change to working hours or starting maternity leave.

Importantly, an employer can insist that the salary exchange continue until the end of the agreement even if a ‘lifestyle event’ occurs.

In addition, an employer may stipulate that exercising a lifestyle event within a certain period, say 3 months, from the agreement review date is prohibited.

Can salary exchange reduce state and other benefits?
Yes, salary exchange can affect certain employer, state and other benefits, some of which are listed below – note that this list is not exhaustive. The impact on benefits can however be mitigated in certain circumstances.

More information on how salary exchange can affect benefits can be found in our guide to salary exchange, guide for employees and sample joiner pack. Also, more information can be found in HMRCs Salary Sacrifice Guidance.

Salary, overtime, bonuses and other employer related benefits
Although salary exchange is a reduction in gross salary, the agreement can be constructed so that salary increases, bonuses and overtime for example are based on the salary before the exchange. This is commonly known as “notional” or “shadow” pay.

Mortgages and other borrowing
Mortgage and other lenders may base the amount that they’re willing to lend on either a multiple of salary or affordability. Employers can provide lenders with details of an employee’s pre-exchanged salary however this may not be accepted. Employees considering borrowing should therefore discuss this with their lender.

Student loans
Repayments of student loans are triggered where earnings are currently above £15,000. If a salary exchange reduces earnings to below this threshold then repayments may reduce or stop. This may mean that it’ll take longer to repay any student loan.

Basic State Pension (BSP)
The BSP is dependent on the number of contributions made in an individual’s working life rather than the amount of NICs. So provided an individual has at least 30 years of contributions, exchanging salary will not affect the level of BSP as long as the exchanged amount doesn’t reduce the individual’s earnings below the Lower Earnings Limit (LEL) for NICs.

State Second Pension (S2P)
S2P is an earnings-related benefit so you’d expect the S2P entitlement to reduce where an employee sacrifices salary. But that doesn’t apply in all cases:

• Those earning less than the NIC LEL – £5,044 p.a. for 2010/2011 – accrue no entitlement to S2P.
• Those earning between the LEL and the NIC primary threshold – £5,715 for 2010/2011 – pay no NICs but get S2P benefits as though they were earning the Lower Earnings Threshold (LET) – £14,100 for 2010/2011.
• Those earning between £5,044 and £14,100 get S2P as though they were earning £14,100.
• Those earning between £14,100 and £43,875 Upper Earnings Limit (UEL) get benefits based on actual earnings.
• Those earning above £43,875 get S2P based on £43,875.

Statutory Maternity/Adoption Pay (SMP/SAP)
SMP/SAP are based on gross earnings that are subject to Class 1 NICs and tax. As these earnings will reduce as a result of salary exchange, there’ll be an impact on SMP/SAP and they may also reduce.

It’s possible to avoid a reduction in SMP/SAP if an employee comes out of the salary exchange arrangement at least 23 weeks before maternity (or adoption) leave starts. The actual number of weeks will depend on the dates used by the individual’s employer. This would usually be done by exercising a ‘lifestyle event’.

If starting/stopping maternity or adoption leave is not an employer listed ‘lifestyle event’, SMP/SAP will be calculated using post-sacrifice earnings.

If the employer operates an occupational Maternity or Adoption Pay policy, they may increase payments up to or above the statutory amount to ensure the individual does not lose out.

Statutory Paternity Pay (SPP)
If earnings are reduced to less than LEL, there’s no entitlement to SPP.

Statutory Sick Pay (SSP)
SSP is a work-related payment which employees are entitled to by law and is not connected to their contract of employment.

If earnings fall below LEL then there’s no right to receive SSP. If this happens employees may still be entitled to income support based on incapacity or incapacity benefit, if they meet the qualifying conditions.

If the employer operates an occupational sick pay scheme, sick pay could still be paid through that scheme even if earnings are less than LEL to ensure employees are not worse off.

Tax Credits
The Working Tax Credit (WTC) and Child Tax Credit (CTC) were introduced in April 2003 to help families on middle incomes. The amount of WTC depends on a number of factors including the number of hours worked, how many children the employee has and the amount of eligible childcare costs.

Working Tax Credit is calculated on actual taxable earnings, so if these are reduced by a salary sacrifice, an individual’s WTC entitlement may increase.

As you can see Salary Exchange offers a way to increase pension contributions at little or no cost to both employer and employee but may not be for everybody. To find out if this can benefit you or your company please just drop me a line.

You can also apply for one of my guides on this subject by following this link:-  http://www.williamgeorgeifa.co.uk/downloads/