TECHTALK JULY 2018 ISSUE 4 VOLUME 17

Transcription

1 TECHTALK JULY 2018 ISSUE 4 VOLUME 17

2 WELCOME TO THE JULY EDITION OF TECHTALK EDITOR Paul Rutkowski Paul is a senior manager within Scottish Widows, having joined the Group in He has over 20 years of experience across a broad spectrum of financial services roles including workplace pensions, individual pensions, proposition management and business development. In this edition of Techtalk, I m delighted to introduce another set of wide ranging articles, with something of interest for all advisers. On the contents page overleaf, you ll find the full list of articles and authors for this edition, including a brief summary of each topic. The Financial Planning team are covering topics relevant to both individual and workplace pensions including a look at the role of post Pension Freedoms death benefits in estate planning, the tax planning advantages of employer pension contributions and how scheme pays operates when a member faces an annual allowance charge. We also look at how Scottish income tax affects pension contributions, and provide a useful summary of state pension provision. Our first guest author, Gareth Davies, provides a timely reminder of the state of play regarding the FCA s approach to DB transfers. Our second guest author, Scott Cadger, takes a look at the history of underwriting, putting developments to improve adviser and customer experiences into context. We aim to provide you with a valuable source of unstructured CPD in each edition of Techtalk, with expert articles refreshing and updating your knowledge. We re also continuing to develop additional structured CPD courses and will keep you informed of progress. Our three courses are available here: The Financial Planning team isn t just responsible for bringing you Techtalk. Advisers and paraplanners can access a wide range of supporting material produced by the same team. Just visit the Scottish Widows Adviser Extranet and go to the Financial Planning page. Enjoy the read. Paul Rutkowski

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4 4 techtalk SCOTTISH INCOME TAX AND PENSION CONTRIBUTIONS What do the differences between Scottish and the rest of the UK income tax rates mean for member pension contributions and salary sacrifice? BERNADETTE LEWIS Bernadette joined the group in She has over 35 years experience in Financial Services with both intermediaries and providers. She has broad and deep technical experience across pensions, protection, tax and trusts. From 6th April 2018, Scotland has different rates of income tax to the rest of the UK. We explain what this means for member pension contributions and salary sacrifice. IDENTIFYING SCOTTISH TAXPAYERS HMRC provides Scottish resident taxpayers with a tax code starting with an S. PERSONAL ALLOWANCE The personal allowance is 11,850 in 2018/19 for all UK taxpayers. It reduces by 1 for every 2 of adjusted net income over 100,000. So in 2018/19, the personal allowance reduces to nil once adjusted net income reaches 123,700. INCOME TAX Scottish income tax rates These rates apply to income above the available personal allowance in 2018/19 to earnings and other non-savings, non-dividend income for Scottish resident taxpayers. Starter rate: 19% 0 2,000 Basic rate: 20% 2,001 12,150 Intermediate rate: 21% 12,151 31,580 Higher rate: 41% 31, ,000 Top rate: 46% Over 150,000

5 techtalk 5 HMRC has confirmed that Scottish taxpayers still benefit from 20% basic rate relief at source for 2018/19. Rest of UK income tax rates These rates apply to income above the available personal allowance in 2018/19 to earnings and other non-savings, non-dividend income for taxpayers resident in the rest of the UK. Basic rate: 20% 0 34,500 Higher rate: 40% 34, ,000 Additional rate: 45% Over 150,000 NATIONAL INSURANCE The same national insurance rates and rules apply across the UK. The following rates apply in 2018/19. Employee Earnings 8,424 to 46,350 a year 12% Earnings over 46,350 a year 2% Employer Earnings over 8,424 a year 13.8% There are no employer NICs on earnings up to 892 a week for employees aged under 21, or apprentices under age 25. The employer support allowance reduces overall employer class 1 NICs by up to 3,000 for 2018/19. Employees above state pension age and still working don t pay NICs. These factors can affect the NI savings available from salary sacrifice. Higher rate taxpayers and national insurance Outside of Scotland, 40% higher rate tax starts applying once earnings reach 46,350 for someone with the full personal allowance. This is also the point at which employee NICs reduce from 12% to 2%. However, Scottish taxpayers start paying 41% higher rate tax once earnings reach 43,430, so they effectively pay 53% tax on earnings between 43,430 and 46,350 (2018/19 rates). MEMBER PENSION CONTRIBUTIONS Group personal pensions Member contributions to group personal pensions (GPPs) are paid net of 20% basic rate tax, using the relief at source method. HMRC has confirmed that Scottish taxpayers still benefit from 20% basic rate relief at source for 2018/19. This means we have certainty that for the current tax year, Scottish non-taxpayers continue to benefit from 20% tax relief automatically on member contributions as will Scottish starter rate (19%) taxpayers. Scottish intermediate rate (21%) taxpayers will benefit from 20% tax relief automatically. If they want to take advantage of the additional 1% tax relief on pension contributions that fall into this tax band, they ll need to claim this from HMRC. They might need to complete a self-assessment tax return to do this. Scottish higher rate (41%) and top rate (46%) taxpayers will also benefit from 20% tax relief automatically. They ll need to claim the remaining tax relief they re entitled to up to 21% or 26% by completing a self-assessment tax return. This means they follow the same processes as for rest of the UK higher rate (40%) and additional rate (45%) taxpayers. Occupational pension schemes Most occupational pension schemes (OPSs) use the net pay method for tax relief on member pension contributions. Where this applies, the employer deducts gross member contributions from each member s before tax income. This means that most members automatically benefit from the correct rate of tax relief at the point their contributions are deducted from their pay. The existing disadvantage of net pay tax relief continues for some low earning OPS members, who already pay no income tax because their earnings are covered by the personal allowance. There s no mechanism for them to reclaim the tax relief on pension contributions that s available to other members. These points apply equally to Scottish and rest of the UK taxpayers.

6 6 techtalk SALARY SACRIFICE With salary sacrifice, instead of making member pension contributions, an employee agrees to a contractual reduction in their salary in exchange for receiving a higher employer contribution. They get their tax relief immediately by receiving less taxable salary, in much the same way as with net pay tax relief. The main benefit of salary sacrifice relating to pension contributions comes from the employer and employee NI savings resulting from the reduced earnings. The NI savings can be used in a variety of ways. For example, the employer can cut its costs and the employees can increase their take home pay. Or some or all of the employee and employer savings can be used to increase the value of the pension contributions. There are a few situations where the different rates of Scottish income tax create noticeably different salary sacrifice outcomes compared to the rest of the UK. We ll look at two examples, taking account of Scottish starter rate (19%) taxpayers, and those paying the effective 53% tax rate because of the national insurance trap. Salary sacrifice and starter rate tax If salary sacrifice is used with a GPP, Scottish starter rate taxpayers will benefit from 19% tax relief rather than the 20% they d receive by making a relief at source member contribution. However, this small disadvantage is offset by saving 12% NI on the sacrificed income. It s not possible to use salary sacrifice to reduce earnings to below the national living/minimum wage rates. EXAMPLE Let s compare GPP member contributions to using salary sacrifice for a lower earner in Scotland versus the rest of the UK. In this example, the 19% starter rate of tax applies to income over the personal allowance for Scottish taxpayers, and 20% basic rate tax applies in the rest of the UK. Assumptions gross employee contribution to a GPP before salary sacrifice normal salary 13,850, post sacrifice salary 13, employer and employee both keep their NI savings. Scotland no salary sacrifice Earnings 13, Personal allowance 11,850 Starter rate income tax 2,000 x 19% Employee NI 13,850-8,424 x 12% Net income 12, Member contribution less 20% relief at source Take home pay 12, Employer NI 13,850-8,424 x 13.8% Scotland salary sacrifice Post sacrifice earnings 13, Personal allowance 11,850 Starter rate income tax 1, x 19% Employee NI 13, ,424 x 12% Net income/take home pay 12, Employer NI 13, ,424 x 13.8%

7 techtalk 7 England, Wales, Northern Ireland no salary sacrifice Earnings 13, Personal allowance 11,850 Basic rate income tax 2,000 x 20% Employee NI 13,850-8,424 x 12% Net income 12, Member contribution less 20% relief at source Take home pay 12, Employer NI 13,850-8,424 x 13.8% England Wales, Northern Ireland salary sacrifice Post sacrifice earnings 13, Personal allowance 11,850 Basic rate income tax 1, x 20% Employee NI 13, ,424 x 12% Net income/take home pay 12, Employer NI 13, ,424 x 13.8% Employee contribution method Tax relief NI saving Net cost GPP Scotland/rest of UK 20% n/a Salary sacrifice Scotland 19% 12% Salary sacrifice rest of UK 20% 12% The slightly higher net cost of the pension contribution for a Scottish taxpayer using salary sacrifice reflects the fact that they re paying less tax on their earnings than if they were tax resident in the rest of the UK. The employer s 13.8% NI saving using salary sacrifice amounts to Salary sacrifice and the Scottish national insurance trap It s possible for some Scottish taxpayers to save up to 53% in tax and NI by using salary sacrifice in respect of the band of earnings between 43,430 and 46,350. For example, someone who reduces their normal salary of 46,350 to 43,430 in exchange for an employer pension contribution of 2,920 would save 41% income tax plus 12% NI on the sacrificed 2,920. In practice, salary sacrifice around this band of earnings is more likely to save a Scottish taxpayer a mix of income tax at 21% and 41% and/or NI at a mix of 12% and 2%. The equivalent situation in the rest of the UK will save the taxpayer a mix of income tax at 20% and 40% and/or NI at a mix of 12% and 2%. It s possible for some Scottish taxpayers to save up to 53% in tax and NI by using salary sacrifice in respect of the band of earnings between 43,430 and 46,350.

8 8 techtalk EXAMPLE Let s demonstrate some possible tax and NI savings in this situation for both Scottish and rest of the UK taxpayers. This example considers someone who s earning enough to be paying the higher rate of tax (41% or 40%) before salary sacrifice, but falls back into the intermediate (21%) or basic (20%) rate bands with salary sacrifice. Assumptions 4,700 gross member contribution to a GPP before salary sacrifice normal salary of 47,000, post sacrifice salary 42,300 employer and employee both keep their NI savings. Scotland no salary sacrifice Earnings 47, Personal allowance 11,850 Starter rate income tax 2,000 x 19% Basic rate 10,150 x 20% 2, Intermediate rate 19,430 x 21% 4, Higher rate 3,570 x 41% 1, Employee NI 46,350-8,424 x 12% 4, ,000-46,350 x 2% Net income 34, Member contribution 4,700 less 20% relief at source 3, Take home pay 30, Further tax relief available 1,130 x 1%, 3,570 x 21% Net income after claim 31, Employer NI 47,000-8,424 x 13.8% 5, Scotland salary sacrifice Post sacrifice earnings 42,300 Personal allowance 11,850 Starter rate income tax 2,000 x 19% Basic rate 10,150 x 20% 2, Intermediate rate 18,300 x 21% 3, Employee NI 42,300-8,424 x 12% 4, Net income/take home pay 31, Employer NI 42,300-8,424 x 13.8% 4, England, Wales, Northern Ireland no salary sacrifice Earnings 47, Personal allowance 11,850 Basic rate income tax 34,500 x 20% 6, Higher rate 650 x 40% Employee NI 46,350-8,424 x 12% 4, ,000-46,350 x 2% Net income 35, Member contribution 4,700 less 20% relief at source 3, Take home pay 31, Further tax relief available 650 x 20% Net income after claim 31, Employer NI 47,000-8,424 x 13.8% 5,323.49

9 techtalk 9 England, Wales, Northern Ireland salary sacrifice Post sacrifice earnings 42, Personal allowance 11,850 Basic rate income tax 30,450 x 20% 6, Employee NI 42,300-8,424 x 12% 4, Net income/take home pay 32, Employer NI 42,300-8,424 x 13.8% 4, Employee contribution method Relief on payment Relief by claim NI saving Net cost GPP Scotland 20% 16.2% n/a 2,999 Salary sacrifice Scotland 36.2% n/a 10.6% 2,500 GPP rest of UK 20% 2.8% n/a 3,630 Salary sacrifice rest of UK 22.8% n/a 10.6% 3,131 The lower net cost of the pension contribution for a Scottish taxpayer reflects the fact that they re paying more tax on their earnings than if they were tax resident in the rest of the UK. The employer s 13.8% NI saving amounts to

10 10 techtalk DB ADVICE AND PS 18/6 THE LAST POLICY STATEMENT? The DB transfer rules following the FCA s Policy Statement PS 18/6, plus a summary of the key points in Consultation Paper CP 18/7. GARETH DAVIES Gareth Davies is a Specialist Pensions Development Manager for Scottish Widows, dealing with technical and legislative aspects of both corporate and individual pensions. Gareth has over 25 years experience in the life and pensions industry working for major product providers, and over ten years experience as a pensions specialist. Gareth regularly speaks at industry and trade events and he is a Chartered Financial Planner, a Fellow of the Personal Finance Society and holds the Investment Management Certificate. In June 2017, the FCA issued Consultation Paper CP 17/16 which proposed changes to the defined benefit advice landscape. We now look at the final rules and guidance contained in the resulting Policy Statement PS 18/6, and also briefly reflect on the proposals contained in Consultation Paper CP 18/7. The long awaiting FCA Policy Statement updating the COBS rules for IFAs advising on defined benefit (DB) pensions finally arrived in March 2018, together with an unexpected added bonus of another consultation paper CP 18/7. In the main, there were few surprises contained in the policy statement but there have certainly been a couple of headline grabbing changes which have raised a few eyebrows. Let s begin by looking at the changes contained in the Policy Statement PS 18/7. The FCA sets the scene and context by acknowledging that the pensions environment in general is changing, and that as a result of Pensions Freedoms customers have more options when accessing their pensions savings. This has led to a massive increase in demand for pension transfer advice and the regulator is now clear that it expects all advisers to fully consider the client s circumstances and properly consider the various options available. Massive increase in demand for pension transfer advice The one big surprise contained in the Policy Statement was the banning of free software under the MIFID 2 inducement rules We consider it is unlikely that providing or accepting free TVA or APTA software would fall within the narrower definition and so should not be used. This has led to most product providers withdrawing their free TVAS services with immediate effect. It remains to be seen what the longer term impact this will have on the capacity in the TVAS/APTA market, but clearly this will mean a short term reduction in supply of this service.

11 techtalk 11 The other key changes implemented in the Policy Statement are as follows: Requiring all advice on pension transfers to be a personal recommendation. Clarifying the role of a pension transfer specialist when checking advice. Replacing the current transfer value analysis (TVAS) requirement with a requirement to undertake an appropriate pension transfer analysis (APTA) of the client s options; and a prescribed Transfer Value Comparator (TVC) indicating the value of the benefits being given up and the cost of purchasing the same income in a defined contribution environment. Applying a consistent approach for pension opt-outs where there are potential safeguarded benefits. Let s take a look at some of these in more detail. Personal recommendation is already defined in the FCA handbook glossary. Having considered the client s individual circumstances, at the conclusion of the advice process, it expects advisers to provide a personal recommendation to the individual to either transfer or remain in the current scheme. My personal view is that the best way to demonstrate and evidence this part of the advice journey is to use some form cash-flow modelling tool, underpinned by realistic assumptions. This could be supplemented with an additional scenario whereby the results are subject to a stress test by imposing a potential 20% or even 30% reduction in value to model the impact of a possible market correction. In addition to this, I would also suggest implementing a clear process to identify and document the client s needs as well as their objectives. These could be captured at outset in the client s own words, and can be built into the cash-flow model and kept under regular review. It is also worth noting that the FCA has decided not to proceed with the changes proposed in CP 17/16 to its starting assumption, and is maintaining its guidance that an adviser should start from the assumption that a transfer will be unsuitable. Whilst this is disappointing, it reflects the high proportion of unsuitable advice seen in supervisory work which has also led it to further consider how transfer advice should be paid for.

12 12 techtalk The FCA has now clarified its expectations of a Pension Transfer Specialist (PTS) as follows: check the entirety of the advice process, not just the numerical analysis, and consider whether the advice is sufficiently complete confirm that the personal recommendation is suitable inform the firm in writing that they agree with the advice, including any recommendation, before the report is given to the client. This means that any disagreements between the PTS and the adviser must be settled before the client is given the suitability report. As previously proposed in CP 17/16, the TVAS is to be replaced by the APTA with effect from 1st October 2018, and will include a prescribed Transfer Value Comparator (TVC). This is designed to reduce the focus on critical yield and lead to a more balanced advice process and better client outcomes. The TVC will require a calculation involving: where relevant, a projection of the ceding scheme benefits to normal retirement age the estimated cost of purchasing those benefits using an annuity, and for those more than 12 months from their scheme retirement date determining the present value needed today to fund the annuity FCA s standard format for provision of transfer value comparator: You have been offered a cash equivalent transfer value of 120,000 in exchange for you giving up any future claims to a pension from the scheme. Will I be better or worse off by transferring? We are required by the Financial Conduct Authority to provide an indication of what it might cost to replace your scheme benefits. We have done this by looking at the amount you might need to buy the same benefits from an insurer. It could cost you 140,000 to obtain a comparable level of income from an insurer. This means the same retirement income could cost you 20,000 more by transferring. 160, , , ,000 80,000 60,000 40,000 20, ,000 Transfer value offered 20,000 Finally, the FCA published an additional consultation paper CP 18/7, with the response to the related consultation which closed on 25th May 2018 due in the autumn. The proposals include the following: 140,000 Estimated current replacement cost of your pension income Raising qualification levels for PTSs to require them to obtain the same qualification as an investment adviser. Guidance to clarify expectations that advisers should be exploring clients attitudes to the general risks associated with a transfer, in addition to their attitude to investment risks. Guidance to illustrate how firms can carry out an appropriate triage service (an initial conversation with potential customers), without stepping across the advice boundary, by providing generic, balanced information on the merits of pension transfers. A requirement for firms to provide a suitability report regardless of the outcome of advice. It is also worth noting that the FCA is seeking views on introducing a ban on contingent charging, which is when a fee for advice is only paid when a transfer goes ahead. The FCA has now clarified its expectations of a Pension Transfer Specialist.

13 techtalk 13 ESTATE PLANNING WITH PENSION DEATH BENEFITS Three years on from the introduction of Pension Freedoms the relatively generous tax rules for pension death benefits remain in place. These can offer simple and tax efficient planning options. CHRIS JONES Chris joined the group in He s worked in a number of technical roles in marketing, product development and technical support. His recent focus has been on pensions taxation and the new pension reforms. For many clients the flexibility and potential tax efficiency of death benefits paid from defined contribution schemes are a significant attraction. option to keep them outside of both their own and their beneficiaries estates can be very advantageous. The key tax factor is the age at which the member dies with age 75 being the transition point at which death benefits become taxable. Where a member dies under the age of 75 all benefits are paid free of tax, whether paid as a lump sum, beneficiary s drawdown or annuity. Most clients will of course require most of their pension fund to provide them with an income during their retirement. However, having the option to pass on benefits to their chosen beneficiaries can provide reassurance that their savings won t go to waste, particularly in the event of early death. Wealthier clients may never need to access all of their funds and having the Wealthier clients may never need to access all of their funds and having the option to keep them outside of both their own and their beneficiaries estates can be very advantageous.

14 14 techtalk Where the member dies aged 75 or over the benefits become taxable. They will be taxed at the beneficiary s marginal rate of income tax as and when the funds are withdrawn. The taxation is the same however the benefits are paid out. This will often mean that beneficiary s drawdown or annuity will provide a much more tax efficient option than the lump sum payment, allowing the tax to be spread over a number of years rather than all at once. The second key planning point is the member is able to nominate anyone to receive benefits there is no requirement for them to be a dependant, opening up the option to pass funds on to adult children or grandchildren, or anyone else they choose. There are no age restrictions on who can receive the benefits whether they are paid as a lump sum or as beneficiary s drawdown. The rules allow the nominated beneficiary to pass on any unused drawdown funds on their death to their own nominated beneficiary, known as a successor. The same tax treatment will apply but the relevant age will be the age of death of the beneficiary rather than the original member. Technically there is no end to this planning; a successor could also pass their remaining funds down to a further successor and so on. The taxation, the flexibility of the nominations and the ability to pass the funds onto a successor, all combine to make beneficiary s drawdown an extremely useful estate planning tool. Funds can remain outside of anyone s estate and within a tax efficient environment. EXAMPLE Liz dies at age 68 with 500,000 remaining in her pension fund and has nominated her husband Brian to receive 100% of her benefits. Brian asks to receive this as beneficiary s drawdown. Brian can receive tax free withdrawals from the funds for the rest of his life taking as much or as little as he needs each year. When Brian dies he can pass on any remaining funds to whoever he chooses. If he were to die at age 78, because he is over the age of 75 the funds become taxable. Brian may choose to nominate his children to receive the funds. However, if they were already wealthy in their own right he may choose to skip a generation and pass the funds down to his grandchildren rather than his children, who may pay income tax at a lower rate. For example, if they used their funds to help with university fees. If Brian had sufficient retirement income of his own, Liz could have instead nominated her children or grandchildren to receive all or part of the funds. They could then have received the funds free of tax for the rest of their lives. By using beneficiary s drawdown the funds remain outside of anyone s estate and invested within the tax efficient pension environment throughout.

15 techtalk 15 USING OTHER FUNDS BEFORE PENSION The tax advantages of pensions can mean it is better to use up other funds first before withdrawing from the pension where a client s other assets exceed the IHT thresholds. For example, using funds within an OEIC first to fund their retirement would reduce the value of their estate and potentially save IHT. Of course, this would need to be balanced with the income tax position, any capital gains tax and the likely tax position of the beneficiary on receipt of any remaining pension fund. NOMINATIONS It s important to ensure clients nominations are up to date so that they can make the most of the planning opportunities available. This is because the rules restrict who can receive beneficiary s drawdown. Where the member has not made a nomination and has left any dependants, the scheme can only set up drawdown for someone who is a dependant. Where the member has not made a nomination and has not left any dependants, the scheme can nominate any individual to receive drawdown. their IHT estate if they die within two years. If they were in good health at the time of the transfer, the value of the benefits is normally negligible so this has no real effect. However, if they were in ill health at the time of the transfer, HMRC determines the value of the resulting loss to the estate. This could cause a substantial death benefits lump sum to be subject to IHT. A recent second tier tribunal ruling (Staveley) relating to the IHT treatment of death benefits following a pension transfer went in the taxpayer s favour. However, there were unusual circumstances that might limit its applicability to other situations. THE OTHER TWO YEAR RULE To ensure benefits are paid free of income tax for deaths under age 75, payments to beneficiaries need to be made within two years of the member s death. The same rule will apply when the nominated beneficiary dies and passes funds onto a successor. The rule also applies where the beneficiaries want to continue in drawdown. However, they only need to make the designation into drawdown, there is no requirement to take any income. It s important to ensure clients nominations are up to date so that they can make the most of the planning opportunities available. This is because the rules restrict who can receive beneficiary s drawdown. These restrictions do not apply to lump sum payments and subject to the scheme rules, they have discretionary powers to pay these to anyone. It will also be important to review nominations for any clients at age 75. The change in the taxation of death benefits at that point may mean an alternative beneficiary is more appropriate. LIFETIME ALLOWANCE (LTA) The lifetime allowance test applies to any uncrystallised funds paid out as a lump sum, beneficiary s drawdown or annuity. Any excess will be subject to the LTA charge in the normal way, either 55% if paid out as a lump sum or 25% if the funds are used to provide income. The income option is clearly more favourable in this situation as the income payments where the member dies under age 75 will be free of further tax. TRANSFERS AND THE TWO YEAR RULE Pension scheme death benefits are normally outside of the member s IHT estate provided the scheme trustees/administrators have discretion over who it s paid to. This means that normally no IHT is payable in respect of death benefits. However, HMRC argues that if a member transfers their benefits, the value of the death benefits is in USE OF TRUSTS Passing funds on via the pension fund will often offer the simplest and most tax efficient option. However, the cost of this is a lack of control and this may not be a suitable option particularly where family situations are more complex. Where clients would like more control over how and when their chosen beneficiaries receive benefits a trust can be used. To be inheritance tax efficient this will still rely on the scheme making the initial payment at their discretion but once the funds are in the trust the trustees can have full control. The price of this is that the funds move from a tax efficient environment to one taxed under the discretionary trust regime. In addition, if the member dies over age 75, 45% income tax is deducted when the death benefits are paid into the trust. This can act as a significant drag on the fund performance over the long term. It also adds potential IHT periodic and exit charges as well as the administrative complexities of having to use a trust. In addition, to achieve the required control in complex situations, this may need to involve bespoke trusts and the appointment of professional trustees which will further increase the costs.

16 16 techtalk RETIREMENT PLANNING AND THE EMPLOYER S CONTRIBUTION An overview of the tax benefits of employer contributions and their benefit to company owners. THOMAS COUGHLAN Tom has spent over 15 years in technical roles. He has wide experience including the provision of technical support to financial advisers covering life, pensions and investment compliance. He currently specialises in pension planning. Employer contributions make up a significant portion of the total contributions paid to registered pension schemes. Here we look at the rules and limits for employers, employees and directors. Employers have a key role to play in their employees retirement planning. As well as making their own contributions they must deduct employee contributions from pay, forward them to the scheme and now, under automatic enrolment legislation, assess eligibility and calculate contributions. Many employers were already playing an active role in this, but auto-enrolment has achieved enormous success in turning this into a formal obligation. Employer pension provision is now a fundamental feature of employment, whereas it was previously an additional benefit mainly for skilled and professional roles and for those sectors paying at least moderate salaries. The workers that continue to miss out are very low earners, those with multiple low-paid jobs and the self-employed, but these are being considered as part of an overall review of automatic enrolment coverage. As well as benefiting true employees, employer contributions can be utilised by company owners, who whilst essentially self-employed can pay themselves employer contributions as part of their remuneration package.

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18 18 techtalk WHAT IS THE BENEFIT TO THE EMPLOYEE? Employer contributions are paid gross, so they do not give rise to a personal income tax liability for the employee: this is equivalent to the receipt of tax relief on personal contributions. Furthermore, the payment of a contribution does not attract national insurance contributions (NICs) in the way that salary, bonuses, commission and certain taxable benefits do. This means that employer contributions are almost always more tax-efficient than employee contributions. But there is an exception to every rule: in this case non-income tax payers who get 20% tax relief under schemes that operate relief at source despite not paying any income tax. The national insurance (NI) saving is what makes salary sacrifice so appealing. The ubiquity of such schemes clearly demonstrates that employer contributions are, in the majority of cases, more tax-efficient than personal contributions. There is more detail on this in my article the benefit of sacrifice in the May 2018 edition of Techtalk. Literature/Doc/FP0680 WHAT IS THE BENEFIT TO THE EMPLOYER? Employer contributions are, in the vast majority of cases, deductible from taxable profit for corporation tax purposes. However, this is not particularly surprising given that they represent an inherent part of any reward package, and that staff costs are perhaps the most genuine trade expense. Other components such as salary and bonuses are similarly deductible from profit. But what sets employer contributions apart from cash rewards is their exemption from employer NICs. Employers are, therefore, usually quite happy for a significant component of their staff costs to be made up of contributions to staff pensions. In most cases employers should not have any issues obtaining a deduction for corporation tax purposes for all employer pension contributions. HM Revenue & Customs Business Income Manual confirms that: A pension payment by an employer is normally wholly and exclusively for the purposes of its trade Only in limited circumstances will a non-trade purpose have to be considered. Primarily, where the contribution is excessive relative to the employee s duties; pension contributions for those connected to the business proprietor, for example, will be scrutinised more closely than others to determine if this is the case. DIRECTORS business-income-manual/bim46005 Company owners have a great deal of flexibility when it comes to drawing money from their business. They can choose from a number of remuneration options and can combine them in different ways, varying the weighting of each. Their main options are salary, dividends and pension contributions. As a general rule, from left to right, payment of the remuneration type becomes more restricted but more tax-efficient. LESS RESTRICTIVE SALARY DIVIDEND PENSION Company owners have a great deal of flexibility when it comes to drawing money from their business. MORE TAX-EFFICIENT Company owners can pay themselves unlimited amount of salary, subject to the success of their business. Salary, however, is subject to the highest rates of tax and NICs of up to 47%. In addition, the salary incurs employer NICs, which company owners will need to factor in to determine how much a given component of remuneration costs them.

19 techtalk 19 EXAMPLE Mel owns Wheels Ltd and wishes to pay herself 100,000 from the company. To keep things as simple as possible she initially wants to look at the effect of paying the full amount as salary, dividends or an employer pension contribution. The net amount that can be extracted in each case is as follows: Salary Dividends Pensions Total Cost 100, , ,000 Employer NIC ( 11,105) n/a n/a Corporation Tax n/a ( 19,000) n/a Gross amount 88,895 81, ,000 Income Tax ( 23,918) ( 13,698.75) n/a Employee NIC ( 5,402.02) n/a n/a Net amount 59, , ,000 Potential Tax n/a n/a ( 30,000) Net Benefit 59, , ,000 Extraction Rate 59.57% 67.30% 70.00% There are a number of assumptions in each case: the salary column assumes Mel has no other income, so has her full personal allowance available; the dividend column assumes that she can pay herself this amount in dividends under HMRC rules; and the pension column assumes that she has sufficient annual allowance available to cover the full contribution and that she will be a higher rate taxpayer in retirement. There are good reasons for a company owner paying themselves salary: one key reason is that paying enough salary to pay NICs (or qualify for NI credits) ensures entitlement to state benefits such as the new state pension. Because of this, many company owners pay themselves at least the NI primary threshold as salary. Dividends are also a very popular part of the remuneration package, and with good reason as they do not attract employer or employee NICs. They must, however, be paid out of post-tax profits, which means there needs to be profit in the business that can be distributed, and they cannot be a deduction for corporation tax purposes. The company s accountant should be consulted as to how much can be paid out in dividends, who will take into account HMRC s restrictions on dividend-based remuneration strategies, which are in place to prevent company owners using the dividend route purely to avoid paying NICs. But it is employer contributions that are usually the most tax-efficient component and, perhaps, the most under-utilised. A strategy that does employ them must take account of the annual allowance, however, particularly the tapered and money purchase annual allowances, as well as their inaccessibility before age 55. But, because of their tax benefits, they should form an integral part of the remuneration package, either via regular contributions or occasional large contributions to maximise available carry forward. To determine the tax efficiency of different combinations of salary, dividends and pension contributions for a particular case, please refer to our Salary, Dividend and Pension Calculator. docs/25880.xls Note: Scottish resident taxpayers have their own income tax rates and bands for 2018/19 which may affect the tax outcomes in our examples.

20 20 techtalk SCHEME PAYS IN FOCUS Looking at when a member can ask their pension scheme to meet the annual allowance charge. JEREMY BRANTON Jeremy has over 30 years experience in the financial services industry covering a number of technical and marketing roles. He joined the group in 2006 as a tax and trusts specialist and also offers technical support on pension and protection planning. When can scheme pays be used? We provide some insight The annual allowance for tax year 2018/2019 is 40,000. All personal, employer and third party contributions made to defined contribution pension schemes and benefits accrued in defined benefit schemes during the tax year are tested against this allowance. If the allowance is breached after taking account of any available carry forward from the three previous tax years the member will normally have to pay tax via an annual allowance charge on the excess. Individuals can also suffer an annual allowance charge where their pension input for the year is lower than the standard annual allowance of 40,000. This could be due to the application of tapering of the annual allowance due to the member s level of earnings (tapered annual allowance) or as a consequence of flexibly accessing pension benefits (money purchase annual allowance). WHAT IS THE SCHEME PAYS BASIS? If the annual allowance has been exceeded, an individual can ask the scheme administrator to meet the charge from the scheme on their behalf. A scheme administrator is only obliged to comply with a scheme pays request where the following conditions have been met: The individual s pension input into the scheme has exceeded the annual allowance for the same tax year the tapered annual allowance and/or the money purchase annual allowance is ignored. The annual allowance charge for the tax year exceeds 2,000. Where scheme pays applies, the scheme administrator becomes jointly and severally liable with the member for the charge and must account for it and pay the charge directly to HMRC within given timescales. The member is also required to include the annual allowance charge on their self-assessment tax return which must be submitted no later than 31st January of the year following that in which the relevant tax year ended. The member also includes details of the amount of the charge that the scheme will be paying. If an individual has contributed or accrued benefits in more than one scheme during the tax year, the scheme pays conditions detailed above apply to each scheme in isolation. HMRC s Pensions Tax Manual see link below provides a useful example on calculating the annual allowance charge where an individual is a member of more than one scheme. In certain circumstances, a scheme administrator can refuse to meet a member s request to meet the charge despite the above conditions having been met. These would include a scheme being assessed by the Pension Protection Fund or where the benefits to be adjusted would include GMP benefits. HMRC provides guidance on scheme pays in its Pensions Tax Manual at: pensions-tax-manual/ptm056400

21 techtalk 21 IS THERE A DEADLINE FOR REQUESTING SCHEME PAYS? If a member wants a scheme to meet the charge under the scheme pays conditions above, it must normally notify the scheme by 31st July in the year following the end of the tax year in which the charge was incurred. So for an annual allowance charge arising in tax year 2017/2018 the deadline would be 31st July Most providers have produced a standard request form for this purpose. This deadline is brought forward where either: a member intends taking all of their benefits from the scheme a member will reach age 75 and a benefit crystallisation event (BCE) will be triggered such as having uncrystallised funds or funds remaining in drawdown. In which case notice must be given before the entitlement to all benefits or the age 75 BCE occurs to allow the scheme to deduct the charge prior to benefits being drawn/the BCE arising. Where the conditions for scheme pays haven t been met but a scheme agrees to pay the charge voluntarily, liability for paying the tax rests solely with the member and tax must be settled by the scheme by the usual self-assessment deadline above just as if the member were meeting the charge personally. Pension savings statements must be issued by 6th October following the end of the tax year. HOW WILL A MEMBER KNOW IF THEY FACE A CHARGE? A scheme must provide a member with a pension savings statement if their pension input into the scheme for the year has exceeded the annual allowance. The statement should include: The total of the member s pension input into the scheme for the tax year. The annual allowance for that year. The total of the member s pension input into the scheme in each of the three previous tax years. The annual allowance for the three previous tax years. A statement must also be issued where a scheme administrator is aware that a member has flexibly accessed benefits and their pension input into money purchase scheme exceeds the money purchase annual allowance (MPAA). Pension savings statements must be issued by 6th October following the end of the tax year. By concession where a scheme has been unable to meet this deadline due to waiting for information to complete it such as from the employer it has three months to send the statement once it has received the information. Where a scheme isn t obliged to automatically issue a pension savings statement, the member can still request one. If the administrator receives a request before 6th July following the end of the tax year in question, it must issue the statement by 6th October. Otherwise, it must issue the statement within three months of the member s request. Members receiving a statement also need to take account of pension input amounts into any other pension schemes they belong to in determining whether a tax charge applies. ASSESSING PENSION INPUT AGAINST THE ANNUAL ALLOWANCE Once pension input for the tax year is determined, a check is needed against the annual allowance plus any carry forward allowance available from the three previous tax years to establish if a charge applies. EXAMPLE Colin is a member of a non-contributory defined benefit scheme with 1/60th accrual. At the beginning of the pension input period he has 15 years accrual and remuneration of 65,000. During the input period he s promoted and his pensionable pay increases to 75,000. His pension input for the period is calculated as follows: Opening value 15/60 x 65,000 = 16,250 Multiplied by 16 = 260,000 Increased by CPI = 265,200 Closing value 16/60 x 75,000 = 20,000 Multiplied by 16 = 320,000 Pension input for the period is therefore closing value - opening value: Closing value Opening value Pension input 320, ,200 = 54,800 As this exceeds the annual allowance, if Colin didn t have any carry forward allowance available from the three previous tax years he would face an annual allowance charge on the excess of 14,800. There s no requirement to make a claim to HMRC to carry forward unused annual allowance or need to show this on an individual s selfassessment return where the application of carry forward means that an annual allowance charge isn t due.

22 22 techtalk WHAT RATE OF TAX IS APPLIED TO THE CHARGE? The excess pension input is added to an individual s taxable earnings and taxed at their marginal rate of income tax. Continuing with our example, we will assume for simplicity that Colin has other income that has utilised his personal allowance with the result that all of his remuneration from his employer is taxable. And that he has no available carry forward annual allowance. Adding the excess of 14,800 to his remuneration from his employer of 75,000 results in a total of 89,800. As this additional slice of taxable income falls in the 40% tax band the charge is 14,800 x 40% = 5,920. HOW IS THE CHARGE TAKEN FROM THE MEMBER S PENSION BENEFITS? Where scheme pays is used to pay an annual allowance charge, there must be a corresponding reduction to the member s benefits under the scheme. For a money purchase scheme, the member s pension pot is simply reduced by the amount of the charge. HMRC s pension schemes newsletter 96 confirms that Scottish taxpayers will have their annual allowance charges from 2018/2019 onwards determined by reference to Scottish income tax rates see Bernadette s article Scottish income tax and pension contributions for a summary of the Scottish income tax rates and bands. For a defined benefits scheme, a just and reasonable adjustment must be made to the member s accrued benefits. This could be by solely reducing the pension the member is due to receive at their retirement age or adjusting both the member s future pension and level of benefits payable on their death. But it wouldn t be possible to meet the charge solely from dependant s benefits or other death benefits alone.

23 techtalk 23 STATE PENSION BASICS EXPLAINED Covering the basic plus additional state pension, the new state pension, pension credit, national insurance qualifying years, and increases to state pension age. BERNADETTE LEWIS Bernadette joined the group in She has over 35 years experience in Financial Services with both intermediaries and providers. She has broad and deep technical experience across pensions, protection, tax and trusts. A look at the differences between the basic plus additional state pension and the new state pension. Also covering pension credit, national insurance qualifying years, and increases to state pension age. The full basic state pension is a week in 2018/19. BASIC PLUS ADDITIONAL STATE PENSION Those who reached state pension age by 5th April 2016 and meet the relevant criteria could claim the basic state pension plus the earnings related additional state pension. This applies to men born before 6th April 1951 and women born before 6th April Those with limited other income and savings may also be entitled to claim means tested pension credit, including both the minimum income guarantee and savings credit. Basic state pension The full basic state pension is a week in 2018/19. It currently increases each year in line with the triple lock, which is the highest of earnings inflation, CPI inflation, or 2.5%. Those who reached state pension age between 6th April 2010 and 5th April 2016 needed 30 qualifying years of national insurance contributions or credits (NICs) to get the full basic state pension. They can get at least some basic state pension with any number of qualifying years. In addition, they can use a spouse or civil partner s NICs history to top up their basic state pension entitlement to a maximum of a week (2018/19) if they have fewer than 30 qualifying years. Different eligibility criteria applied to those who reached state pension age before 6th April 2010.

24 24 techtalk The full new state pension is a week in 2018/19. Additional state pension Additional state pension is an earnings related top up paid in addition to the basic state pension for eligible individuals. It s based mainly on the state earnings related pension scheme (SERPS) and its less generous replacement, state second pension. SERPS ran between 1978 and 2002, and state second pension between 2002 and Additional state pension can also include graduated retirement benefit, a 1961 to 1975 earnings-related scheme. An individual s additional state pension entitlement is reduced by any contracting out deduction (COD). This is an adjustment for any years someone was contracted out of either SERPS or state second pension. This could have been via an occupational pension scheme, where the member and employer paid reduced NICs. Or via an appropriate personal pension, which was funded by NICs rebates. NEW STATE PENSION People who reach state pension age from 6th April 2016 and meet the relevant criteria are entitled to claim the new state pension. This applies to men born on or after 6th April 1951 and women born on or after 6th April The full new state pension is a week in 2018/19. It currently increases yearly in line with the triple lock. Those receiving less than the maximum and with limited other income and savings may be eligible for the pension credit minimum income guarantee. The basic concept of the new state pension is simple, although the transitional provisions add complications. The earnings related element has gone, and the single tier new state pension builds up at 1/35 of the maximum for each qualifying year of NICs. So an individual needs 35 qualifying years of NICs to get the full amount. They also need at least 10 years of NICs to get any new state pension. Entitlement is normally based on the individual s own NICs history, with some exceptions under the transitional provisions. The main transitional arrangements apply to everyone who d built up an entitlement to basic and/or additional state pension under the previous system. The Department for Work and Pensions (DWP) converted any state pension entitlement as at 6th April 2016 into a starting amount of new state pension. This starting amount was the higher of the amount someone would have got under the old state pension rules and the amount they d get if the new state pension had been in place at the start of their working life. If someone s starting amount was less than which was the full amount of new state pension for 2016/17 their actual starting amount increases in line with the new state pension. So currently triple lock increases apply. They ll also get a further 1/35 of the full amount of the new state pension for each additional qualifying year of NICs they build up from 2016/17. This applies until they reach the full amount of the new state pension or state pension age whichever happens first. If someone s starting amount was more than , the excess became their protected amount. This protected amount increases in line with CPI inflation not the triple lock until they reach state pension age. At state pension age, they get the full new state pension plus their revalued protected amount. PENSION CREDIT Pension credit is a non-taxable, means tested benefit that can top-up state pension entitlement. State and private pension income, plus any earnings and other sources of income including most state benefits are taken into account for pension credit means testing. Savings and investments over 10,000 are treated as if they produced 1 of income for every 500 or part of 500. Pension credit can be made up of guarantee credit (usually called the minimum income guarantee) and savings credit. In 2018/19, the minimum income guarantee is 163 a week for single people and a week for couples meaning spouses, civil partners or cohabitees. The savings credit element is only available to those who became entitled to pension credit by 5th April In 2018/19, this element can provide up to a further a week for single people and a week for couples. In 2018/19, the minimum income guarantee is 163 a week for single people and a week for couples.

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26 26 techtalk If someone s state pension forecast and NI record shows gaps in their NI record, they should check if they can claim any NI credits before paying any class 3 NICs. NI QUALIFYING YEARS, CONTRIBUTIONS AND CREDITS Qualifying years employees Employees normally get a NI qualifying year if they re earning more than the primary threshold ( 162 a week in 2018/19) from one employer. They can also get a qualifying year if they re earning above the lower earnings threshold ( 116 a week in 2018/19) from one employer, even though they don t pay any NICs. Those who work multiple low paid jobs can lose out if none of those individual jobs pays above the lower earnings threshold. Directors of owner-managed limited companies often receive salary at the primary threshold level ( 8,424 a year in 2018/19) and the balance of their remuneration as dividends and/or employer pension contributions. This builds up qualifying years without actually having to pay employer or employee NICs. It usually also keeps their salary within the personal allowance although this is tapered away at 1 for every 2 of excess income for those with adjusted net incomes over 100,000. Self-employed class 2 NICs Self-employed people currently build up qualifying years by paying class 2 NICs. Their class 4 NICs aren t linked to any state pension entitlement. This may change if proposals for reforming selfemployed NICs go ahead. In 2018/19, a self-employed person pays class 2 NICs if their profits exceed 6,205 at a flat rate of 2.95 a week, equating to a year. Self-employed people with profits under 6,205 can either claim the small earnings exemption, or pay class 2 NICs voluntarily at a lower cost than paying class 3 voluntary NICs. Class 3 voluntary NICs It s often possible for someone to improve either their basic or new state pension entitlement up to the maximum by paying voluntary class 3 NICs. This usually applies within six years of the gap in someone s NIC history occurring, or within six years of reaching state pension age. However, the individual should first check whether increasing their state pension will just reduce their entitlement to means tested benefits. In 2018/19, class 3 NICs are payable at a flat rate of a week equating to a year. Class 3A NICs Those who reached state pension age by 6th April 2016 had a one off opportunity to pay class 3A NICs between 12th October 2015 and 5th April This involved paying an age-related lump sum in return for extra additional state pension of between 1 and 25 a week. The extra amount increases in line with CPI. NI credits Individuals also build up qualifying years through NI credits. If someone s state pension forecast and NI record shows gaps in their NI record, they should check if they can claim any NI credits before paying any class 3 NICs. The rules for NI credits have changed over time, but at present the basic criteria are as follows. NI credits are available to those receiving jobseeker s allowance, employment and support allowance and carer s allowance. It s possible to get NI credits by claiming child benefit for a child under 12 even if someone then opts out of receiving it because of the high income child benefit tax charge. Grandparents and other family members under state pension age who care for a child under age 12 while their parents are at work may be eligible for specified adult childcare NI credits. DEFERRING STATE PENSION Those who reached state pension age by 5th April 2016 could defer taking their state pension entitlement by as simple a means as not submitting the claim needed to trigger payment. Each full year they defer equates to a 10.4% increase in their eventual state pension entitlement. Once in payment, this additional amount increases in line with the CPI. They also have the option to take their deferred payments as a lump sum plus interest at base rate plus 2%. The tax treatment of the lump sum is also relatively generous. It isn t added to their other income to determine how much tax is due. Instead, it s taxed at the highest rate that would apply to their other income in the same tax year, ignoring the lump sum itself. Those who reach state pension age from 6th April 2016 also have the option of deferring their new state pension. But the terms are less generous. Deferring for a year gives a pension increase of approximately 5.8%. There s no option to take the deferred amount as a lump sum. In both cases, it isn t possible to defer state pension if the individual or their spouse, civil partner or cohabitee is receiving some types of state benefit.

27 techtalk 27 INCREASING STATE PENSION AGE At the time of writing, the state pension age is 65 for men. Women s state pension age has been increasing from 60 since 2010 and will reach 65 by November Under Pensions Act 1995, the process of equalising men s and women s state pension ages was originally timetabled to end in Pensions Act 2011 accelerated this timetable to complete by November 2018 and introduced the overall increase in both men s and women s state pension ages to age 66 by October The increase to age 67 between 2026 and 2028 was covered by Pensions Act The DWP announced in July 2017 that following the Cridland Report, the state pension age would increase to 68 between 2037 and 2039, rather than between 2044 and 2049 as previously planned. Future reviews will aim to ensure that state pension age increases track longevity improvements. STATE PENSION AGE INCREASES Nov 18 Oct Men Women Note: this chart is illustrative, not an accurate depiction of the timetable. STATE PENSION FORECAST & NI RECORD Clients can check their state pension age and obtain a state pension forecast plus their NI record via The website is also a useful source of further information on all aspects of state pension and pension credit. Clients can check their state pension age and obtain a state pension forecast plus their NI record via COPE State pension forecasts include a figure for the contracting out pension equivalent (COPE) which can generate confusion. This is a notional amount that a contracted out occupational or personal pension supposedly provides to substitute for the actual contracted out deduction from the individual s state pension entitlement. In practice, occupational or personal pension benefits based on contracting out are normally paid as an undifferentiated element of someone s overall entitlement from that particular scheme.

28 28 techtalk UNDERWRITING RISK SELECTION NOT AVOIDANCE An introduction to protection insurance underwriting history and current practice. SCOTT CADGER Scott is Head of Protection Underwriting and Claims Strategy for Scottish Widows, supporting the development of Scottish Widows Protect in the IFA market. Scott is also a qualified actuary, so is well placed to understand risk selection practices from both an underwriting and actuarial viewpoint.