02 November 2017 - Post by:Rebecca Peet
High earners hit by the tapered annual allowance may be liable to pay some or all of their tax charge from savings – could voluntary scheme pays be the answer?
Voluntary scheme pays has been on the agenda since the new tapered annual allowance was introduced in 2016. Increasingly, schemes are deciding to offer this facility to members, but if you want to be prepared for the 31st January self-assessment deadline you will need to get moving.
Since the annual allowance was considerably reduced to £50,000 at the start of 2011 (this is now £40,000), more people than ever have become subject to a tax charge on their annual pension input amount (this includes employee and employer contributions, and increases in total DB pension value). The scheme pays mechanism was introduced in response to concerns that people might struggle or be unwilling to pay this tax charge up front.
Scheme pays allows pension scheme members to require their administrators to pay an annual allowance tax charge on their behalf in return for a corresponding reduction in their pension benefits. Two conditions must be met: 1) the tax charge has to exceed £2,000; and 2) the individual’s pension input amount has to exceed the standard annual allowance of £40,000 as schemes are only required to pay the tax liability arising on any pension input amount exceeding this threshold.
The second condition is the problem, as the scheme pays legislation has not been updated since the introduction of the tapered annual allowance. This means that members who are hit by the tapered annual allowance have no statutory mechanism to pay any tax charge on their pension input amount below £40,000 from their pension pot.
This is where voluntary scheme pays comes in. More schemes are opting to voluntarily allow a member’s tax charge on pension input amounts below £40,000 to be paid out of their pension benefits. This is understandable, as it can be a significant benefit for members with relatively little downside for employers. In addition, the tax efficiency of pension savings is reduced if an individual has to pay a charge out of their own income or savings, so if employer pension contributions are seen as an important part of employee remuneration, the lack of a scheme pays facility could undermine this.
However, there are a few points you should consider before deciding whether to offer this facility to members:
- Process – if the trustees and administrators of your scheme are already well versed in scheme pays processes, it could be straightforward to extend this to offering voluntary scheme pays. In our experience, administrators and platform providers are becoming increasingly proficient in providing this extra process. However, it is certainly worth investigating, as if it is not the case then introducing this feature could add extra complexity to administration and payroll.
- Timing – this is the main issue, particularly if you want to offer voluntary scheme pays this year. Unlike the mandatory scheme pays process, the member is solely liable for the tax charge (even though in practice the scheme will pay it). This means that the tax charge needs to be paid by the self-assessment tax deadline of 31 January.
- Parameters – you should consider whether to impose parameters around the voluntary scheme pays facility. In particular, you may want to consider adopting a threshold tax charge – for example a £2,000 threshold in line with the mandatory scheme pays mechanism.
If you think that offering this facility could be for you, then the next step is to consider whether you will try to implement it in time for this year. An amendment to your rules may be required, and you will need to inform members of the option, so if you decide to offer it this year, you will need to move quickly.
Rebecca Peet is an associate at Allen & Overy LLP.