Death knell for final salary schemes
It is feared that the government may be planning to scrap tax relief on employer pension contributions for high earners - potentially sounding the death knell for final salary schemes.
Shocking new figures have emerged from the Budget that reveal the Treasury will rake in an enormous £3.1 billion from its pension tweaking - amounting to an astonishing average bill of £10,650 for high earners.
By reducing tax relief from 40% to 20% on pension contributions for individuals earning more than £150,000 in 2011/12, the government will receive £200 million in that tax year.
In the following year, this figure, which was hidden away in the small print of the Budget, will jump to a staggering £3.1 billion.
It is feared that the reason the figure is so high is because the government intends to scrap tax relief on employer contributions to high earners' company pensions, in addition to individuals' own personal contributions.
Hargreaves Lansdown, an independent financial adviser firm, calculates that there are only 291,000 taxpayers in the UK currently earning more than £150,000 - making the average cost of the government's measures a whopping £10,650.
Tom McPhail, head of pensions research at the company, calls the additional tax charge "catastrophic" and warns it could sound the death knell for final salary pensions.
Final salary pension schemes are already expensive for companies to offer, he explains, not least because of huge deficits that must be declared on balance sheets. One of their saving graces, however, is the fact that company directors also benefit from the tax breaks on contributions. In addition, employer contributions can be offset against corporation tax.
In light of the changes to tax relief, McPhail warns: "many companies will just shut their final salary schemes down and walk away".
A case study supplied by Hargreaves Lansdown shows that a final salary scheme member, who earns £210,000 in 2010/11 and £230,000 in the following tax year, could lose £16,040 in tax relief due to the changes.
According to McPhail, high earners should try and stuff as much money as they can into their pension during the next two years, before the rule change comes into effect.
However, the Budget also contains a clear warning that the government will be carefully monitoring pension contributions. Darling said individuals were allowed to receive tax relief at the higher rate on either a £20,000 contribution, or their normal pattern of contributions, whichever is higher, between now and 2011.
But Alan Smith, director at First Actuarial, is not convinced that the changes to tax-relief on pension contributions will have a "material" impact on final salary schemes.
"Many directors move around a lot, and probably will have their own private pension arrangements rather than final salary schemes," he explains.
This year’s Finance Bill will include legislation on exactly how pension contributions will be policed during this timeframe.
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.