As tax relief reductions are already forcing higher earners out of pensions, there could be a mass exodus if the Chancellor goes ahead with more reform. Rebecca Shahoud looks at how it could damage pensions.
It may not come as a huge surprise to many that high earners are dropping out of pension schemes as the Chancellor's tax relief reforms of recent years take hold.
The tax relief on lifetime allowance (LTA) has decreased rapidly from £1.8m to £1m in five years, while the annual allowance has dwindled from £255,000 to £40,000 over the same period.
Higher earners leaving
A recent survey by the Association of Consulting Actuaries (ACA) found that over 78% of large (5000+) employers said that those with higher incomes have left pension schemes as a direct result of tax relief reductions.
If many higher earners have already chosen to ditch pensions with the prospect of yet further tax relief reductions in the March Budget, what knock-on effect does this have for the future of pensions?
The ACA believes that any further tax reforms must be designed to incentivise saving rather than being used by the government to simply raise tax revenues.
Its chairman David Fairs said both the industry and government must "pull together" to convince employers and employees to save more in order to improve retirement incomes on the whole.
PTL managing director Richard Butcher says the past has similarities with the future.
"If you reduce tax relief, you are dis-incentivising high earners to save. The problem is then that the member loses interest in pension provision for themselves," he explains.
"It has a knock-on effect for other members in the scheme. The evidence that this happens goes way back to 1988 when a cap was introduced on earnings.
"Senior executives who could no longer benefit from being in the final salary pension scheme had to leave, because the chief executive officer had no personal interest in fighting to keep it."
The Lang Cat founder Mark Polson agrees that when higher earners have doubts about their schemes, this can lead to the company's pension offering being downgraded in importance.
"Higher earners are the ones making the decisions about the schemes from an employer perspective, and they could also be the trustees," he says.
"If the financial director of a company drops out because after 20 years he's breached his lifetime allowance, what does that do to the individual's trust in pensions? Does the pension then become a less important part of the overall benefits package for the whole workforce?"
Polson has seen cases where employees particularly teachers have been promoted, which has led to a breach of the lifetime allowance and resulted in tax penalties. He warns that if there are further reductions to tax relief on pension savings, employees will be looking to find revenue from other avenues such as higher wages.
Furthermore, there is a danger of people on more modest salaries believing that pensions are useless because they see that their bosses on higher salaries are leaving the company scheme.
"People on more modest salaries are going to start thinking, ‘I always thought pensions sucked, and now I know they do'," Polson says.
Pinsent Masons head of pensions Carolyn Saunders believes that the overall model and design of the scheme may suffer as a result of high earners leaving.
"The expectation is that more employees will want to leave schemes, which is a problem in the sense that a lot of people disengage from the scheme. Then it becomes an increasing irrelevance for them, because it only provides them with a small pension, in terms of how it relates to their earnings," she explains.
Butcher adds that pensions will simply not operate economically if high earners do not contribute to schemes. By removing the contribution levels of higher earners, the smaller pots do not get subsidised.
He says: "The average cost of administering a pot over the course of a year is £104. If a lower earner contributes just £30 per year to the scheme, then the economics break down."
The industry is acknowledging a potentially difficult future for pensions if it is to lose higher earners and their contributions. But what can be done to soften the blow?
Polson thinks the solution is to either remove the lifetime allowance completely - or at least not restrict it further.
He adds that the trickle-down effect from higher earners leaving pensions must be avoided. "I think it would be good to see trustees and employers engage [with employees] to make sure that where there are issues [of people leaving pensions], they only apply to rich folk," he says.
Butcher believes there is no solution but to keep high earners in pension schemes. Otherwise commercial providers could decide that if high earners are leaving schemes, by way of balance, lower earners would be ousted as the schemes would not be able to provide for small pots.
"The alternative is that National Employment Savings Trust (NEST) does it all," proposes Butcher.
"NEST has a statutory right to accept everyone, so it will have to be picked up by the tax payer."
For now, many in the industry will be hoping that the Chancellor will take note of these issues and leave tax relief alone on Budget day.
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