Golden handcuffs

Dominic Thomas
Jan 2023  •  6 min read

Golden handcuffs…

For many employees, a key reason to remain with their employer is because of pension benefits, however the playing field of employer pension schemes is far from level and the cynic in me questions whether Government tax policy is deliberately attempting to reduce the cost of pensions to employers, particularly the State employers such as the NHS.

Firstly, it’s important to understand the two basic types of pension. The clue to what they are is in the unusually straight-forward name.

1 – Defined Benefit (DB) or Final Salary Scheme

Your pension (benefit) is based on your final salary when you leave the scheme, whenever that is at the scheme normal retirement date (NRD).

The amount you get is a fraction of your final salary, your membership of the scheme and work for the employer builds your entitlement. So a scheme with a 1/60th rate of “Accrual” 25 years of membership would provide 25/60ths  (41.6%) of your final salary. This will be inflation-linked within parameters set by the scheme.

The amount you receive has nothing to do with how much you contribute, that can be any amount (sometimes nothing). It is your employers duty to honour the agreement not simply for the remainder of your life but likely the remainder of your spouse’s life as well.

According to ONS data to 2019 (the most recent at the time of writing) there are about 7.6m active members (people still building benefits)  of DB schemes, of these 6.6m are in Public Sector schemes.

2 – Defined Contribution (DC) or Money Purchase Scheme

These schemes are more straightforward in that they are investment-based schemes and the only guaranteed definitions are how much the employer is going to contribute as a percentage of pensionable salary (and the employee). How much this is ultimately worth will depend on how well the money is invested and the charges applied. Many employers use fairly cautious investment strategies in the misguided belief that this is better, yet as most people will save for their retirement for three or four decades, this will be rather like driving with the handbrake on.

The Auto Enrolment pensions that were introduced to automatically add staff to a pension rather than ask them if they wanted to join are essentially defined contribution schemes. They have been a success in the sense that more people are now saving into a pension.

The majority of employers do not offer a DB scheme, in fact hundreds have been closed over the years. There are barely any open DB schemes in the private sector, because they cost an awful lot to run and provide. There are roughly 10.4m people drawing a pension from a DB scheme and it’s fairly evenly split between private and public sector pensions. Remember that these are pensions payable for many years with a degree of inflation-proofing. Back in 2006 there were about 3m members of private sector DB schemes, half of them were closed, but by 2019 only 0.6m members were actively building benefits due to the number of closed schemes, deemed too expensive. Contrast this to the 0.9m members of open private sector DC schemes in 2006 which has risen to a whopping 10.6m.

To put a little more ‘flesh on the bones’ of the open private sector DB schemes, employers contribute a weighted average of 19.1% with employees adding a further 6.5%. Compare this to the weighted average private sector DC scheme where employers contribute 3.5% and employees just 1.6%. It doesn’t take a maths genius to work out that its much cheaper (by a country mile) for employers to provide a DC scheme, for which they pay annual contributions when their member of staff works for them and not a penny more thereafter.

Stating the obvious, if you are running any business, profit is what sustains a future; reducing costs increases profits (or should). The Public Sector cannot generally make quick and substantial changes like this. Generally the approach has been to alter existing DB schemes, with pensions starting later (65, 67, 68 as opposed to 60). Member employee contribution rates have increased – doubling in many cases. Finally, the rate of accrual has also been changed, often dressed up as better, but invariably forfeiting other benefits such as a lump sum. This is where most Union and legal challenges have been directed.

So taking a typical doctor who began their career paying 6% into a 1/80th pension scheme that would provide a pension for life from age 60 and a one-off tax-free lump sum. If they started working without any career breaks they might build 36 years of service (36/80ths) providing a 45% pension of their final salary (say £130,000) of £58,500 a year and a one off lump sum of £175,500.

If we exclude inflation, a same salary doctor will need to work an extra 7 years to get their pension at 67. They pay closer to 13.5% of salary to the pension and build it as 43/54ths of 79% of their salary (no lump sum)… but the Government was smarter than that, the maths isn’t really 1/54th of final salary, it’s of each year … the term ‘career average earnings’ captures this.  A doctor starting out is obviously paid substantially less than one at the peak of their expertise and career earnings – so it’s nothing like a final salary but an average salary over 43 years.  Taking the midpoint as an example, 21 years into a career – or retiring on a salary that you had 21 years ago. In fairness it isn’t quite like that, there is some inflation-linking, but this is detail you don’t need to know right now. The principle is how pensions in the Public Sector have been sliced and diced to save money.

When you add in draconian Government/HMRC rules about the Lifetime Allowance (a tax charge of 25% or 55% for those with pensions valued at over £1,073,100 and the Annual Allowance formula used, (which for many triggers a substantial tax on a pension income they have not yet had), it is very hard to conclude anything other than a deliberate strategy to remove higher paid long-term employees … like doctors.

So quite apart from the awful treatment medics often get in the media and utterly fictional suggestions of Consultants barely breaking from a round of golf to turn up for work occasionally, there is little wonder that most of them feel betrayed by a nation that they chose to serve. I can certainly tell you that from three decades of working with NHS doctors, I’ve not met any that became multi-millionaires through their work within healthcare. Some are certainly more entrepreneurial than others, but most of them simply love medicine and get satisfaction making a real difference in people’s lives, more likely describing it as a ‘calling’.

The reasons for the NHS being in crisis are complex and many, but part of the reason is that many doctors are being forced to reduce the number of sessions that they work or retire early so as to avoid a scenario where they are essentially paying more tax than the income they earn … actually paying to work. It is down to the Government and policymakers to have an adult approach to pensions and scrapping many of the really very badly thought through self-defeating rules.

You can read more articles about Pensions, Wealth Management, Retirement, Investments, Financial Planning and Estate Planning on my blog which gets updated every week. If you would like to talk to me about your personal wealth planning and how we can make you stay wealthier for longer then please get in touch by calling 08000 736 273 or email info@solomonsifa.co.uk

Golden handcuffs2023-12-01T12:12:39+00:00

The Autumn Statement 2016

The Autumn Statement 2016

With a few hours to go Philip Hammond will be delivering his first Autumn statement, perhaps his last too if reports are to be believed that he will scrap them… who knows. In any event here is my quick wish list for the Autumn Statement

My Autumn Statement Wish List

(from a financial services perspective)

Abolish the Lifetime Allowance, which is currently £1m – if you hold more than this in pensions and you haven’t already “protected it” you will suffer an excess charge. Utterly pointless and discourages people from saving for their financial independence. This would also imply scrapping all previous protections.

Abolish Taper Relief – the new rule that has caused a raft of problems for those earning over £150,000 who can end up able to pay less into a pension (and still may suffer a penalty) than can be invested into an ISA. Utter lunacy, creating enormous headache for some.

Abolish Higher Rate Tax Relief – not what you might expect me to say and on the caveat that the two previous points are met. This saves the UK considerable sums, yet continues to offer an incentive to save for a pension.

Abolish Tapered Personal Allowance – either everyone gets one or nobody gets one. At the moment if you earn over £100,000 your personal allowance reduces by 50p for every £1 over £100,000.

Scrap the new Main Residence IHT allowance – just give everyone an allowance of £500,000 and have done with it. What former Chancellor George Osborne created is a shambles of smoke and mirrors.

Re-establish the different systems for Final Salary (Defined Benefits) pension schemes without any annual allowance, restricting total contributions to any pension to a fixed % of income by the employee (it used to be 15%). Vast sums and energy is used by departments in the NHS, Teachers, Local Government etc all creating utterly pointless, time sucking reports about the Annual Allowance and Lifetime Allowance. This is completely unnecessary.

Abolish LISA – another attempt to hit pensions with the high exit charges and daft array of decisions. Scrap this and other utterly pointless versions of an ISA. Have the single ISA allowance of £20,000 invest it however you like.

Stamp Duty – introduced to calm the property market which is now largely locked up with anxiety about Brexit etc. Huge tax take by Government and feels like a mugging. This needs reduced dramatically.

Fair Taxation

Earn it and tax it here. If you or your business generate income here in the UK it should be taxed at UK Corporation tax rates. Take note Google, Starbucks and Mr Green (et al). So all that nonsense for cross transfer pricing must end.

Genuinely Seeking Transparency and Tax Simplification? Have three rates of personal tax 0%, 20%, 40%. Whatever the source (dividends, capital gains, income etc). Huge sums are wasted on preparing numbers for a system that is designed to confuse. People break the rules deliberately or without knowing.

Corporations

Businesses pay corporation tax, this could be the same rates, with different allowances as personal taxation… this might mean busineses would use their revenue to reduce profits, either through inward innovative investments, expenses, employing people or redistributing to shareholders. More innovation creates more value, wealth, jobs….more tax take.

Means-Testing

If you are retired and have an income in excess of say £100,000 you forefeit your State Pension. You also forfeit free travel on public services and also the Winter fuel allowance…. come on, if you have a £100,000 income and don’t work any more, you aren’t going to need it or miss it and a relatively small number of retired people have £100,000 pension.. but really if you are a celeb you can give up your State pension and bus pass.

Landlords

Being a landlord is just like being a business. You have power over where people live. Some vetting is clearly needed (obviously not all landlords are bad). Landlords should have to apply to be a landlord license and register properties and all those living in them. Property has to be inspected every 3 years to ensure it is suitable for real people to live in. The new rules introduced about CGT, Stamp Duty and interest relief need reviewing, fair rents and fair offsets.

Ok, highly unlikely these will happen, but I really think some better ideas from Chancellors are required…

Our APP will be updated by the end of the day with all the relevant changes. It is FREE to have simply search for Solomons Financial Planning on either APP platform. There are loads of free tools and calculators to try out including an expenses tracker.

 

Dominic Thomas
Solomons IFA

You can read more articles about Pensions, Wealth Management, Retirement, Investments, Financial Planning and Estate Planning on my blog which gets updated every week. If you would like to talk to me about your personal wealth planning and how we can make you stay wealthier for longer then please get in touch by calling 08000 736 273 or email info@solomonsifa.co.uk

The Autumn Statement 20162025-01-21T16:34:24+00:00

The Future of Pensions

The Future of Pensions

I am currently at my annual conference in Wales – the Chartered Institute for Securities and Investments (CISI) with whom the IFP – Institute of Financial Planning merged last year. Yesterday we covered a number of valuable topics, but the talk that resonated most with me was from former Pensions Minister MP Steve Webb, who talked about the future of pensions – amongst other things.

I had to admit that my BS radar is usually on hyperdrive when listening to any politician these days, which is probably a sad reflection on me, however I was very impressed by what he had to say, albeit he did not paint a terribly pleasant picture of the future. Of course, only time will tell if his predictions come about and in fairness, he was quick to remind us of the problems with predicting the future, particularly in a climate where since the last general election all of the major political parties have changed their leaders and the country has voted to leave the EU.

Book cover of Yes Minister - A Very Courageous Decision

Play it again Sam…(or Phil)

Webb was clear that changing pensions is pretty difficult and appears to be a low priority to either the Government of Civil Service. He gave an insight into the slow turning wheels of Whitehall, sounding much like an episode from Yes Minister. Given all the change that we have had (State Pension, Auto Enrolment, Pension Freedoms, Annual Allowance Taper, Lifetime Allowance…) he suspects and urges a period of quiet inaction from the Chancellor, Philip Hammond. This is particularly pertinent to those concerned about the loss or reductions of tax relief on pension contributions or changes to the tax free cash entitlement. He made the case that the public and financial planners could not plan ahead in confidence if the rules are changed every year, yet warned at Chancellors are easily tempted by ideas to collect more tax, however short-sighted.

Whilst on the subject of tax he made it clear that the Treasury are naturally inclined to taxing now rather than in the years ahead, so there is a very real pressure to take the view that tax relief reductions in the short-term outweigh the advantages of taxed incomes in the future, so by inference, a system of loss of tax relief and no taxation of pension income is a genuine prospect. He argued that this was evidenced by the Treasury’s love for ISAs and obvious contempt for pensions with the Lifetime Allowance reductions (and associated tax penalties) and the new tapered annual allowance. Personally he would scrap the LTA but retain a cap on annual pension contributions (which I certainly agree with). He did point out that of course putting trust in future Chancellors to honour a commitment not to tax pension income in the future required a high degree of faith, which  deliberately provoked some mirth from the audience.

Turning to Brexit, he simply outlined his view that interest rates are likely to be very low for a long time, which would place pressure on people to look for better returns than the puny sums they achieve from their savings. He argued that this would likely lead to yet more scams as people fall for yet more illusory promises of high returns. He also warned of the impact on final salary pension schemes which, because of the assets that they hold and the way calculations are performed, would have larger deficits in their pensions (due to low interest rates) probably leading to some, or perhaps a majority of companies trimming their dividend payments.. which in turn makes the task of achieving investment income harder still.

He seemed to have little regard for our regulator of whom he said was “not fit for purpose” and thought the new LISA was perhaps the most badly constructed investment idea for years. If you follow me on social media, you will know my thoughts on this already.

So, whilst Steve Webb found a receptive audience, I was left with the sinking feeling that there was little hope for common sense to return to the Treasury… but who knows… we all get to find out in a few weeks time for the Autumn Statement.

Dominic Thomas
Solomons IFA

You can read more articles about Pensions, Wealth Management, Retirement, Investments, Financial Planning and Estate Planning on my blog which gets updated every week. If you would like to talk to me about your personal wealth planning and how we can make you stay wealthier for longer then please get in touch by calling 08000 736 273 or email info@solomonsifa.co.uk

The Future of Pensions2025-01-21T15:03:17+00:00
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