In its response to the Government’s consultation on pension tax relief measures, Hymans Robertson, independent experts in benefits and investment, has outlined its thoughts and key recommendations to the Department for Work and Pensions.

Chris Noon, Partner at Hymans Robertson said: “With the current economic and political landscape providing a once in a generation opportunity for pension reform, we welcome the Government’s plan to address the complex issue of tax relief. For too long the system has been in need of simplification and on the face of it, the revised proposals strike a better balance of raising the required tax revenue and reining in administrative complexity.

“However as with any aspect of pension reform, it’s vital that whatever measures are implemented help foster a wider savings culture amongst the UK population. With this in mind there are several areas that require further thought as the Government develops its final proposals.

“Firstly in shifting from earnings to an accrual based system, the Government has fundamentally shifted the burden from high paid employees to those on much lower salaries that happen to enjoy generous pension accrual. Such changes are another nail in the coffin of defined benefit plans and it’s important the Government recognises this and introduces appropriate measures to mitigate this.

Transitional protection:

“A further issue that needs to be considered by the Government is the lack of transitional protection for those employees who have suddenly been impacted by the introduction of a lifetime allowance. Without this transitional protection many businesses may find a large number of senior staff deciding to take their benefits early as it becomes economically inefficient to continue saving for retirement. Such a situation may cause succession challenges for many companies.

“Equally relevant is the fact that under such heavily reduced annual allowances, the function of lifetime allowance in the medium term becomes questionable. Such limits may also act a disincentive to many defined contribution members to adopt more aggressive investment strategies.

Dealing with anomalies and ill health retirement:

“As with any large scale change in legislation, there are several anomalies that need to be considered, most notably around the issue of ill-health retirement which under current proposals isn’t exempt from annual allowance tests. Whilst potential abuse of the system is an important concern, the Government must first consider alternative ways of monitoring such plans rather than forcing a complete redesign of several functional and well run schemes.

The need for communication:

“How the Government communicates these changes and how they are likely to evolve over the short, medium and long term also needs to be considered. Changes to pension tax relief will force many employers to design new schemes in order to retain and attract talented employees. Further detail around how annual and lifetime allowances will increase over time is necessary to reduce the amount of ongoing intervention required by companies.

“Whilst the Government has rightly responded to previous unworkable proposals. There is a real danger that in the rush to get the new regime in place for April 2011, unintended mistakes are made that take years to rectify”

Specific Government recommendations:

On Annual Allowance:

• Keeping the revaluation of previous year’s benefits outside of the annual allowance
• Setting the annual allowance at £40,000 to ensure only those employees with moderate to high levels of pay are impacted
• Reducing the impact on moderate earning employees with long service in defined benefit plans by:
• Introducing an income threshold of around £80,000 below which the annual allowance regime does not apply
• Setting a higher allowance for plans that are contracted-out of the State Second Pension to reflect the effective accrual of this benefit in the plan
• Keeping normal ill-health retirement benefits exempt from the annual allowance text and introducing the appropriate anti avoidance provisions to prevent abuse of the system
• Setting out detailed commitments to show how annual allowances might grow in the short, medium and long term

On Lifetime Allowance:

• Introducing transitional arrangements that do not result in employees needing to retire
• Maintaining the lifetime allowance valuation factor at 20
• Setting out detailed commitments to show how lifetime allowances might grow in the short, medium and long term
• Only applying the lifetime allowance test to those employees with a lifetime allowance above a particular threshold as at 6 April 2011. For employees with a lifetime allowance below this level, the regime would never apply. This lifetime allowance threshold could be set by reference to an employee’s age. For example our analysis, based on the typical salary progression of high earning employees and reasonable investment returns would suggest the following thresholds: