The Finance Act 1989 introduced an earnings cap which limits the amount of remuneration which can be taken into account in calculating the maximum benefits and contributions available under approved schemes. The earnings cap is £91,800 for the tax year 2000/01. The maximum pension that an individual who is subject to the cap and who retires in 2000/01 can receive from an approved occupational scheme is therefore two-thirds x £91,800 = £61,200. The earnings cap is normally increased on 6 April each year in line with the increase in the RPI over the 12 months to the preceding September, although the cap was frozen for a year in 1993-94. Subject to exceptions which relate to "uncapped" members of a scheme who join another scheme operated by the same employer or corporate group, the cap affects all employees joining an occupational pension scheme on or after 1 June 1989 and those joining on or after 14 March 1989 if the scheme was not established prior to that date. Since earnings inflation generally exceeds price inflation, over time the proportion of salary pensionable in approved schemes will decrease. The relatively low level of earnings inflation in the 1990s has meant that this has not yet been a major factor. However, there are signs that the gap between earnings inflation and price inflation is starting to widen again.
An employer faced with a new employee who is subject to the earnings cap has a number of options.
For example, the employer could :
• Take no action
This may become more popular. As time passes, capped pensionable earnings will become the norm and employers may be unwilling to make special arrangements for new employees, particularly where existing employees whose salaries have gone through the cap during the course of their employment are not compensated.
• Increase remuneration to compensate .
This option has become more attractive since the imposition of National Insurance Contributions ("NICs") on employer contributions to FURBS (see below)
• Provide compensatory benefits under an unapproved scheme
If an employer elects to provide benefits under an unapproved scheme, he has the option of doing so via a funded unapproved scheme ("FURBS") or an unfunded unapproved scheme ("UURBS"). An UURBS is normally a contractual promise to top up benefits to the level they would have been on retirement or death if the cap did not exist. One advantage of an UURBS is that the employee’s benefits under the approved scheme can be augmented to the extent allowed by the Inland Revenue, hence reducing the cost of the unapproved scheme to the employer where the approved scheme is in surplus. Even where Inland Revenue limits restrict the pension payable, there will almost always be some leeway so that at least part of the UURBS promise can be met via the approved scheme.
This ability to use surplus to reduce costs is perhaps one reason why large employers have tended to favour UURBS. Another is that UURBS are easier to establish and operate, and easier to combine with final salary arrangements, than FURBS. In addition, new employees are more likely to accept an UURBS promise from a large employer since security of benefits is unlikely to be an issue. From the employee’s perspective, there should be no difference in receiving pension benefits via an UURBS than under an approved scheme except that it will not be possible to commute part of the benefit for a tax free lump sum unless the employer agrees to meet the employee’s tax liability (note that company law prohibits this where the employee concerned is a director). The same cannot be said of lump sum death in service benefits. In theory, they could be unfunded (ie self-insured by the employer), although in practice they are likely to be funded even where the pension benefit is unfunded, in which case employees will be taxed on the premiums
paid by the employer as a benefit in kind, although no Inheritance Tax should be payable by the beneficiaries if the arrangement is structured correctly. Again, some employers may agree to meet the employee’s tax liability on the premiums. Despite the relative advantages for larger employers of UURBS outlined above, it was possible to discern a trend towards FURBS in the mid to late 1990s. One reason was pressure from employees since, although the employer’s contributions to a FURBS are treated as taxable benefits of the employee, the proceeds of the FURBS may be paid as a tax free lump sum and are not normally.subject to inheritance tax where they are payable at the trustees’ discretion. (This ability to use FURBS for tax planning, and the fact that security was more of an issue for their employees, has meant that FURBS have always been more popular with smaller employers). However, just as the FURBS movement was gaining momentum amongst larger employers, changes were introduced which reduced their appeal both for employers and for employees. The first was the introduction, with effect from 6 April 1998, of NICs on contributions to FURBS, which increased the cost to the employer of FURBS by 12.2%. Second, originally the trustees of FURBS were liable to both Income Tax and Capital Gains Tax at the basic rate (currently 22%). However, for gains after 6 April 1998 (when the CGT basis was changed) the rate at which CGT is payable on gains in FURBS is 34%, ie the rate applicable to trusts. (The CGT indexation allowance will be given for periods during which FURBS assets were held up to April 1998. For the period between April 1998 to the date of disposal of the assets, taper relief will apply and reduce the amount of the gain the longer the asset has been held. The Trustees of the FURBS will also normally be entitled to use their annual Capital Gains Tax exemption of half the personal exemption to reduce the tax liability).
Although these NIC and tax changes should in theory have slowed the trend towards FURBS considerably, in practice this does not appear to have been the case. There are perhaps three main reasons for this. The first is that, as the number of individuals who have been given unfunded promises grows, larger companies have become concerned at the level of growth of unfunded liabilities on their balance sheets, particularly during a period when corporate earnings have been strong enough to fund the benefits without any real impact on the profit and loss account. The second is the overall trend towards defined contribution arrangements which are easier to combine with FURBS. The third is that despite the erosion of the tax and NI advantages of a FURBS executives at smaller employers still see FURBS as a useful form of tax planning, particularly since assets are shielded from Inheritance Tax. Indeed FURBS appear to have been remarkably resilient to the changes, which suggests that they will continue to have a role in executive remuneration.
The information and opinions contained in this publication are provided by national law firm Hammond Suddards Edge. They should not be applied to any particular set of facts without seeking appropriate legal or other professional advice.
