A growing number of senior executives are concerned about the pension earnings cap, according to research by consultants William M. Mercer. Of over 100 major employers surveyed, 62 per cent said that the cap was raised by senior executives as an issue at recruitment interviews, with the number rising to 83 per cent in the case of board directors. Currently the government only permits tax relief on pensions up to an earnings limit of £95,400, producing a maximum pension of £63,600 under the current two-thirds of salary rule.
Since the restriction was introduced in June 1989, an increasing number of executives are being hit as a growing proportion move to new employers – thus triggering the cap rules – and as executive earnings rise faster than the annual cap increase (in line with RPI). Assuming a 4 per cent annual increase in earnings above RPI, an executive aged 40 and earning £50,000 would be restricted by the cap well before reaching age 65.
The survey found that 58 per cent of employers have developed a formal policy to deal with compensating executives for the restriction on retirement benefits in their main occupational pension scheme. The methods of dealing with the problem are diverse, ranging from optimising benefits under the approved company pension scheme, establishing a funded or unfunded unapproved retirement benefits scheme (FURBS or UURBS), to providing an additional amount of salary. Many employers adopt more than one solution.
Some 27 per cent of respondents said they gave no additional compensation to overcome the effects of the earnings cap.
Some 28 per cent of respondents are now offering extra cash as the solution, compared with 20 per cent two years ago,
Funded Unapproved Retirement Benefits Schemes (FURBS) continue to be the most popular method of augmenting executive pensions, despite the introduction, in 1998, of National Insurance contributions and the increase in capital gains tax under these schemes. Some 34 per cent of employers choose this route.
Unfunded Unapproved Retirement Benefit Schemes (UURBS) are another popular alternative. Unlike FURBS, these schemes promise a set level of benefits that is met directly from company cash flow rather than a trust arrangement. Such schemes account for 24 per cent of the various top-up options, although their popularity has declined in recent years – down from 30 per cent in 1998.
“We were surprised by the reduction in popularity of UURBS – since, in theory, the lack of National Insurance contributions on payments make them an attractive option from the employer’s point of view,” said Ken Barclay, Worldwide Partner at William M. Mercer. “It appears that executive concern over lack of funding and security is a factor, as is the preference of employers for other options providing fixed benefit costs.”
A cost comparison for each type of top-up provision revealed some interesting results. Participants were asked to indicate the likely annual cost of implementing their current policy for a new executive aged 45 earning £140,000. The resulting comparative figures showed that the defined-benefit UURBS solution costs twice as much as extra salary or the FURBS option which is mostly defined contribution-based. The cost of funding a top-up pension through FURBS was just £14,000, while extra salary averaged £13,000. These compared with UURBS benefits costing a more substantial £30,000.
When asked about future policy on overcoming the earnings cap, FURBS benefits continued to be cited by 42 per cent of employers as the main vehicle, while extra salary was preferred by 36 per cent of employers. Interestingly, long-term incentive plans (cited by 17 per cent) were felt to be a more probable solution in the future than UURBS benefits which were the preferred option of just 12 per cent of respondents.
The survey also covered compensation methods for loss of other benefits above the cap. The findings showed that life insurance is the most popular unapproved benefit – provided by 90 per cent of respondents in 2000 compared to 70 per cent in 1998. This figure reflects their relative low cost and the high demand from executives.