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Employers swap bonuses for tax-free pensions

REMUNERATING high earning employees in a tax efficient way has always been difficult, and the recent interest in bonuses has made it even more tricky for employers. The introduction of the 50 per cent rate of taxation on those earning over £150,000 has also spurred many to look at ways to protect its high earners. One alternative which has been attracting the interest of employers is the EFRBS (the Employer Financed Retirement Benefit Scheme). Several FTSE 250 companies are looking into the scheme, and fund manager Fidelity recently launched this product.

An EFRBS is a scheme commonly used to provide retirement benefits to high-net-worth individuals, and is not registered with HMRC. It is usually set up under a trust and used to recompense key employees, directors or shareholders during retirement. There are two types of EFRBS: funded, where an employer contributes funds to the trust in advance of the employees’ retirement; and unfunded, where the employer only contributes funds during the retirement of the employee.

An EFRBS, being an unregistered arrangement, is not subject to the restrictions placed on registered pension schemes and as such is a more flexible investment vehicle. It benefits from less restrictive investment opportunities than registered pension schemes and can also lend and borrow money, invest in unquoted companies and effect commercial transactions with scheme members or the employer. Furthermore, contributions made to an EFRBS are not subject to either the annual allowance (the annual limit on tax free pension savings) or the lifetime allowance (the total value of pension in registered schemes that may be built without incurring extra tax charges).

Where statutory conditions are met, no income tax liability or employee’s NICs will be payable when the employer contributes to the EFRBS. The employers’ contributions will not be subject to income tax in the employees’ hands, until a qualifying benefit is paid out of the EFRBS.

The significant advantage for high earners is that contributions to the arrangement are not caught by the new pension rules (brought in by the budget in 2009) which can trigger a tax charge on individuals in respect of contributions made by the company. Accordingly, high earners may be able to avoid the 30 per cent pension input tax charge that is generally applicable in respect of employer contributions to registered schemes made on their behalf by having the employer contribute instead to an EFRBS.

In addition, if an employee has, or is likely by retirement to have, benefits that exceed the lifetime allowance, an unfunded EFRBS may be a viable option for providing retirement benefits in excess of that allowance. The rate of tax payable on benefits paid under the EFRBS (currently 40 per cent and rising to 50 per cent for 2010/11) is less than the penal 55 per cent tax which is payable on lump sums in excess of the lifetime allowance payable from a registered scheme.

An EFRBS allows employers to motivate key high earners, or make tax efficient loans to itself or its employees. The EFRBS market is growing, and one which City institutions are sure to find it more attractive in the months ahead.

acopestake@jonesday.com
ireid@jonesday.com