When tailoring flexible benefits for executives, financial advice seems to complement the fat pay cheque, but there are other choices to be considered, says Matthew Stibbe
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Case Study: Kingfisher
Senior staff in many organisations have long taken advantage of discretionary bonuses to top-up their pensions and obtain other benefits. For higher rate taxpayers diverting a bonus into a flexible benefits pot can be very tax-efficient but there are pitfalls for the unwary. What's more, next year's pensions simplification changes will create both a short-term opportunity and a long-term squeeze on bonus- to-pension payments and will force employers to find new, tantalising alternatives.
Here's a typical scenario. An executive in a multinational firm is told that they may get a substantial bonus this year; but without any commitment from the employer. So if they were to receive a bonus, would they prefer some of it to be paid into their pension instead of paid in cash directly to them? And if so, what proportion would they wish to receive in this way?
To be tax-efficient, the bonus must be discretionary. According to David Hewison, a partner at accountancy firm Smith and Williamson, the critical factor is that the bonus mustn't be a contractual entitlement. If a contract of employment says someone is entitled to a percentage of the firm's earnings as a bonus, then it cannot be transferred tax-free into a pension. Instead, HM Customs & Revenue will tax it wherever it ends up.
This doesn't mean employers can't talk to staff who might receive large bonuses but the conversations must be carried out cautiously so as not to give any commitment. However, employers must get an indication from the would-be recipient about their wishes before the bonus materialises. Typically, a benefits manager would frame conditional questions in terms of percentages or proportions. Get the wording wrong or leave the discussion too late and firms run a serious risk. Nicholas Stretch, a partner at law firm Norton Rose, says: "[It can be] an HR disaster or the employer has to quietly pay the tax."
Employers can try to obtain Revenue clearance in advance for a particular arrangement or discuss it with their local tax inspector. However, there are costs and delays in doing so, especially as many of the schemes are put in at the last minute.
Changes in pensions legislation that come into force from 6 April next year will also change the way companies do things. Employees who have reached the overall lifetime pension allowance or who have reached their annual contributions limit will have little tax incentive to sacrifice bonus payments to top up their pension. On the other hand, there are opportunities for staff to dump money into their pension fund before April.
Bonus-to-pension payments will still be attractive to younger employees who have not reached their lifetime limit. However, very high earners may be frustrated by the annual limit on contributions.
Staff who have grown used to being able to top up pension funds from bonuses in a tax-efficient way may feel short-changed by bonuses that are taxed at the full rate, creating a pressure on employers to compensate. Worse, employers will have to pay employer's national insurance contributions on cash bonuses. Darren Smith, a senior flex consultant at Hewitt Associates, says: "The message we always try to give is that tax legislation changes. If you get into the scenario of compensating for tax you're on a hiding to nothing."
Some organisations also let employees put a proportion of their bonus into share schemes. Unless these are Revenue-approved tax-efficient schemes such as sharesave or share incentive plans, they are unlikely to save any tax for the employer or employee. However, at a senior level, it is likely that staff may already have substantial holdings of shares or options in their employer and might be unwilling to swap the certainty of a cash bonus for the undiversified risk of additional shares. In addition, at this level "all the tax-efficient ways of giving employees shares are likely to be exhausted already", says Hewitt's Smith.
However, Stretch is seeing more deferred bonus schemes. These involve taking, say, half of a cash bonus when it is due and deferring the rest for a year in the form of company shares. The employer offers to double it after three years so potentially the employee could make a killing, especially if the share price improves. "It's not particularly tax-efficient but you do end up with more [in the end] and the employer gets a kind of golden handshake," he explains.
In the realm of tax-efficient payments, the remaining options are pretty limited. However, there are a number of modestly tax-efficient benefits that might lend themselves to bonus-sacrifice.
There is no upper limit on tax-free bicycle schemes. Providing that employees use it to cycle to work on a regular basis, there's no reason why they shouldn't surrender some of their bonus payment in return for a gold-plated, carbon-fibre racing bike. Not every executive looks great in Lycra but this flexible benefit may appeal to younger high-flyers.
A home computing scheme can be used to buy a PC worth up to £2,500 which will buy a high-spec computer system for a senior manager to use at home.
Another popular benefit with top managers is the ability to buy extra holiday or sabbatical days. Building up a substantial bank of time can be enormously attractive. It is also something of a golden handcuff because a would-be recruiter would have to compensate individuals for the break they never had.
A variation on this theme is executive education. Companies will provide senior staff with business mentors or personal trainers as well as executive MBA courses or similar training plus the time off to do it. Some of these are taxable benefits but job training can be a tax-deductible business expense.
Other firms, meanwhile, have private jets or corporate jet cards. These are normally used strictly for business purposes but an employer can give access to these resources for private use on a cost-only basis. A round trip by Learjet to Nice might run to £6-8,000 on a chartered aircraft but less in a company plane. There are no tax benefits but it is an attractive perk and cost-effective for staff.
Firms are also offering top managers enhanced concierge services, wine selection and delivery, and other lifestyle benefits. Again these have no tax advantages but can leverage a company's buying power and achieve some economies of scale to reduce prices.
For most employees, flex schemes are administered using the internet. But for those higher up the company, it makes sense to do it in a more personal way. "It's probably not worth investing in a system per se for a small group of recipients," says Stretch. However, many companies are beginning to offer workplace financial education to accompany flex and, at a senior level, enhanced financial advice can be a valuable benefit in itself as well as a method of helping staff figure out what to do with their bonuses.
It also gets employers out of an awkward spot. Angus Jones, managing director at Clarity Global, says that although the first £150 per person of any advice is tax-free, providing a modest tax break for this benefit, and while there is a cost to the employer, there are benefits of fee-based (rather than commission-funded) advice. Jones argues that it is particularly attractive to more numerate senior staff with more complex financial affairs. Costs to the employer can be offset by savings to the employee in terms of flexibility and reduced commission costs to the adviser.
The last five years has seen many tax-efficient loopholes closed by the government. Being paid in diamonds or platinum won't save national insurance any more. Similarly, tax-efficient conditional share bonus plans are a thing of the past. There is still some value in topping-up pensions and buying shares with bonus payments but for a smaller and smaller pool of people. With A-Day approaching, that pool will become even smaller. Consequently, employers have to become more inventive and canny if they want their bonuses to have the maximum impact.
Execs' flex perks
- Pension top-ups
Case Study: Kingfisher
Kingfisher recently partnered with Clarity Global to provide its top 25 staff with a one-to-one financial advice service. The next 550 staff will be offered online and seminar-based services to help them in their decision-making.
The company hopes to save money by only having one financial adviser to talk to, and employees will benefit from unbiased, fee-based advice. It may even save them money. Senior staff with complex financial affairs can spend as much as two hours a week sorting out things like insurance and pensions during normal working hours so having professional advice and support can cut this overhead.