Executive Summary
• When linked with employee share plans, a self invested personal pension (Sipp) can boost pension pots by thousands of pounds because shares from approved schemes can be rolled over into the pension, tax-free.
• Employees in share incentive plans (Sip) can move their shares tax free into a Sipp when their Sip matures. Employees in a sharesave can do so with only capital gains tax to pay.
• Once the shares are in the pension, there's no income tax to pay on dividends nor capital gains tax to pay if an employee decides to sell. The shares follow the same rules as other pension assets: they can be sold and the proceeds used to buy alternative pension assets, but they cannot be moved out of the pension before the employee's retirement date,
• Senior executives who have a shareholding requirement can put the shares into the Sipp in a tax-efficient way.
Main article
Getting employees to save for their retirement isn't easy at the best of times, but when share prices are in free fall, and any investment in the pension could be worth less tomorrow, it's nigh-on impossible. Employers can, however, make one change to the package that will not only boost employee pension contributions, but will also make employee share ownership more attractive, and give employees a tax saving into the bargain. That change is the introduction of a group self invested personal pension (Sipp), which when linked with employee share schemes, can boost the pension pot by thousands.
The difference from a GPP is that they allow much broader investments, including single company shares. This means that shares from approved schemes can be rolled over into the pension, tax-free. So any employee in a share incentive plan (Sip) can move their shares into a pension when their scheme matures, tax-free, and any employee in a sharesave can do so with only capital gains tax to pay.
Now, admittedly this isn't much use for sharesave at the moment, because as Jackie Holmes, a senior consultant with Watson Wyatt points out: "Most share options are underwater, so most employees are just taking the cash." It's the link with a Sip that has potential. "It is one of the key drivers of Sipp growth," says Steve Langmead, a consultant with Mercer HR Consulting.
Holmes explains: "The key thing with a Sip is you are getting tax relief when you initially invest the money, as you buy it before tax and National Insurance. Then when you roll it into a pension you get another round of tax relief. It's treated like any other pension contribution, and attracts relief at the employee's marginal rate - whether that's basic or higher rate. It's a double-whammy. Once the shares are in the pension, there's no income tax on dividends or capital gains tax if you decide to sell." [see box left].
For higher-rate tax payers there's a chance to get an immediate benefit from that tax relief too. Dave Petchey, group Sipp business development manager for Hargreaves Lansdown, says: "The scheme will refund the basic rate, but the extra has to be claimed by the individual through the tax return. That portion of the tax relief is offset against any tax liability in that year, providing an immediate benefit."
There are also additional advantages for senior executives who are compelled to hold shares in the company. Holmes says: "Senior executives may have a shareholding requirement, so putting it into the pension serves the purpose and allows them to do it in a tax-efficient way."
And while the employee takes advantage of tax relief, there are benefits for employers too. Perhaps the biggest is the boosting of retirement saving, helping to ensure that when it's time for employees to stop work, they will be able to afford to do so. The boost to savings can be massive. When Henderson Global Investors set up a Sipp for its maturing sharesave, for example, 150 employees set up a pension and transferred in the proceeds of the share scheme. It resulted in additional pension contributions of just over £3 million.
The introduction of a group Sipp to facilitate this transfer can also be a useful way to make pension changes more palatable. Holmes says: "When people are making changes to the pension they are looking for a sweetener, so they can say 'you can boost your pension through the share plan'."
To take advantage of these benefits, employees have to follow strict rules when transferring the proceeds of a scheme. The sharesave matures at a specific date, and there are 90 days to roll shares over into a Sipp. Sips, meanwhile, don't have a specific maturity date. You have to hold your shares for five years to get tax relief, and shares should be rolled over within 90 days of the day they become tax-free. The way the shares are rolled over is also important. Holmes says: "It cannot be a transfer. Transfers don't get tax relief. It has to be an 'in specie' move."
And of course, once the shares are in the Sipp they follow the same rules as any other assets in that pension. They can be sold and the proceeds used to buy alternative pension assets, but they cannot be moved out of the pension before your retirement date, Holmes says: "The downside is once the shares are in the Sipp, they can't take the proceeds until they are 50 (55 from 2010) and even then they can only take a quarter of the pot as a lump sum."
This downside means rolling shares over may not be suitable for all employees. Mercer's Langmead says: "The vast majority of people will have earmarked funds from their Sip or sharesave for other things, whether that's paying off debts or buying a new car."
And this isn't the only downside. Higher earners with large pension pots may run into trouble if they transfer too many shares to their pension. They need to make sure that any transfer doesn't risk them exceeding their lifetime limit, which would mean their pension would be frozen.
Employees also need to think about the costs involved. Sipps can charge the employee, or the employer for transfers, and tend to charge the employee. So, for example, when shares are rolled over, there is a stamp duty cost of 0.5% of the transfer. There may also be a charge from the administrator, and because most schemes tend to have a tranche of shares maturing every month, this could prove expensive.
These complications mean detailed communication is vital if employees are going to understand the scheme, buy into it successfully, and not fall foul of the rules. Holmes says: "It requires very careful communication." Employees need to understand both how the system works, and how this may fit within their other financial plans. Langmead says: "Financial planning needs to be brought to the fore. People need to think whether this is really what they want to do."
So far, only a few employers have made the leap and established a group Sipp. According to the Employee Benefits/Axa Pensions Research 2008 only 5% of respondents had them. However, in the last few months, the market has gained momentum. Philip Hutchinson head of corporate Sipp sales for Pointon York Sipp Solutions, says: "Interest in corporate Sipps has gone crazy this autumn." As the economic climate worsens, the opportunity to boost pensions and get employees to feel better about money tied up the share schemes becomes too good to ignore†
Worked example of tax relief†
Situation: A higher rate taxpayer contributes £125 a month to a share incentive plan, which provides matching shares at 2:1
Year 1: He has contributed £1,500 to the share incentive plan (Sip), but after income tax and NI relief it has only cost him £885. The employer has contributed £3,000, and assuming the share price is static the plan is worth £4,500.
Year 5: The shares from year one are rolled into a self-invested personal pension (Sipp). The value of the shares is treated as a net contribution, so basic rate tax relief of £1,125 is added, and higher rate relief of £1,125 is claimed by the employee.
Result: From £885 of contributions he has £5,625 of shares, and £1,125 in cash from the tax relief, giving a total value of £6,750.
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