The fall out from Sir Fred's pension

BY Ian Pollock
Personal finance reporter, BBC News

Sir Fred's Edinburgh home was vandalised in March

In a villa on a private estate near Cannes on the French Riviera, Sir Fred Goodwin has been doing more than just enjoying the sunshine and escaping the people who vandalised his Edinburgh home, and car, earlier this year.

He, or at least his lawyers, have been busy negotiating with the bank he used to run, the now government-controlled RBS.

The deal they have agreed will see him return half the increase in his pension pot that the former directors awarded him last year.

The increase in his pension had been seen by RBS as a price that was right and proper to keep Sir Fred on board while he handed over responsibilities to his successor.

It meant that at the age of 50 he would take with him a full pension that he would otherwise have enjoyed only by working to the age of 60.

He retired in January this year on a pension of £703,000 a year. However, he later converted some of his £16.6m pension pot into a tax-free lump sum of £2.7m, in exchange for a lower annual pension.

After this latest deal, his annual pension will now fall from £555,000 to £342,500.

High earners

However, Sir Fred's pension saga has probably affected all higher rate tax payers.

I think he made it possible for the government to treat high earners as fair game on pensions Tom McPhail, Hargreaves Lansdown

Some observers think that the revelations about RBS's generous pension arrangements for its former chief executive led directly to one of the most surprising aspects of this year's Budget.

That was the proposal that from 2011, anyone earning more than £150,000 should have to pay as much as 30% tax on any contributions made to their pension schemes by their employers.

"I think he made it possible for the government to treat high earners as fair game on pensions," said Tom McPhail of financial advisers Hargreaves Lansdown.

"His pension arrangement and the public reaction to that created a climate where the government thought it fair to penalise high earners' pensions," he added.

How it happened

It is worth recalling just how Sir Fred was able to build up such a huge pension after just 10 years at RBS.

When he joined in 1998 aged 40, the bank agreed, in effect, to pay him not so much a pension when he retired, more a salary for life.

All this was revealed when RBS wrote to the Treasury Select Committee earlier this year, to explain how his pension had been set up.

It revealed correspondence in which the bank told Sir Fred how it would guarantee that he eventually retired on two-thirds of his final salary.

To achieve this it decided firstly to treat him as if he had been a member of the bank's final salary pension scheme since the age of 20.

That gave him an extra 20 years membership of the non-contributory scheme.

It also decided to pay into the scheme at double the normal rate during his years of his actual employment with the bank.

Bridging the gap

A letter to Sir Fred from the bank's group director of human resources, Neil Roden, summarised the arrangements.

If these arrangements prove inadequate the Group will still be responsible for providing the full entitlements RBS letter, 2004

"Benefits will be calculated assuming a notional start date of your 20th birthday," he said.

"In particular this means that if you remain with the group until age 60 your pension will be two thirds of your full basic salary," he added.

One problem at the time of this letter was that Inland Revenue rules limited anyone's pensionable salary in a tax-approved pension scheme to just £97,200, two-thirds of which amounted to just £64,800 a year.

However, his basic salary in 2003 was now £898,000, entitling him already to a pension of £334,000 according to the bank's annual report.

To bridge the huge gap between the Revenue limits, and the pension already promised, RBS made a number of further commitments to Sir Fred.

"Benefits will be calculated ignoring the effect of the earnings cap (currently £97,200 a year)," Mr Roden wrote.

To do this the bank promised to pay the extra money to Sir Fred directly from its own funds, or via a pension scheme common at the time for highly paid executives known as a FURBS (a funded unapproved retirements benefits scheme).

Contractual entitlement

To emphasise that the pension would, if necessary be paid by the bank directly, and not by the pension scheme, the bank wrote:

"The benefits set out in this letter... are a contractual entitlement and, to the extent they are not met from the Group fund or a FURBS, the Group has a legal obligation to pay these benefits to you."

A later letter from 2004 underlined the bank's commitment.

"If these arrangements prove inadequate the Group will still be responsible for providing the full entitlements," it said.

Things became even better for Sir Fred in 2007.

If he eventually decided to take 25% of his pension pot as a lump sum, then any money from either a FURBS or directly from the bank would land him with a 40% tax bill.

So in further letters the bank simply agreed to pay any such tax bill for him.

What is not known is if Sir Fred negotiated hard for these pension promises, or if the bank's directors simply thought they were a good idea to retain a top man who deserved all he would get.

But they have shone a light on the extent to which the pension arrangements of the very highly paid are, in fact, more valuable then their salaries.

HM Revenue & Customs (HMRC) recently revealed it expects the number of higher rate taxpayers to shrink by a million in just two years, because of the recession.

It seems the details of Sir Fred's pension package did not pass unnoticed as Alistair Darling pondered ways to raise more tax from the rich in his last Budget.