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Simplicity, Security And Choice Working And Saving For Retirement


Summary of the government's proposals

  • No change to the excessively complex two-tier system of State benefits and means tested benefits;
  • No change in State Pension Age although there will be greater flexibility regarding the age at which benefits can be taken;
  • There will be no new tax incentives. The principles underlying the tax treatment of retirement savings will be broadly unchanged - full tax relief on contributions, investment growth will be largely tax free, part of the benefits can be taken in the form of a tax free lump sum while pensions will be taxed as income. However, a single, simplified tax regime covering all types of pension provision will be introduced;
  • Pension provision will remain voluntary. However, an independent commission will be set up to regularly review the voluntary pension system relative to compulsory provision;
  • Consideration will be given to simplifying the existing regulatory framework as well as introducing greater protection for members of pension schemes that wind up.

Initial Barnett Waddingham reaction

We are extremely disappointed that the Government has not been bold enough to address the complexities and shortcomings of the current State system and has chosen to ignore the comments and expert advice received from just about everyone in the pensions industry.

The Government will be very keen to promote the "radical" nature of its proposals but the proposed simplification of the tax regime will not mean a radical change in the willingness or ability of the majority of the population to save for their own retirement. Regular review and reform of the tax system is an integral part of the Government's ongoing responsibility to provide a modern and efficient fiscal framework and should have been done years ago. It has nothing whatsoever to do with a fundamental reform of the pensions system. In our view, the Government's proposals will do nothing to address the "savings gap" or the "crisis in confidence" affecting pensions in the UK at the present time. There is nothing concrete to encourage the poorer members of society to save for retirement or to reverse the increasing number of pensioners subject to means tested benefits. Neither do the proposals do anything to encourage employers to run final salary occupational pension schemes for their employees. In some cases the Government has not even managed to make any firm proposals - it has simply expressed a willingness to consult!

The Government has put a great deal of faith in a "partnership" and "voluntary" approach but the underlying message is abundantly clear - it is up to individuals to save more or work longer. The Government has also shied away from compulsory pension contributions as politically unacceptable. Instead it has passed this particular hot potato (and the subsequent responsibility for introducing compulsion) to an independent commission. The Government has quite clearly ducked this fundamentally important issue. Do we really need another "independent review" and yet another prolonged period of consultation and debate? We were expecting the Government to tackle this issue in the Green Paper. Instead we will have to wait years before the current "crisis in pensions" is properly addressed. The Government is fiddling while Rome burns.

The consultation documents

There were actually four documents published on 17 December!

  • Simplifying the taxation of pensions: increasing choice and flexibility for all (a consultation document issued jointly by HM Treasury and the Inland Revenue);
  • Simplicity, security and choice: Working and saving for retirement (the Green Paper);
  • Simplicity, security and choice: technical paper (this paper considers the detailed technical aspects of the proposals set out in the Green Paper);
  • Report on the Quinquennial Review of the Occupational Pensions Regulatory Authority (OPRA).

Simplifying the taxation of pensions: increasing choice and flexibility for all

A key aspect of the Green Paper is the "radical" simplification of the pensions tax regime. The proposals are set out in the consultation document issued jointly by HM Treasury and the Inland Revenue. The consultation period ends on 11 April 2003. The consultation document does not explain how the new tax regime or the transitional arrangements will work in practice. Therefore, at this stage, we can only summarise the main principles as they appear in the consultation document:

  • The Government is proposing a "clean break" with effect from a given date known as A-day. Detailed proposals will be set out next year with A-day possibly being 6 April 2004. All pensions saving after A-day will follow a single set of rules that will apply to savings in all types of pension scheme.
  • In the new system there will be a single lifetime limit on the total capital value of pension saving that can attract favourable tax treatment. The Government intends to set this limit at £1.4million in 2004 with indexation broadly in line with price inflation thereafter. If an individual's pension benefits from all sources are taken at the same time, the lifetime limit will be tested once at the point of retirement. If an individual's pension benefits are taken at different times the lifetime limit will need to be checked each time, with certification of the proportion of the lifetime limit used up each time benefits are taken. If the value of an individual's overall pension fund exceeds the lifetime limit there will be a "recovery charge" tax of 33.3% on the excess funds above the lifetime limit. In addition, all of the excess benefits will be taxable as income at the individual's marginal rate.
  • Pension rights built up before A-day will be valued and converted into equivalent rights under the new regime. The Government has said that existing rights built up under current tax regimes will be "respected" although it is not clear how this will work in practice. The £1.4m lifetime limit is approximately the capital value of the maximum benefits that a member of an occupational pension scheme subject to the earnings cap can currently receive. As such, everyone will become effectively capped for future pension accrual after A-day.
  • Tax relief at the individual's marginal rate will continue to be available on pension contributions. There will be an annual limit on tax relievable inflows to an individual's pension fund - both contributions to any defined contribution scheme and growth in pension rights in defined benefit occupational schemes. The proposed annual limit in 2004 is £200,000 which will also be indexed thereafter. Any 'inflows' above the annual limit will be subject to an income tax charge.
  • There will be no restrictions on the number or types of pension scheme to which an individual can contribute i.e. full concurrency will be allowed.
  • There will also be a single, consistent set of rules about the delivery of pension benefits. The maximum tax free lump sum will be set at 25% of the capital value of the pensions savings.
  • When an individual dies before taking benefits, the whole value of their pension funds could be paid as a tax free lump sum, except for any recovery charge tax on payments above the lifetime limit.
  • The proposals include allowance for more flexible retirement options. In particular, individuals will be allowed to draw benefits while continuing to work for the same employer. As part of the introduction of more flexible retirement the Government intends to increase the minimum retirement age from 50 to 55 by 2010, and the concept of normal retirement age will disappear from tax legislation.
  • The Government is hoping that these proposals will encourage more flexible annuity products, with the formal approval of "cash back on death" annuities and "limited term" annuities, although the requirement to purchase an annuity by age 75 will remain.
  • The Government has acknowledged that there are some major practical (and actuarial) issues that need to be resolved regarding the valuation of different types of benefits at different times. However, the Government intends to adopt a straightforward and (where necessary) broad-brush approach to keep the whole process as simple as possible. A key element will be the use of a single set of unisex factors, issued by the Inland Revenue, to value defined benefits for checking against the lifetime and annual limits.
  • A worrying aspect of the tax simplification is for small self administered schemes (SSAS), where there are proposals to have a single set of permitted investments for all types of pension arrangement, in particular limiting investment in the sponsoring company's shares to 5%. The Government is also seeking feedback on the restrictions that should apply on loans to connected parties and commercial property transactions with the sponsoring employer.
  • In respect of funded unapproved retirement benefits schemes (FURBS) there is only a comment that their tax treatment will be developed for the next round of consultation.

Simplicity, security and choice: Working and saving for retirement

The Green Paper sets out the "good news" that the UK's old age dependency ratio will rise less than in the rest of the EU, that UK private funded pension provision is at internationally high levels of around 80% of Gross Domestic Product (GDP) and public spending on pensions is expected to remain at stable, manageable levels of about 5% of GDP over the next 50 years. The Government also counters the arguments of a wholesale pensions savings gap.

The Government does, though, acknowledge in the Green Paper that about 3 million workers are believed to be seriously under-saving for their retirement. The Paper goes on to set out the challenges to adequate and secure pension provision of increasing longevity, decline in employer pension provision, underfunding on the winding up of final salary schemes, complexity of pension arrangements and many workers leaving employment too early.

The proposals are intended to meet these challenges by providing a simpler pension tax regime, improved member information, more flexibility over retirement options, better member protection and a competitive and accessible financial services industry. The proposals also integrate with the Treasury consultation paper discussed above. The Government wishes to consult extensively on these changes not least because, in a number of cases, it has failed to put forward any firm proposals. In this respect, the Green Paper contains more questions than answers. The consultation period ends on 28 March 2003.

The Green Paper sets out a number of proposals to improve pension information for individuals, covering:

  • Greater provision of combined private and State pension forecasts and State pension forecasts for the self- employed;
  • Improved provision of generic pensions advice and planning tools.

The main issues relating to simplification are as follows:

  • Replacement of the Minimum Funding Requirement (MFR) with a scheme-specific funding approach (a Statement of Funding Principles). However, the Green Paper does not provide any detailed proposals which is somewhat disappointing given that the abolition of MFR was first announced over 18 months ago. The paper was similarly vague on the new requirements for calculating cash equivalent transfer values;
  • The Government seems reluctant to permit the removal of survivors' benefits or Limited Price Indexation as recommended by the Pickering report. The Government will only introduce these changes if "it has good reason to believe that the coverage of, and contributions to, occupational pension schemes would be higher than would otherwise be the case". The good reason put forward by Pickering is that less valuable and less expensive pensions are better than no pensions at all;
  • Simplification of contracting-out requirements. These include a suggestion that the Government would consider weakening the "Reference Scheme Test". This would mean that occupational pension schemes could provide lower benefits whilst still retaining their contracted-out status. In respect of simplifying accrued guaranteed minimum pensions (GMPs), the Paper gave no detailed proposals, instead asking for workable solutions to be suggested by the pensions industry;
  • Requirement for all schemes to include member-nominated trustees (MNTs), but with the nomination and selection process being less prescriptive. The employer opt-out facility would be abolished;
  • Trivial commutation is to be extended to be available where all pension funds are less than £10,000 in value at age 65;
  • The uniform accrual requirements for occupational defined contribution schemes are to be removed;
  • There are also proposals to consolidate all pension legislation and simplify the restrictions on amending accrued pension benefits, the internal dispute resolution procedure, the procedures for paying individual transfer values and pensions on divorce.

Greater protection for members' benefits is dealt with as follows:

  • The Government has put forward two possible changes to the statutory priority order when schemes are wound up. The two alternatives are to either increase the priority for members within 10 years, say, of retirement age or alternatively base the level of protection on the number of years of service rather than age;
  • The Government has also suggested a capping system so that members who take early retirement just before winding up would only receive protection of their pensions up to a certain level, say a pension of £30,000 per annum. This would prevent senior employees from "jumping ship" immediately prior to winding up with a subsequent reduction in benefits for remaining members;
  • Final salary pension schemes face particular problems when winding up with an insolvent employer. The pension scheme ranks alongside other unsecured creditors which gives the scheme very little chance of securing additional funds. The Government has recognised this problem and suggested creating a new category of creditor as well as the possibility of an insurance scheme or central discontinuance fund. The idea of insurance and a central discontinuance fund was considered in detail prior to the Pensions Act 1995 but dismissed as unworkable. The Government does not seem to have said anything new apart from "let's look at this again";
  • It is proposed that in the event of fraud, the scheme would be compensated in full from the Compensation Fund;
  • For solvent employers winding-up pension schemes, the Government wishes to consult on ways of improving member protection, but it does not wish to increase the overall pension burden on employers. It is proposed that employee consultation is carried out before any amendments are made to schemes.

Finally, in this particular consultation document, the Government has put forward proposals to allow immediate vesting of pension scheme benefits, rather than waiting two years as is currently the case, transfers without consent in certain situations and compulsory scheme membership as a condition of employment. The Government has also taken the opportunity of reiterating its proposals for reforming the Transfer of Undertakings (Protection of Employment) legislation.

Report on the quinquennial review of OPRA

The quinquennial review concluded that OPRA had fulfilled its role extremely effectively. However, the review noted that there had been unnecessary processing of large volumes of paper associated with relatively minor breaches and recommended a move to a more risk-based assessment using a de minimus reporting requirement. The review also recommended a closer working relationship between OPRA and other regulatory bodies. To a large extent this will be superseded by proposals set out in the Green Paper for a "new kind of regulator".

The review recommended a more pro-active role for the new regulator providing greater protection to scheme members, whilst providing support and advice to those responsible for administering pension schemes. The new regulator's objectives should be to focus on the key risks to pension scheme members, and be seen to be doing so.

It is anticipated that the implementation and planning process towards a new regulator will be taken forward on a joint basis between OPRA, the DWP, HM Treasury, the Inland Revenue and key professional bodies.

Please speak to your usual Barnett Waddingham contact to discuss any of the above.

Barnett Waddingham, December 2002.