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Current Pensions Issues Autumn 2004
"ON THE BOIL"
Topics new or changed since the previous commentary
Finance Act 2004
The Government's proposals to simplify the pension taxation system received Royal Assent as the Finance Act 2004 on 22 July 2004. The consultation period on the draft regulations ends on 5 November 2004 and the new legislation will come into force in April 2006 (known as "A-Day").
Details of the taxation proposals were set out in our earlier Current Pensions Issues notes. A few new topics include:
Defined Benefit Schemes with less than 50 members must purchase annuities
Defined Benefit schemes with less than 50 members will be required to purchase annuities from an insurance company, and will no longer have the opportunity to pay the pension through the scheme. This may be an issue for some small defined-benefit schemes which do not currently buy-out members' pensions. However, we understand that further grandfathering rules will be included in secondary legislation this autumn to remove the requirement to purchase an annuity for pensions already in payment at A-Day.
Surplus on insurance policies
Individuals who did not receive part of their pension annuity due to technical "over funding" may be able to claim back their lost benefits in 2006. This has occurred where annuities were bought in the past with relatively high fixed pension increases, and these increases have taken the pension above the Revenue limit (which can only increase at 3% pa or RPI, if greater). Under the new taxation regime, the annuitant's pension will no longer be compared each year to his/her Inland Revenue maximum pension. Instead, the value of the insurance policy will be compared to the lifetime allowance at A-day, initially set at £1.5m, and any surplus previously withheld due to a breach of Inland Revenue limits may be returned as a windfall profit, albeit taxed. This will be subject to tax, and the agreement of the insurance company.
Lifetime allowance for occupational money purchase schemes
It had been thought that defined contribution schemes would be disadvantaged relative to defined benefit schemes. A defined benefit scheme can provide a pension of up to one-twentieth of the lifetime allowance (so £75,000 pa initially) but, as annuity prices are often much higher than £20 for each £1 pa of annuity, a fund of £1.5m would typically only buy a pension smaller than £75,000 pa. However, the legislation sets out provisions for defined contribution scheme members purchasing an annuity to have the opportunity to choose between the better of the £1.5m fund or £75,000 pa pension allowances - further Revenue guidance is expected before the year end to clarify the fine detail of these provisions.
Barnett Waddingham LLP has set up a dedicated team to review the Act and will keep you up to date with any further developments.
In our view, sponsoring employers and pension scheme trustees should have tax simplification high up on their agenda. Issues to discuss include redesigning benefits to fit with the new regime, the possible effects of removing existing Revenue limits from the scheme rules, member communications and further issues for high earners. Your BW consultant will be happy to guide you through these issues.
Pensions Act 2004
We are still awaiting further details of many of the issues covered by the Pensions Act. These include the scheme specific funding requirement that will replace the Minimum Funding Requirement (MFR), the Pensions Protection Fund (PPF), and further details on simplifying contracted-out benefits. The Pensions Act is expected to return to the House of Commons and receive Royal Assent in November 2004.
The DWP hopes to implement most of the new legislation between April 2005 and April 2006. Some proposed implementation dates are:
April 2005
- Withdrawal of the need to provide LPI pensions for money purchase schemes
- Reduction in the cap on LPI indexation from 5.0% to 2.5% in final salary schemes
- The start of the PPF
April 2006
- Changes to contracted out money purchase benefits
- Withdrawal of the requirement to provide AVC facilities
Pension Protection Fund Levy
A recent amendment to the Pensions Bill will allow trustees to pass on all or part of the cost of the non risk-based levy to members.
The new Pensions Regulator
The current chief executive of the Occupational Pensions Regulatory Authority, Tony Hobman, has been named as the chief executive of its successor body the Pensions Regulator. We are currently awaiting further clarification of the Regulator's powers.
Member Trustees
In a surprise announcement to the TUC conference in September, the new Secretary of State for Work and Pensions, Alan Johnson, said the Pensions Act will increase the minimum requirement for member-nominated trustees from one third to 50% of trustees.
Anti-avoidance and financial support directions
A few controversial clauses were originally drafted into the Pensions Act to prevent employers from avoiding pension scheme liabilities. The first set of clauses (the antiavoidance clauses) deal with the statutory debt when an employer leaves a group pension scheme. The second set (the financial support directions) requires groups of companies outside of the pension scheme to provide financial support for a pension scheme where the participating employer in the scheme is financially weak.
These clauses were described in our summer edition of Current Pensions Issues and are intended to be retrospective to 11 June 2003. The clauses have been temporarily suspended by the House of Lords and may be amended, although the Government have made it clear that they remain committed to the principles underlying the new provisions. Parties to a proposed corporate transaction may in future be able to ask for confirmation that the Regulator will not exercise its anti-avoidance powers if the transaction proceeds as proposed. In the meantime, the Occupational Pensions Regulatory Authority (OPRA) may be willing to offer an informal clearance on whether a transaction is likely to invoke the anti-avoidance powers.
What is a Money Purchase Scheme?
A pension scheme has gone to the High Court to establish whether it is a defined contribution or a defined benefit scheme.
The scheme in question, the KPMG Staff Pension Fund, was established in 1949 and has a benefit structure not untypical of pension schemes at that time. Members must contribute a fixed percentage of their earnings to the Fund and, at retirement, the members' assets are used to buy a pension. This sounds like a money purchase scheme so far, but there are two complications. Firstly, the pension is provided from the scheme on fixed conversion factors (which depend on the age of the member at the time the contribution was paid and the factor in use at that time). Secondly, there is no investment return at all. Looked at another way, the scheme is providing a pension calculated as a fixed proportion of salary for each year worked. The case hinged on the fact that pensions were paid from the fund and so there could be a surplus or deficit in the scheme - it was therefore ruled that the Fund was not a money purchase scheme. Other schemes that pay pensions from the fund should be aware that they would probably not be classed as money purchase schemes and so would need a scheme actuary and regular MFR valuations.
"In Brief"
The Myners Report
Paul Myners was commissioned by the Treasury to carry out a review of investment decision-making in UK pension schemes. The review was published in March 2001 and made a number of recommendations commonly referred to as the "Myners Principles". The Government endorsed the Myners Principles in October 2001 and encouraged pension schemes to adopt them on a voluntary basis. The Department of Work and Pensions (DWP) recently published the findings of its quantitative research into the take-up of the Myners Principles by pension scheme trustee boards. Further information can be found in our separate newsletter entitled "DWP Survey of Myners Compliance".
Transfer of Public Sector Employees to Private Sector
In June 1999, the Treasury published the "Fair Deal for Staff Pensions" setting out a standard for the protection of occupational pensions for public service staff transferred compulsorily to private sector employers. Further guidance has now been issued to clarify some aspects of the standard and this information can be obtained on request from your normal BW contact.
Transfer Values
The Minimum Funding Requirement (MFR) amount is currently the minimum transfer value allowed by legislation, although many schemes now regard this amount as inadequate. In the light of the demise of MFR, the Actuarial Profession's guidance for calculating transfer values is again under review and it has been suggested that an optional "standard" basis will be established in the future.
New Work and Pensions Secretary
Alan Johnson has been appointed as the new Secretary of State for Work and Pensions following the resignation of Andrew Smith. Mr Johnson joins from the Department for Education and Skills, where he was Minister of State for Lifelong Learning, Further and Higher Education and was previously in the Department of Trade and Industry.
New draft regulations
The Department of Work and Pensions has recently issued two sets of draft regulations for consultation. The first covers the Minimum Funding Requirement and the transitional arrangements in force until the new scheme specific funding requirement is in place. The second amends the winding-up and debt on the employer regulations to bring the debt on an insolvent employer in line with the debt for a solvent employer. As usual, Barnett Waddingham LLP will be submitting comments.
Financial Assistance Scheme
Earlier this year the Government announced its plan to set aside £400m over the next 20 years to compensate members who have suffered following the wind up of their scheme with an insolvent employer. A consultation period runs until the end of November 2004 at which point the Government will finalise the details of the scheme. It is expected that the scheme will be in place by spring 2005 and the Occupational Pensions Regulatory Authority (OPRA) has published an update (Update 9) for trustees of underfunded schemes in wind-up giving guidance on how to act during this interim period.
The Department for Work and Pensions (DWP) has recently published research into the number of people affected by pension schemes winding-up under-funded and with insolvent employers. This research suggests that around 65,000 people may have lost over 20% of their expected pension benefits. The Parliamentary Ombudsman is investigating whether the Government or regulators have any responsibility for shortfalls.
Commutation Factors
An article in the Financial Times in July 2004 drew attention to the fact that tax-free commutation factors can appear less than generous when compared to today's level of annuity rates. If you have any concerns regarding your scheme's current commutation factors then please speak to your normal BW contact.
Review of the Actuarial Profession by Sir Derek Morris
Sir Derek Morris has been appointed by the Government to conduct a review of the actuarial profession. The deadline for comments on the initial consultation paper has now passed and we have submitted our views. The results of his report and the recommendations are expected in Spring 2005.
Stakeholder Charging Cap
When Stakeholder schemes were first introduced, the Government capped the maximum annual management charge at 1.0% of the value of the fund. From April 2005 this maximum charge will be increased to 1.5% per annum for the first ten years, starting with the day on which the first contribution is made, reverting to 1% per annum thereafter.
Equitable Life
The Parliamentary Ombudsman, Ann Abraham, would like to re-open the investigation into the demise of Equitable Life. However, this will only happen if the Ombudsman is allowed to investigate the Government Actuary's Department (GAD), which does not currently fall under her jurisdiction.
Equitable has also set out its proposals for compensation from the Equitable Life Rectification Scheme. Only members who were entitled to a guaranteed annuity rate and took retirement benefits from the policy between 1 January 1994 and 19 July 2000 will be considered.
"ON THE BACKBURNER"
This section covers topics which are not yet resolved, and remain broadly unchanged from previous commentaries. A summary is included for ease of reference.
FRS17
We are still expecting that, for accounting periods starting on or after 1 January 2005, companies will have to adopt FRS17 fully and that listed companies will also have to comply with the International Accounting Standard 19. For further details on the accounting standard and our latest survey on FRS17 assumptions, please follow this link.
Government Consults on Age Discrimination
The European Employment Directive on age discrimination is due to be implemented by member states by 1 October 2006. The Government has issued a paper for consultation entitled "Equality and Diversity: Age Matters". We have submitted our response to the Government, and are now waiting to see the outcome.
Pension Transfers on Business Sales
The European Court of Justice (ECJ) ruled that early retirement pension benefits need to be maintained by the buyer of a business. The implications of this judgment, and its interaction with the TUPE clauses within the Pensions Act 2004, may only become clear over time but nevertheless employers need to consider this matter very carefully in the context of a prospective sale or purchase of a business and may also need to review past transactions.
Please speak to your usual contact at Barnett Waddingham LLP to discuss any of the above.
Barnett Waddingham LLP, September 2004.