Pension Matters September 2011

Welcome to Pension Matters, produced by Torquil Clark.

Every month I will update you on the latest legislation and news surrounding corporate and personal pension planning. To find out more about the topics covered in this edition, please call 01902 576707.

Ian Hill, Pensions Technical Manager

Annual Allowance Charge - Scheme Pays

HM Revenue & Customs (HMRC) has published guidance on "Scheme Pays", the facility by which members due to pay an annual allowance (AA) charge can ask a scheme to pay it for them from their pension saving.

The guidance has been awaited by trustees, particularly of defined benefit (DB) arrangements, to understand what reduction to pension savings they can apply and so begin to set policy; and by administrators to know how to deal with retirements now. The fact it was published only two days before schemes may have real-life cases shows the challenge it has presented to HMRC.

The guidance explains that there are two routes - "mandatory access" where the member can demand Scheme Pays up to certain levels in certain circumstances (which are set out) and voluntary access that schemes may choose to offer in wider circumstances.  Regulations have written the power to apply either into all schemes.

HM Treasury indicated flexibility for trustees in deciding the form of benefit reduction for DB arrangements, so long as (using normal actuarial practice) the reduction was just and reasonable from the point of view of the member, other members of the scheme and the tax office.  However, HMRC read the legislation as imposing several constraints on offset design, for example imposing that reduction designed in a DB format must apply "whole of life" (so not, say, recouped over five years after retirement).

There is a helpful easement affecting immediate cases.  HMT had indicated when a member starts to draw all benefits from a scheme, they must first finalise outstanding Scheme Pays claims they want to make,- acknowledging that this will cause real time pressure and the need to use estimates with later corrections.  However, the guidance confirms, that the law permits reductions to be agreed and formalised after retirement, albeit under "voluntary access" Scheme Pays. The guidance strongly warns of tax pitfalls in doing this, but does not show helpful existing exemptions that may make this an important way to buy time, especially in immediate ill-health cases which may trigger large AA charges.

There is concern is that it gives no help on points about AA charges incurred just before a member retires.  These include the effect of Scheme Pays on how much tax free retirement cash sum can be allowed and how this varies depending on timing; similarly for how Scheme Pays impacts on the lifetime allowance charge.

The guidance is not sufficient by itself for trustees to set policy, seemingly leaving readers to look to the HMT policy statement.  It does not mention that trustees of a DB scheme can choose to recoup the tax paid on behalf of a member from a member's DC AVCs in the scheme, which seem a simple approach that will be popular.  There is no mention of  HMT's clear intent that trustees do not load Scheme Pays reductions with the ongoing costs arising when a member chooses Scheme Pays (even if this appears "just and reasonable" given the impact of such costs on other members of the scheme).  Trustees who do not have retiring members wanting to use Scheme Pays now might best hold back making longer term policy on Scheme Pays until something more holistic emerges.

A helpful example in the guidance shows how the AA charge and how much Scheme Pays a member can demand depends on his/her taxable income for the whole tax year.  This is just one of many reasons why imminent retirement cases will be based on estimates that turn out to be wrong.  The guidance notes that members have four years to ask for corrections to Scheme Pays; no doubt this will be used a great deal.

Changes to contracting out regulations

The Department for Work and Pensions is consulting on proposed changes to contracting-out regulations.

They have asked for views on the following:

• Increasing the fixed rate revaluation of guaranteed minimum pensions (GMPs) for early leavers from 4.0% to 4.75%, which was recommended by the Government Actuary in February 2011, will apply to those ceasing pensionable service after 5 April 2012
• Allowing trustees of formerly contracted-out defined contribution occupational pension schemes to remove by resolution those parts of scheme rules directly relating to protected rights that are no longer required as a result of the abolition of protected rights from 6 April 2012.  Any such amendments must be made before 6 April 2015

Consultation closes on 6 November 2011.

Even if an employer is committed to keeping a Defined Benefit  scheme open to some or all members, the increase is another reason to consider contracting back in and possibly reducing benefit accrual proportionately. There are a number of other benefits in doing this -

• The contracting-out rebate is currently not fair value for the benefits the scheme has to provide
• Pension risk is transferred back to the State
• Lower accrual rates reduce the risk of members exceeding the Annual Allowance.

NEST: employer terms & conditions and online tool announced

The National Employment Savings Trust (NEST) has published the terms and conditions for employers that intend to use NEST to meet auto-enrolment duties under the workplace pension reforms.

Formal terms and conditions for participating employers are available and a NEST employer admission agreement.

NEST has also announced that it will soon be launching an online tool for advisers to enable them to manage employers' schemes on their behalf. The way the online administration has been set up means that an employer can give an IFA access to their account and allow the adviser to administer the account on their behalf

Registering for Fixed Protection

Individuals wanting to register for Fixed Protection to assist with the reduced Lifetime Allowance must ensure HMRC receive this by 5 April 2012.

If benefits accrual on or after 6 April 2012 fixed protection will be lost. In a repeat of what emerged with Enhanced Protection in 2006, for many it may be the case that they have to become a deferred pensioner if they want Fixed Protection, so individuals considering registering for Fixed Protection should take very careful advice before giving up accrual in a final salary scheme.

Flexible drawdown payments

Scheme administrators should review their processes if they have been offering members the choice of the 35% rate for post retirement death lump sums.

The Finance Act 2011 is now in force, together with several sets of supporting regulations.

Slow Transfer payments

A five day turnaround is challenging if you consider that administrators need to demonstrate they have been through an adequate checking/reviewing process before releasing payment of any benefits.

But that is what the deputy Pensions Ombudsman has suggested in a recent pension transfer case.

In a recent determination concerning Ms Jones and the Tyco Holding (UK) Ltd CARE Pension Scheme, the deputy Pensions Ombudsman upheld a complaint of undue delay in processing a transfer.  As a result of the delay, payment to a personal pension had not been completed by the time Ms Jones' husband died.  This resulted in the benefits that became payable to his dependants being very different to those that would otherwise have applied.

The initial request for the transfer quote was made on 11 May 2009 and the member died on 9 October 2009, so the processing of the transfer was in fact well within statutory deadlines.  However, various delays by all parties were mentioned in the determination, with the main focus being on a delay of just over two weeks in the administrators spotting that they had not received all the necessary paperwork and then, when they had received this, taking a further 19 days to make arrangements for the transfer to be paid.  The member's death occurred 14 days after all the paperwork had been received.

In reaching her decision the deputy Ombudsman stated that "it should not take more than five working days to raise and issue a transfer value cheque" from the date that all necessary information is received.

PPF Levy invoices

The Pension Protection Fund (PPF) will start issuing 2011/12 pension protection levy invoices from September.

It is likely that the invoices will be issued with detail supporting information setting out how the risk-based and scheme-based levies have been calculated and with a guide to the levy including general information about paying and querying the levy.  The FAQs on the invoicing process are also likely to be updated.

For those responsible for Final Salary Schemes, please do check that your levy invoices have been determined correctly (see below) as any discrepancies need to be raised with the PPF within 28 days of the date of the invoice.  Employers are likely to be given the same timescale to query their failure score with D&B.

Queries must be lodged within 28 days of the invoice date and typically interest will be charged if the invoice is not paid by that time.

Incorrect information not an excuse for incorrect PPF levy calculation

The Deputy Pension Protection Fund Ombudsman has rejected an attempt by a Defined benefit Scheme to overturn a pension protection levy calculation that is known by all concerned to have been based on materially incorrect information.

Confusion arose in the D K Moriarty Limited Pension Scheme because two Section 179 valuations were submitted in the run up to the 2008/09 levy year.  The first, submitted by the scheme's actuary, used an incorrect asset value.  The second, submitted by the trustees, used the correct and much larger asset value.

In line with its published policy, the PPF Board opted to use the first Section 179 valuation as it had a later effective date although this was only by one day).  After some correspondence, the trustees accepted the 2008/09 levy calculation.

The erroneous figures were used again in the 2009/10 levy calculation. Following objections from the trustees the issue was taken to the PPF's Reconsideration Committee which ruled against the trustees, arguing that even though the asset figure used to calculate the levy was materially incorrect, there was nothing sufficiently exceptional about the case to justify overturning the levy calculation.

The Deputy Ombudsman has now found that the Reconsideration Committee acted reasonably in rejecting the trustees' case, especially given that the error was not the fault of the PPF.

This case underlines the stance held by the PPF when considering mistakes on the part of others.

Importance of knowing who the statutory employer is

• meeting the scheme funding objective of the pension scheme;
• paying the section 75 debt when an employment cessation event occurs on employer departure from a multi-employer scheme, on scheme wind-up or on employer insolvency;
• triggering entry to a Pension Protection Fund (“PPF”) assessment period on insolvency.

The importance of this has been highlighted recently by a number of schemes who mistakenly believed that on the insolvency of their employer, they were entitled to compensation from the PPF.

Unfortunately, as a result of previous events, the schemes had lost their statutory employer(s) and therefore did not meet the entry conditions to the PPF. The Government is considering extending the Financial Assistance Compensation Scheme to assist affected members of those schemes, but this situation does highlight why it is important to identify, and to keep track of, the statutory employer(s) to the scheme.

The Regulator is also concerned about schemes where the remaining statutory employer is a Defined Contribution employer. This situation may have arisen where the Defined Benefit (“DB”) section is closed to accrual but there is an open DC section, or where a DC scheme has received a transfer-in of liabilities from a DB scheme. Although the scheme may remain eligible for the PPF and be subject to scheme funding requirements, legislation states that a DC employer cannot be subject to a statutory section 75 debt on the employer. The Regulator states that it is likely that less weight can be placed on the strength of the employer covenant in this situation than if the employer had some section 75 liabilities. The trustees should be aware of the risk and review the situation accordingly.

Ignorance is no excuse for not registering for 'transitional protection' against tax charges

In this case, the member retired from his post as a full-time director of a large life insurance company in 1992 and started to receive his occupational pension. In 1994, he invested in a second pension into which he paid contributions between 1994 and 2004. In 2010, he advised the pension provider that he wished to take his benefits under the pension policy.

The member was informed that his pension would be subject to a lifetime allowance charge of around £65,000. Consequently, in September 2010, he submitted a claim to make a late election for transitional protection. This was rejected by HMRC because applications for transitional protection had to be made by 5 April 2009 at the latest.

The member appealed on the grounds that he had not previously been aware of the changes to the taxation of pension benefits and that this should be treated as a reasonable excuse for his late claim. However, the First-Tier Tribunal dismissed his appeal with the judge observing that "prior to and after 6 April 2006 HMRC put extensive advice in the public arena on the changes to the taxation of pension savings, which was accessible at different entry levels". The changes to pension taxation in 2006 had also been publicised in national newspapers, and their consequences had been "tempered by the three-year period after its implementation in which an individual could secure protection against the change".

On the evidence, the member had been aware of the 'A-Day' changes but for some reason did not perceive the relevance of them to his own situation. It was held that "ignorance of the legal provisions dealing with protection of pension benefits had no rational basis, and did not constitute a reasonable excuse".

The Lifetime Allowance (LTA) is reducing from £1.8 million to £1.5 million in April 2012. However, by registering for fixed protection by 5 April 2012 and complying with the conditions for such protection, an individual can retain an LTA of £1.8m. The above case should serve as a salutary reminder of the importance of submitting claims for protection by the prescribed deadline.

20 year-olds three times more likely to reach 100 than their grandparents

New analysis by the DWP has highlighted that twenty year olds are three times more likely to reach 100 than people of their grandparent’s age (80 year olds) and roughly twice as likely to reach 100 than people of their parent’s generation (50 year olds).

This reflects how much life expectancy is changing across the generations.

These figures also show that a baby born this year is almost eight times more likely to reach 100 than one born in 1931. A baby girl born this year has a one in three chance of living to 100 and a baby boy has a one in four chance.

Minister of State for Pensions Steve Webb said:

"These figures show just how great the differences in life expectancy between generations really are. The dramatic speed at which life expectancy is changing means that we need to radically rethink our perceptions about our later lives. We simply can’t look to our grandparents’ experience of retirement as a model for our own. We will live longer and we will have to save more."

In 2066 it is estimated that there will be at least half a million people aged 100 or over.

PPF 7800 Index Update

The PPF 7800 Index has been updated to the end of July 2011. Highlights include:

• The aggregate deficit of the 6,533 schemes in the PPF 7800 index is estimated to have increased over the month to £67.3 billion at the end of July 2011, from a deficit of £8.3 billion at the end of June.
• The funding ratio fell from 99.2 per cent to 93.7 per cent.
• Total assets were £1001.4 billion and total liabilities were £1068.7 billion.
• There were 4,684 schemes in deficit and 1,849 schemes in surplus.