Pension Matters January 2011

Welcome to Pension Matters, produced by Torquil Clark Employee Benefits.

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, Pension Technical Manager

How robust is your retirement Policy?

An unsurprising decision in the case of Ayodele v Compass Group Plc given the nature of the duty of employers to consider procedure set out in the default retirement age segment of the Equality Act 2010. 

The company had a retirement policy providing for retirement at age 65.  The policy included a duty to consider any request to work beyond that age, but offered no formal guidance as to how that consideration should be carried out.

Mr Ayodele, on being notified of his pending retirement at age 65, asked to continue working for a further two years.  His request was refused, as was his subsequent appeal against that decision.

Mr Ayodele won his claim of unfair dismissal as the tribunal found that, whilst a "summary process" for dealing with retirements and requests to continue working beyond retirement can be fine in itself, there is an implicit duty on an employer to perform a statutory obligation "in good faith and genuinely".

Plans for a new pensions regime considered

The  Treasury is looking at proposals which could allow savers to access a 25 per cent lump sum from their pension fund early  which may include an integrated Isa/pension regime.

Government officials are preparing to issue a consultation before the end of the year seeking views on whether the policy could boost saving and the circumstances under which people should be allowed to access their savings pot early. The proposal could be a step towards a merging of the pension and ISA systems in the UK.

While several potential models of early access were outlined in a Pensions Policy Institute paper in November 2008, pensions minister Steve Webb has previously indicated a preference for the 25 per cent lump sum model as it "chimes with what's already in the system".

NEST charges announced

NEST Corporation has announced that a 0.3% annual management charge will be levied on member funds under management in the National Employment Savings Trust (NEST) and that the charge on contributions will be 1.8% a reduction of 2%.

Many Defined Contributions currently operate on lower charges than indicated above. There has yet to be any explanation of precisely what these charges cover and the firm linkage of the contribution charge to NEST's set-up costs may yet prove to be disincentivising, especially as it is likely to be many years before the ambition of a pure annual management charge expense structure is achieved.

New annuity rules bring common sense

The Government has published its draft of the Finance Bill 2011. Comments are invited by 9^th February 2011.

There are a number of pension related issues including the requirement of purchasing an annuity by the age of 75 for individuals who have money purchase pension schemes. The rules of the particular pension scheme may have to be changed to allow for this extra flexibility. It is proposed that the new rules will come in from 6^th  April 2011.

• If the individual can show an existing pension income of at least £20,000 pa, from a mix of State pensions, existing annuities, and other scheme pensions (but excluding any temporary pension or drawdown pension) then under the new flexible drawdown they can take a drawdown without restriction.  This could include 100% of the fund, that means  all the fund can be taken.  That part of the drawdown would be taxed as income.  
• For those who do not have pension income of at least £20,000 drawdown can't be more than 100% of the annual payment from an equivalent annuity.  The maximum must be reviewed every three years until the member is age 75 and then annually thereafter
• If an individual wishes to take a tax free cash sum, they have to do so when starting income drawdown.  The current age 75 limit for taking cash is being removed. This negates the reason for starting drawdown before age 75.
• In either form of drawdown, individuals may take no income at all in a year. Effectively one can delay withdrawing any benefits indefinitely
• Lump sums paid on death (at any age) from residual funds once drawdown has started will be taxed at 55%.  This is higher than current rate of 35% for those who die before age 75 but more attractive post age 75. Inheritance tax (IHT) will not apply so long as the trustees have ultimate discretion on the choice of beneficiary

An individual using the new flexible drawdown can only do so if they are no longer an active member of any registered pension scheme; and if they make any pension savings anywhere thereafter, such savings will all attract the annual allowance charge.

The age 75 ceiling is being removed for certain lump sum payments (such as pension commencement lump sums, serious ill-health lump sums, winding-up lump sums and trivial commutation lump sums).

RPI to CPI... Read the small print

The department for Work and Pensions (DWP) has set out the proposals for occupational pension schemes to use the Consumer Prices Index (CPI) as opposed to the changes in Retail Prices Index (RPI) for statutory revaluation and indexation of pensions

This is not a straight forward exercise as the proposals do not reach all private sector schemes as the Government does not plan to employ a statutory override that would have the effect of forcing all schemes to move from RPI to CPI. All occupational pension scheme sponsoring employers  and trustees should now revisit the small print in their pension schemes to establish if they are eligible to take advantage of the changes and investigate the true value of those potential changes in the future.

The main issue is that for those schemes that expressly refer to pension payments being linked to RPI, they cannot by law change the rules because it would be a worsening of members' benefits.

All occupational pension stakeholders should now be looking at their scheme rules and decipher the pensions wording.

A large percentage of schemes in the UK link specifically to RPI, (and some a fixed amount) meaning employers that offered final salary schemes could not benefit from the changes.

Some financial commentators believe that the historic link between RPI and CPI will not be maintained and the indices will move to parity and the potential gains envisaged for pension schemes in any event will simply not materialise. It may very well be more costly in the long run.

The changes will come into force as early as next year.

Lifetime Allowance Reduced

It is confirmed that the LTA will reduce, from its current level of £1.8m to £1.5m, on 6 April 2012.

Enhanced Protection (EP) and Primary Protection (PP) - for those individuals who registered as part of the April 2006 changes,- will continue in most circumstances to have the same effect as though the LTA had not reduced (so, for example, PP uplifts will reflect the LTA of £1.8m after 2012 - or more if the new £1.5m standard limit is ever increased and actually overtakes the £1.8m).

For those without EP or PP on 5 April 2012, a new form of protection will be available, "fixed protection" (FP).  Anyone can register for FP by that date, to be granted a personal LTA of £1.8m (again, this will increase if the standard £1.5m limit ever overtakes the £1.8m).  FP will however be lost if, after 5 April 2012:

• Any money purchase contributions are made
• Defined benefits rights grow by more than the leaver revaluation rate stated in the pension scheme rules at 9 December 2010 or CPI, if higher
• a new arrangement is set up other than to receive a "permitted transfer" (broadly meaning transfer of accrued rights to another registered scheme for benefits on a money purchase basis, or in relation to certain business transactions)

Continuation of cover for scheme death in service benefits will in general not compromise FP.

Individuals who do not have "protected lump sum rights"  could see a real expectation of tax free cash sum of £450,000 drop to £375,000 overnight on 6 April 2012.

Members planning to register for FP have 15 months to make further savings.  But they will need to have regard to tax charges that can arise from the existing Special Annual Allowance rules in place until 5 April 2011,  as well as the Annual Allowance provisions announced on 14 October applying for 2011/12, but for this they have the benefit of carry forward provisions for 2008/09 to 2010/11.

It will be a headache for Schemes to advise its membership on these issues as any breaching of the new protection regime potentially additional lifetime allowance tax charges can be triggered. Watch out for ‘auto-enrolment'.

Further detail on the Annual Allowance

Following on from the 14 October announcement, the Government has at last announced its policy regarding (limited) easements for benefits paid on grounds of ill‑health. 

This new exemption from testing benefit accrual in an arrangement against the Annual Allowance is for the Pension Input Period ending in the tax year in which the individual becomes entitled to all the benefits in the arrangement, if as a consequence of medical evidence "the individual is suffering from ill-health which makes the individual unlikely to be able to undertake gainful work (in any capacity) at any time in the future (otherwise than to an insignificant extent)".

Schemes will need to consider the circumstances when their enhanced benefits do not fit the exemption and so would trigger substantial tax: this may be an area for further clarification.

Money Purchase Contracting out

Legislation will be amended so that transfers from defined benefit (DB) contracted-out schemes to non-contracted-out schemes will, subject to certain safeguards, be allowed after 2012. 

This follows concerns raised that the regulations as written would have effectively ended the option for many individuals to transfer their benefits out of a DB scheme to another scheme, such as a personal pension.

Disclosure of Information by Trustees

The long awaited Occupational, Personal and Stakeholder Pension Schemes (Disclosure of Information) (Amendment) Regulations 2010 ("the Regulations") have finally been laid before Parliament.

The Regulations will come into force on 1 December 2010. These Regulations will allow, but not require:

• all trustees to use email and the web to meet the disclosure of information requirements;
• trustees of schemes with money purchase benefits to shorten the annual benefit statements issued to members.

Trustees will now be able to provide information to members by email or by making the information available on a website. However, trustees will not be able to fulfil their disclosure obligations by means of email or making information available on a website if a member requests that they continue to receive paper communications. Also, if trustees are providing information electronically, they must be satisfied that the recipient is able to access and print, or store, the information.

Trustees must also take into account the needs of people with disabilities.

Trustees can only start providing information to members electronically, rather than through paper communications, after having issued a notice in writing (on paper) to members. The notice must state that the trustees intend to provide information by electronic means, but that the member can ask to continue to receive paper communications if he or she wishes.

Where the trustees intend to make information available on a website (rather than by paper communication), they must write to the members at their last known electronic or postal address, advising them that the information will be placed on a website. This notification must include the website address and details of how to access the information.

This process must be repeated whenever further information is placed on the website. This is logical as it will inform members that new information is available. However, if a member has failed to supply an e-mail address after three times of asking, and has not asked to continue receiving paper communications, then this notification process is waived.

Employer Covenant Guidance

The Pensions Regulator has published guidance for trustees of all occupational pension schemes with a defined benefit (DB) element on the practice that it expects trustees to follow in assessing, strengthening (through contingent assets and other forms of security), monitoring, and taking action on employer covenant. 

The Regulator hopes that trustees will adopt approaches to covenant assessment, strengthening and monitoring having regard to the guidance it has provided, but in a manner that is appropriate to the circumstances of the scheme and events which may affect it.

To be fully effective, trustees need to have a good understanding on covenant strength and the risks to corporate profitability on an ongoing basis as well as be aware that its measurement and analysis is something of an art.

Although the Regulator is not dogmatic as to how trustees should go about measuring and monitoring covenant, it would not be surprising if this latest guidance results in increased use of externally sourced advice in what is a complex area with no easy answers.

EFRBS

Legislation  from April 2011, will apply a new employment income tax charge to those third party arrangements which allow an employee to enjoy the benefit of money paid or assets provided through structures which are in substance a reward or recognition or loan in connection with the individual's employment.