UK: Pensions Update - March 2011

Last Updated: 6 April 2011
Article by Caoimhe O'Neill and Michael Jones

Budget Update

Despite postponing this newsletter to capture any significant Budget announcements – there were no huge surprises this year.

Primary interest lies in the proposed overhaul of the state pension. The DWP will publish a Green Paper on this, including the possibility of introducing a single tier state pension. This will have ramifications for DB schemes that are currently contracted out, but changes little for contracted out DC schemes for whom contracting out will cease in 2012 (see below for the latest update for Dc schemes).

Other pensions related points raised in the Budget were anticipated and are covered (where appropriate) below.

TAX: HMRC publishes FAQ on disguised remuneration

Employers should take into account HMRC guidance when planning their remuneration strategies.

As a response to questions raised in the legal and business worlds regarding the tax treatment of "disguised remuneration", HMRC has published its own set of FAQs with the aim of clarifying some areas of uncertainty. The FAQs set out HMRC's position with regard to how they perceive the draft provisions contained within the Finance Bill 2011 will operate in practice. Following its publication it is now possible for tax advisors to provide more definitive advice.

In our view, this will be of interest to most employers, but in particular, employers who:

  • are considering establishing or contributing to an Employee Benefits Trusts or Employer-Financed Retirement Benefit Scheme;
  • make awards under deferred remuneration plans;
  • are participating in a group-wide deferred remuneration plan and individuals who are beneficiaries of employee trusts.

Budget update: The effect of the proposed disguised remuneration changes will be altered in the Finance Bill 2011 to target third party arrangements aimed at avoiding restrictions on pensions tax relief but the impact will be structured to limit the impact on employers and individuals where it is possible to identify arrangements that cannot be used for tax avoidance purposes.

Useful links

Please click here for the HMRC FAQ. The Charles Russell tax team has also produced two briefing notes on the issue of disguised remuneration: please click here for our note from December 2010 dealing with the legislation itself and please click here for our note commenting upon the HMRC FAQs.

Tax: Annual allowance charge – Government clarifies position

Flexibility for members who incur the annual allowance charge to pay the tax from scheme benefits.

On 3 March, the Treasury issued an announcement about the Government's proposed method for allowing individuals to meet an annual allowance tax charge in respect of their pension benefits.

The document follows the 30 November 2010 consultation relating to options to meet annual allowance tax charges, which closed on 7 January 2011. That consultation sought opinions on 2 options for meeting the tax liability e.g. payment from pension benefits at the point the charge arises or payment at the point the pension benefit crystallises. The Government's conclusion in the March announcement is that the payment out of pension benefits should arise at the point the tax charge arises.

The main points arising from the March 2011 announcement are as follows:

  • The Government anticipates that for most individuals their pension scheme will be adapted so that pensions savings remain below the £50,000 annual allowance. The Government therefore expects that only the minority of cases will trigger an annual allowance charge.
  • The Government acknowledges that payment of any amount due as the annual allowance charge would be difficult for certain individuals if it was payable from their current income, particularly in the early years of the new annual allowance charge regime. In particular, a problem of cash flow would be more likely to arise in respect to high earners with long service in final salary pension schemes particularly where significant pay increases occur.
  • Any individuals with an annual allowance charge in excess for £2,000 will be able to opt to meet their tax charge (or part of it) from their pension benefits. Therefore, individuals with less than a £2,000 tax charge must meet it from other resources.
  • Members of all types of pension scheme are able to use this facility, therefore it applies to DB and DC schemes.
  • However, no scheme will be required to provide this facility if the tax liability did not arise a result of savings in that particular scheme. Therefore, an annual allowance charge triggered by reference to pension savings under a DB scheme can't be paid from a DC scheme as of right, unless that DB scheme chooses to offer that option.
  • Schemes will only be required to pay the proportion of the member's annual allowance charge attributable to the excess over the annual allowance in that scheme (unless they choose to allow the member to pay the full charge). DC schemes obviously only have to pay by reference to assets available within that relevant pot.
  • Schemes applying the annual allowance liability must do so free of charge.
  • Schemes in the PPF assessment period. or schemes which enter the PPF assessment after the member has made the election but before they process the request are exempt from offering the facility.

Significantly underfunded DB schemes are not exempt from the requirement per se however the Government intends to introduce legislation that provides an exemption in exceptional circumstances.

Schemes will be provided with flexibility around how they offset the annual allowance charge through reduction pension benefits, how they set the terms of engagement with individuals and other parameters within which the charge will be deducted. The member himself must claim the right to an off-set from the pension benefits through their self-assessment tax return and inform the scheme of the election.

The announcement sets out how such a deduction would be calculated under a DB scheme, and the role trustees have in making that calculation. DB schemes will therefore need to take advice from the actuary to work out the deduction.

Overall, these procedures seem eminently sensible and, whilst requiring some member communication and the adoption of statements as to benefit entitlements, it should be manageable for most pension schemes. We expect a detailed legislation and regulations to clarify the more technical details in the coming months.

Public Sector

Government consults on the "Fair Deal", the policy which ensures public sector employees receive full pension protection on transfers into the private sector

On 3 March 2011, the Government commenced consultation as to whether to scrap the requirements of the "Fair Deal" for comparable pension benefits to be provided to employees who are compulsorily transferred out of the public sector into the private sector.

The consultation, which is due to close on 15 June 2011, follows recommendations contained within the interim report of the Independent Public Service Pension Commission (headed by Lord Hutton). Lord Hutton's interim report found that the "Fair Deal" policy, coupled with the current level of public sector pension structures created a significant disincentive for private sector organisations to take on public sector services because of the pension costs and administration burdens.

Whilst Fair Deal has only ever been a policy rather than law and does not apply to every public-to-private transfer, it has nevertheless become, since its publication over a decade ago, the standard to which most public-to-private contracts have been structured. "Fair Deal" requires the transferring authority to ensure that transferring employees are provided with comparable pension benefits for the future and the option to transfer their historical accrued benefits, so that all the member's pre and post transfer pension benefits remain linked to final pensionable salary.

The consultation process will look at:

  • Changing requirements for future benefit: The Government is consulting with respect to the level of pension provision going forward, i.e. potentially changing the accrual rate, the definition of pensionable salary etc.
  • Removing the past transfer obligations: For example, introducing a new minimum requirement for CETVs and even considering whether transfers on to new providers should be required at all.
  • Scrapping Fair Deal: The Government is looking at whether simply requiring statutory TUPE levels of benefits following a transfer would be sufficient for the purposes of reducing the cost for providing pensions for independent providers but at the same time not potentially making it uncompetitive for in-house bidders to provide the benefits in these circumstances.
  • Onward transfers: The consultation welcomes views on how onward transfers and re-tenders should be handled.

The Government accepts that where existing contracts contain 'Fair Deal' style provisions then these contractual obligations would continue to apply regardless of any change in the Government's policy, although the consultation paper suggests that the parties could "resolve any contractual issues as appropriate".

In our view, the consultation has potential to significantly alter the landscape of public-to-private enterprise and possibly introduce new private sector providers into a market which is currently prohibitively expensive for smaller contractors. However, the needs of the private sector employers will have to be finely balanced with union and workforce expectation of decent post transfer pension provision.

With respect to existing contracts, it is likely that any changes will have minimal or no effect and the suggestion to 'resolve as appropriate' opens up an unwelcome element of uncertainty.

Public Sector: Hutton report publishes conclusions

Lord Hutton issued the findings of his report into the future of public service pension schemes. In general terms the conclusions of the report are that future public sector pensions should be based on a career average system rather than the current final salary method.

The other significant change proposed by Lord Hutton is to raise normal pension age for public sector pensions to reflect the increase in basic state pension. Therefore increasing normal pension age from 60 to 65 for some current public employees building up to a progressive state pension age of 68.

As expected these recommendations were greeted with caution by the various public sector employee representative bodies, but various industry commentators have said that Hutton's recommendations reflect a balanced solution to the ever increasing costs associated with the public sector schemes.

In the Budget it was announced that Hutton's recommendations were to be accepted in full (without "cherry-picking") and we can look forward to consultation in the Autumn on the detailed implementation.

Discrimination: ECJ Rules on gender based factors could impact on pensions

ECJ Courts deliver a blow to the use of gender based actuarial factors – pension schemes will need to keep an eye on this development.

On 1 March 2011, the European Courts delivered a landmark judgment on the use of actuarial factors based on gender, when calculating insurance premiums and pension annuities. In the Association Belge Des Consommateurs Test-ACHATS & Others the ECJ held that this practice was a derogation from the principle of equal treatment.

The case did not look directly at pensions but at the interplay of the EU laws. In Article 5(2) of the Gender Directive (2004/113/EC), EU states were allowed to implement the Directive in such a way as to allow gender-based differences in premiums and benefits, where their use was based on relevant and accurate actuarial and statistical data. The Gender Directive was implemented in the UK by the Equality Act 2010.

The main question before the ECJ was whether this exemption in Article 5(2) of the Gender Directive was compatible with the basic principles of equal treatment for men and women. The ECJ held that it was not and that with effect from 21 December 2012 it will be invalid.

It is unclear at this stage how this will impact occupational pension schemes. Most occupational pension schemes have historically used these types of gender based actuarial factors and following the Gender Directive, UK legislation specifically permits their use.

Schemes will therefore need to consider whether, from 21 December 2012, the discrimination exemptions contained in Regulation 4 of the Equality Act 2010 (Sex Equality Rule) (Exemptions) Regulations 2010 will remain good law.

We imagine that there will be parliamentary clarification on the matter in the coming months. Trustees should be keeping this point on the agenda at forthcoming trustee meetings and taking advice when more is known. We will keep you updated of any developments but if you wish to discuss it in the meantime, please contact us.

Discrimination: Sea Containers case confirms the importance of adhering to the scheme's amendment power

Equalisation continues to cause problems for schemes as the seismic effects of the Barber judgment from 1990 are still being felt in DB pension schemes over twenty years later.

The Barber judgment required that men and women should have the same normal retirement date for pensions. A simple premise that has caused innumerable problems for pension schemes over the years.

Each case brought before the Courts tends to turn primarily on its own facts but some striking trends emerge. Many schemes (including the Sea Containers 1990 Pension Scheme) purported to equalise the normal retirement dates in the 1990s by announcement. However these changes will be invalid unless the scheme's rules specifically provided the power to amend by announcement (rather than by deed).

As a result of the enormous liability caused by a failure to equalise properly, many of the cases look at creative legal solutions to the problem. In the Sea Containers case it was held that despite the scheme's definition of 'normal retirement date' containing wording allowing the employer and trustees to agree an alternative date, the member announcement and conduct of the parties at the time did not amount to a separate contract or arrangement, nor were the members estopped from denying that the had accepted the amendment. Therefore the scheme had not been equalised by the member announcement.

Scheme administration: Ombudsman directs administrator to pay pension shortfall

On a cautionary note, administrators of pension schemes may be liable to compensate members for any loss arising from their failure to keep accurate records (maladministration).

In the case of Mrs A (79435/1) the Pensions Ombudsman has directed the scheme administrator to compensate her for the loss to her benefits. The scheme administrator twice told Mrs A that it had received a transfer-in of her benefits from her old scheme.

When it came to Mrs A's retirement, she took her pension on the assumption that all her benefits had been consolidated into one scheme. At that point that the administrator discovered the error. However, Mrs A had already retired and it was too late to effect the transfer. Mrs A therefore lost out on the 'salary linkage' element.

The Pensions Ombudsman unusually determined that the administrators had to provide the compensation. Although Ombudsman's rulings are not precedent, this does seems to indicate a shift away from past Ombudsman decisions were only minor awards were made for 'distress' in the case of scheme maladministration.

Contracting-Out: DWP publishes fact sheet on the abolition of Contracting-Out

We previously reported on the abolition of contracting-out for DC schemes from 2012. Trustees of DC schemes which are currently contracted-out may want to look through the recently published document from the DWP. The aim of the fact sheet is to provide sufficient information for trustees to be able to manage the transition and the full document can be found at DWP: Trustee factsheet: Abolition of contracting out on a defined contribution basis (February 2011).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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Caoimhe O'Neill
Michael Jones
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