The Irish Pensions System - What Next?

Contents

• The Irish Pensions System – What Next?
• Legislation update
• Criminal Justice Act 2010

The Irish Pensions System - What Next?
By Peter Fahy

Peter Fahy examines recent developments and considers what changes a new Government may bring. During the current hiatus while the 2011 election campaign is underway, it is worth examining the events of the past eleven months, and also looking at what an incoming Fine Gael/ Labour Government may mean for the occupational pension system in Ireland.

The rollercoaster

Pension schemes have been more exposed to political scrutiny in the past couple of years than perhaps the preceding couple of decades. It used to be about what the State can do for retirement saving; now it's about what retirement saving can do for the State – and not in a good way.

It is just eleven months since the National Pensions Framework was officially launched in March 2010. The mission statement of the Framework is "we must plan now to ensure the adequacy of retirement incomes and the long term future and sustainability of our pension system."

Key proposals included

• €10 billion of the National Pension Reserve Fund, which is intended to finance the future cost of public sector pensions, has been earmarked to recapitalise the banking system. The Minister for Finance has been given effective control of the remaining assets of the Fund by the Credit Institutions (Stabilisation) Act 2010.
• Existing deadlines for the submission of funding proposals by defined benefit schemes to meet the funding standard were suspended last October.
• In November, the outgoing Government committed in the National Recovery Plan (NRP) to reduce aggregate expenditure on pension tax relief by €700m (private sector) and€240m (public sector) over the period 2011 to 2014. This is to be done by abolishing employee PRSI and health levy relief on pension contributions, reducing the annual earnings cap for tax relief on contributions and reducing the standard fund threshold. In addition, the rate of income tax relief on pension contributions is to be progressively reduced to 20% by 2014.

• In the December 2010 Budget and subsequent Finance Act, the outgoing Government followed through on their NRP proposals, and went further, as follows:

• Legislation to enable pension schemes invest in Irish Government backed or 'sovereign' annuities was enacted in December.
• However, proposed amendments to the funding standard and to the regulatory system that were to have been announced by the Pensions Board have been deferred until after the election.

What has happened since?

Some of the key developments since March 2010 are as follows:

• €10 billion of the National Pension Reserve Fund, which is intended to finance the future cost of public sector pensions, has been earmarked to recapitalise the banking system. The Minister for Finance has been given effective control of the remaining assets of the Fund by the Credit Institutions (Stabilisation) Act 2010.
• Existing deadlines for the submission of funding proposals by defined benefit schemes to meet the funding standard were suspended last October.
• In November, the outgoing Government committed in the National Recovery Plan (NRP) to reduce aggregate expenditure on pension tax relief by €700m (private sector) and €240m (public sector) over the period 2011 to 2014. This is to be done by abolishing employee PRSI and health levy relief on pension contributions, reducing the annual earnings cap for tax relief on contributions and reducing the standard fund threshold. In addition, the rate of income tax relief on pension contributions is to be progressively reduced to 20% by 2014.

• In the December 2010 Budget and subsequent Finance Act, the outgoing Government followed through on their NRP proposals, and went further, as follows:
• The new universal social charge and PRSI has been applied to all employee contributions, and 50% employer PRSI has been applied to employee contributions.
• The annual earnings limit for tax relief has been reduced from €150,000 to €115,000.
• The tax free lump sum on retirement has been reduced to €200,000.
• The standard fund threshold has been reduced to €2.3 million.
• Legislation to enable pension schemes invest in Irish Government backed or 'sovereign' annuities was enacted in December.
• However, proposed amendments to the funding standard and to the regulatory system that were to have been announced by the Pensions Board have been deferred until after the election.

Looking at the above, the mission statement of the National Pensions Framework has been swept aside by more recent events. So where do we stand now?

What might a new Government do?

Of all the measures outlined above, the one that has most potential to drive a stake through the heart of occupational pension schemes is the proposed reduction in income tax relief for employee contributions to 20%. However, if this measure is not introduced, it must be acknowledged that, under the EU/ IMF bailout deal, the savings to be generated by it must be found elsewhere.

Fine Gael's fiscal plan has the following to say on the 20% proposal:

"Under the Government's plan, tax relief on contributions to pensions by middle and higher income employees will be more than halved from 41% to 20%. Given that many of the resulting pensions will then be taxed in retirement at almost 50%, this will destroy the incentive for tens of thousands of middle income Irish families to save for retirement."

Instead, Fine Gael proposes:

• A temporary, annual 0.5% contribution for all private pension funds, so that older beneficiaries of past tax relief make some contribution to deficit reduction. An equivalent reduction could be applied to public and private sector defined benefit entitlements.
• Abolition of PRSI relief on employer pension contributions
• Allowing defined contribution pension savers to access funds early, within reasonable limits, to meet their current business and personal responsibilities (and taxing the draw-downs).
• Cutting the limit on tax free lump sums on retirement to €250,000.
• A cut in the standard fund threshold for pensions to €1.5 million for public and private sector workers, while also increasing the notional annuity cost of defined benefit, final salary schemes from the current 20:1.
• An increase in the 'deemed distribution' rate on large Annual Retirement Funds (ARFs) to avoid their use for inheritance tax planning.
• Applying from 2012 marginal rates of income tax, rather than Capital Acquisitions Tax, to ARFs on the death of the beneficiary to avoid their use for inheritance tax planning. This could be accompanied by a 1 year window in 2012 for beneficiaries to accelerate withdrawals from ARFs at a tax rate of 35% leading to a windfall for the exchequer at a crucial time.

This seems a better package overall than the NRP, albeit some elements are potentially dangerous. However, the proposals are not costed, so it is difficult to be certain how feasible they are.

Labour's manifesto is much less specific, but states the following:

"Labour will target a further reduction of €500 million in the total amount of relief, but rather than simply standardising the rate of relief, Labour favours an approach that retains strong incentives for people to invest in pensions while also making the system fairer. This will include capping the tax relief on pension contributions from both employers and employees, reducing the maximum tax-free lump sum, reducing the maximum pension fund and including pension tax relief in the minimum effective tax rate."

The reference to capping tax relief on employer contributions is worrying for defined benefit schemes in particular. However, Labour's plans again seem more holistic than the outgoing Government's.

The difficulty is that Labour is assuming a renegotiation of the budgetary parameters agreed under the EU/IMF deal, which puts a huge question mark over all of their proposals, not just their pension proposals.

What should sponsors and trustees of pension schemes do now?

The developments of the past 11 months have generated huge uncertainty for occupational pension schemes. Nevertheless, it is important to note that the only thing that has actually changed in a meaningful way is the reductions in tax relief actually implemented under the Finance Act, 2011. You should consider lobbying against, or supporting your representative organisations in lobbying against, the proposed 20% cap on income tax relief. This has the potential to hugely damage both defined contribution and defined benefit schemes.

You should assume that the days of large individual pension 'pots', either within a defined benefit or a defined contribution scheme, are gone, and amend your HR, financial and actuarial planning for your pension schemes accordingly. The €2.3 million standard fund threshold may well be reduced further, as may the annual earnings cap for employee contributions. Both of these measures feature strongly in the Fine Gael manifesto.

Sovereign annuities as enacted, so far, are something of a wild card. Trustees should be wary of the difficulties of using sovereign annuities to discharge pension liabilities under their schemes in the current financial environment. When such annuities were originally proposed, the yield gap between Irish and German bonds was of the order of 1.25 to 1.5%.

For larger schemes with strong employer covenants, sovereign annuities may be a very useful tool in reducing the short term funding cost of your schemes. However, this assumes that appropriate changes will be made to the funding standard to recognise sovereign annuities, which has not happened yet.

There is likely to be a new deadline for the submission of funding proposals at some stage in the latter part of 2011, and trustees and employers should be preparing themselves for that deadline. There are also likely to be changes to the funding standard to reduce short term volatility in funding costs, and perhaps create a framework for the 'new model' pension scheme.

In summary, sponsors and trustees need to pay much closer attention than in the past to political developments. The attitude of the new Government to the NRP and the short term crisis management inherent in recent pensions policy will be critical to the future health of all occupational pension schemes.

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Legislation Update
By Ian Devlin

Ian Devlin provides an update on recent legislative developments which impact on pension schemes.

Civil partners

The Civil Partnership and Certain Rights and Obligations of Cohabitants Act, 2010 came into force on 1 January 2011. This Act creates certain rights for registered civil partners involving same sex couples in a wide variety of areas, including pensions.

From a pensions perspective, the key points to note are that:

• a benefit under a pension scheme, retirement annuity contract (RAC), trust RAC and certain other pension arrangements that is provided to a spouse will be deemed to provide equally for civil partners,
• the protection against discrimination on grounds of marital status within the Pensions Act has been extended to cover discrimination on grounds of civil partnership status,
• the ability to obtain pension adjustment orders will also apply to situations where civil partnerships are being dissolved.

The Act also allows qualified cohabitants to apply to the courts for various forms of financial redress, including pension adjustment orders. The ability to obtain such orders is subject to satisfying the court that the applicant is financially dependant on the other cohabitant.

At a day-to-day level, the key change this Act introduces for pension schemes is that certain contingent benefits previously only payable to spouses will equally be payable to a member's civil partner. Schemes should therefore put in place arrangements to ensure that members notify them of the existence of civil partners. This will ensure that trustees can take civil partners into account where, for instance, they have to exercise discretionary powers over how certain death benefits are applied as between spouses and other dependants.

Prohibition on Self-investment

Effective from 23 September 2010 'self-investment' above certain thresholds is now prohibited under the Occupational Pension Schemes (Investment) (Amendment) Regulations, 2010 (the 2010 Regulations). Previously, 'self-investment' simply resulted in the scheme actuary ignoring self-invested assets in assessing whether a scheme satisfied the statutory minimum funding standard.

Under the 2010 Regulations, self-investment in the sponsoring employer cannot exceed 5% of the resources of the scheme and total self-investment in the employer group cannot exceed 10% of the resources of the scheme.

Broadly, 'self-investment' is defined as the investment of a scheme's resources in the employer, an affiliate of the employer, or directors of the employer or its affiliates. For the purposes of this definition, investment is deemed to include investment in:

• property other than land or buildings used by,
• loans to; or,
• moneys due to the scheme held by,

the employer, an affiliate of the employer or directors of the employer or its affiliates. It also includes investment in shares or securities issued by the employer or its affiliates.

Certain exceptions to what would otherwise represent 'selfinvestment' apply where scheme sponsors or their affiliates are financial institutions such as banks, life insurance companies or regulated investment funds.

The immediate impact of this change is that any schemes which hold assets which represent self-investment should, if they have not already done so, immediately divest themselves of assets which exceed the 5% or 10% thresholds described above.

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Criminal Justice Act, 2010 – New Obligations for Pension Scheme Trustees?
By Patrick Collins

The Criminal Justice (Money Laundering and Terrorist Financing) Act, 2010 (the Act) commenced on 15 July 2010. Patrick Collins considers what implications the Act will have for pension scheme trustees.

The Act places obligations on designated persons as defined in the Act. Designated persons are required to conduct client due diligence, which entails measures to establish the identity of the client. Designated persons are also required to report any suspicious transactions of clients, to Revenue and An Garda Siochana. Designated persons must train their employees in relation to the requirements of the Act. Designated persons must also keep records in relation to their clients.

Designated persons include trust or company service providers as defined in the Act. A trust or company service provider means any person who is in the business of acting, or arranging for another person to act, as a trustee of the trust. This raises the question as to whether trustees of pension schemes are designated persons. The Act does not expressly exclude pension scheme trustees from the definition of designated person. For example, is a pension scheme trustee in the 'business' of acting as a trust or company service provider?

Corporate trustees of pension schemes may receive remuneration for their services, and could therefore be regarded as being in the business of acting as a trust or company service provider. The position is less clear in cases of pension scheme trustees who do not receive payment for their services.

On 19 January 2011, the Pensions Board issued a press release clarifying these issues as follows:

1. A company which is established on a once off basis to administer a pension scheme for its employees which has obtained Revenue exempt approval does not fall within the definition of "trust or company service provider" as the company does not provide the service as part of its business.
2. The Act does not apply to pension scheme trustees eg directors, employees or pensioners, in relation to such pension schemes but does apply to persons whose profession or business it is to provide trustee services on a commercial basis. The Pensions Board's statement clarifies the legal position. That is, trustees who provide pension scheme trustee services on a commercial basis must obtain an authorisation to do so from the Department of Justice and Law Reform. The Department is the competent authority under the Act for regulating trust or company service providers.