A-Day, 6 April 2006, might still be eight months away, but organisations need to put plans in place now to meet the government’s new tax simplification legislation. Victoria Furness asks how much progress employers are making.
Mobile phone operator O2 has almost finalised its preparations for the area of legislation that it believes will have the biggest repercussion for its senior employees: the introduction of new lifetime and annual allowance limits of £1.5 million and £215,000 respectively.
Tina Clayton, head of group pensions, explains: "We have been working on our plans since August 2003 when the legislation was still in its draft form. We started to collect information on the retained benefits of our 150-strong senior executive population in order to create individual assessments and understand the number of people likely to be affected by the lifetime allowance."
Given that O2 is a relatively young company, having demerged from BT in November 2001, only a handful of senior executives will be affected by the lifetime allowance. Nevertheless, the company has devised a policy for managing employee earnings above this limit. "We have agreed that we will offer a cash alternative for those employees affected by the lifetime allowance. [They] have now received a letter explaining this offer and telling them about the options available to them. They have until December to tell us what they want to do," explains Clayton.
The remaining senior employees that took part in the initial assessment have received the results of this showing where their pension fits in relation to the lifetime allowance.
O2 also took the opportunity to review all forthcoming pensions legislation and its impact on its pension scheme in the run-up to A-Day. As a result of this, it is now looking at the possibility of offering a Muslim-friendly pension fund that complies with Sharia (Islamic) law, among other measures. In addition, O2 has widened entry to its pension scheme to enable 16-year-old employees to join if they wish.
"We are trying to give as much personal choice as we can within the legislation. We will also be embracing flexible retirement and allowing employees to withdraw their pension benefits while working for us," says Clayton.
One company that has had a flexible retirement policy for many years is supermarket chain, Sainsbury’s. Under current tax legislation, an employee that wants to draw their pension while still working has to leave his or her current employer and find work elsewhere. But after A-Day, this rule will be abolished so an employee can continue to work for their existing employer.
This is nothing new at Sainsbury’s, which was one of the chief lobbyists for pensions reform in this area. Geof Pearson, pensions manager, explains: "We have managed to do this [under current legislation] by asking anyone who wants to draw their pension and continue working for us to take leave of four weeks to show that there has been a clear change of contract. This gives people the opportunity to enjoy a better work-life balance. They can keep economically active and make up the loss in earnings by taking their pension. That must be good for all concerned: the individual, the employer and the economy."
The supermarket is also keen to encourage saving for retirement among its workforce. For this reason, it will continue to offer additional voluntary contributions (AVCs) to its staff, even though there is no requirement to do so after 6 April next year.
Pearson explains why the company took this decision: "At first sight, there seems to be a contradiction in what is happening. We do not have to provide AVCs anymore to our members, but one of the advantages of pensions simplification is that pensions will be easier to understand and, therefore, people should be encouraged to save more. One of the best ways to do this is through AVCs."
On the issue of death benefits, however, Sainsbury’s is still undecided on its policy. "In many cases, simplification means that we do not have to pay a widow’s pension and could offer it as a lump sum instead. Our dilemma is that while it might be more tax advantageous for us to offer a lump sum, on the other hand, is it responsible or sufficiently paternalistic?" explains Pearson.
Drinks manufacturer Diageo is currently in the throes of implementing its strategy for dealing with pensions simplification. One decision that has already been made is its plan to keep its unfunded, unapproved retirement benefits scheme (UURB) in place for senior members of staff.
At present, members of Diageo’s pension scheme post-1989 receive an unapproved benefit on any salary above the earnings cap. But with the introduction of pensions simplification legislation next April, the earnings cap disappears to be replaced by a new lifetime and annual allowance.
Since a number of Diageo’s employees will be earning above the £1.5 million lifetime limit – especially members of the pre-1989 pension scheme earning large salaries – the company has decided to continue with its UURB scheme and introduce a scheme-specific earnings cap so any earnings above the lifetime allowance can be treated as an unapproved benefit once the reforms kick in.
Ian McQuade, head of pensions consulting at consultancy Dunnett Shaw, which has been working with Diageo on the administration of its pension plan, explains: "Diageo is retaining a scheme-specific earnings cap so the benefits within the plan remain the same and they [will] retain the UURB scheme so they do not have to fund it immediately. One reason for Diageo’s decision is that their staff understand how UURBS work already so people might as well carry on and continue to pay money into it."
Had Diageo decided to wrap its unapproved plan into an approved scheme, everyone already in the UURB scheme would have had to learn about the new tax recovery charges that come into force on A-Day. As it is, only a much smaller group – those members of the pre-1989 pension scheme that have never had an earnings cap – will need to be educated about changes to their pension plan.
Diageo has also been proactive in communicating changes to employees and is one of several companies working together to develop a modelling tool for the industry. Internally, Diageo is using this tool to develop CD-Roms for senior employees that will show them how they will be affected by pensions simplification. Paul Charles, pension strategy and policy manager at Diageo , says: "This is important for helping employees predict the likely impact of new tax reforms and aid their decision-making in the lead-up to A-Day."
IT distributor, Sematron, has taken a slightly unconventional approach to pensions simplification following advice it received from IFA firm, Millfield Partnership. John O’Brien, managing director at Sematron, explains: "Millfield brought to our attention that the rationalisation of pension schemes on A-Day opens up some new opportunities for us – such as a contracted-in money purchase scheme (Cimp) – despite appearing to remove choices for people. Cimp certification rules basically allow an individual to obtain some tax-free cash earlier than they would have been able to do so under other pension schemes. When most people talk about their pensions, one of their priorities is how much – and how early – they can obtain some tax-free cash; Cimp presents that opportunity."
From A-Day, when a single universal regime comes into force, employees will no longer be able to join a Cimp scheme. But anyone who was previously a member of this type of scheme will be able to claim their tax-free lump sum, depending on their age. Those employees aged 50 years old have the most to gain from joining the scheme as they can claim their tax-free lump sum on A-Day. Others will be able to claim their lump sum on their 50th birthday unless it falls after 2010, when the retirement age rises to 55.
However, O’Brien notes that some younger employees were also keen to join the Cimp scheme: "Although they might not receive the lump sum for ten-to-15 years, this might be at the time their three-year-old son is going to university," he explains.
By the time A-Day arrives, Sematron will have been running the Cimp scheme for 18 months. Despite creating an additional administrative burden because the Cimp scheme operates alongside Sematron’s group personal pension plan, O’Brien believes it has been worth it for his employees. "It is one of the few opportunities to take home some salary tax-free and even if an employee cannot take the lump sum from Cimp until he or she is 55, it is still an earlier date than other payouts."