International reward: Take a look at offshore pension schemes

If you read nothing else, read this …

  • Employers offer international pension plans (IPPs) to ensure they properly and competitively compensate employees for living outside of their home country.
  • An employer needs to find a suitable offshore jurisdiction on which to base its IPP, understand the tax implications of the scheme, decide which employees are eligible for it, and how it should be designed.
  • Some offshore pension providers place restrictions on the number of US members in a scheme.

Case study: Mars scheme has DC and DB flavours

Mars, which manufactures brands such as Pedigree, Dove and Snickers, set up an international pension scheme for its globally mobile senior managers in 2008.

The scheme, based on a design incorporating both a defined contribution (DC) and defined benefit (DB) pension, is in two parts. Employees put contributions into the DC section, which is managed by Boal and Co in the Isle of Man, while the employer-funded section of the IPP is based wherever the employees are based. This part of the scheme is not subject to typical local pension tax rules because it is unapproved and therefore not tax qualified.

Hung Tran, international benefits and control manager, Europe, Middle East and Africa (EMEA) at Mars, says: “We put the money (employer contributions) aside. We do not physically put the money in to be invested. We set it aside and we give a guaranteed return on it, so it operates like a bank account. It is not invested anywhere; it is basically sitting on the company’s balance sheet.”

Mars contributes 10% and matches what an employee puts in by 1.5% up to a maximum of 9%. This means that Mars puts a maximum of 19% into the scheme, which currently has about 20 members.†

“Previously, we provided a lot of DB benefits where there was not the requirement for our members to contribute,” says Tran. “All the risks sat with the company. We moved away from that model because we believe the sharing of risk is actually more appropriate.”

An international pension plan can be an attractive way to reward expatriate staff, but an offshore scheme involves crucial choices for employers, says Nicola Sullivan

A lot more goes into setting up an international pension plan (IPP) than placing employees’ money on a little rock in the middle of the ocean. Not only do employers need to find a suitable offshore jurisdiction for their IPP, they also need to understand the tax implications of the scheme, decide which staff are eligible for it, and how it should be designed.

Before addressing these factors, however, the first move for many employers will be to convince their board of directors of the business reasons for offering an IPP. Compensation and benefits professionals, whose remit covers international employees, will be keen to ensure that expatriate staff receive a competitive benefits package and are compensated for living outside their home country.

Jana Mercereau, senior international benefits consultant at Towers Watson, says: “There is certain cadre of employees who move around constantly. We call them the nomads, the lifetime expats who never return to their home country. These employees are key to their employer because they are in management, are highly paid and are significantly sought-after individuals who have specific knowledge about their business or market.”

Fail to match up

Globally mobile employees might work in a country that does not have an established pensions infrastructure and some local schemes may fail to match up to what they would have received in their home country. In the Middle East, for example, there are no domestic pension schemes. Instead, employees receive an end-of-service-gratuity payment when they leave their employer, which is based on how long they have worked for the organisation and is typically paid out on a monthly basis.

Not surprisingly, Towers Watson’s International pension plan survey, published in November 2011, found that the Middle East remained a popular region for international pension plans, with more

than one-third of plans that were set up last year being explicitly for employees based in the region.

“From a pension perspective, employers have to entice [expats] or compensate them for living abroad,” says Mercereau. “Employers want to fill the gap because they will not be receiving state social security benefits if [employees] move every three years and they will not have a local pension plan they can draw upon. And if they do, it will be little pots that never achieve much, and that is not going to equal a stay-at-home benefit.”

Once employers have identified the business need for an IPP, they then need to decide on the offshore jurisdiction under which to place it. There are a number of factors employers need to consider when looking at jurisdictions, such as the Isle of Man, Guernsey, Jersey, Bermuda and Singapore. These include the regulatory environment, compliance with UK legislation, familiarity of the jurisdiction, local time zones and language.†

Stuart Clifford, a principal at Baker Tilly Isle of Man, says: “If they want to use a sole jurisdiction, what has that jurisdiction got to offer in the way of protection to their members? If I am going to stick my employees’ money on a little rock in the middle of the sea somewhere, I am surely going to prefer one that has a specific dedicated set of legislation, regulations and a [pensions] regulator. I would always say to an employer ‘look at how your pension is regulated. Are there laws specifically designed to protect members in that jurisdiction?’”

Employers need to identify which employees should be eligible for the IPP from the outset. After all, if all staff with an international remit think they are entitled to the scheme, it could become more expensive than the employer first thought.

Mark Price, a principal in the international consulting group at Mercer, says: “Over a five-year period, an employer may find that there are tens, if not hundreds of people going into the IPP who should not be in it. It is not the end of the world, but IPPs can be quite expensive on a per-head basis, and people tend to think, ‘oh good, there is an offshore pension, I’ll go into that’. Employers have got to be really good on eligibility and make sure that they stick to their own corporate guidelines.”

US membership

It may also prove challenging for employers to include employees in the United States (US) in an IPP. Some providers exclude or place limits on US membership of schemes because of the reporting requirements stipulated by the country’s Employee Retirement Income Security Act (Erisa).

Price explains: “Most providers will exclude US persons from the scheme because if the US persons are included, then the scheme becomes subject to US legislation, like Erisa. A lot of plans will have a 10% limit on US members and some will dismiss them altogether, and that is a key problem with the international pension plan.”

As with any workplace pension, employers will want to ensure that their plan’s design suits the requirements of the business and the scheme members themselves. According to Towers Watson’s survey mentioned previously, most international pensions are based on the design of a defined contribution (DC) arrangement and three-quarters of the plans set up over the past year were trust-based.†

Karen Kelly, a senior consultant at international actuary and consultancy firm Boal and Co, says: “Firstly, employers need to decide on the kinds of benefits they are trying to offer their employees. Is it to mimic a home country plan, like a UK or US plan? Is there any benefit differential for anybody who is not working in their home country?”

Employers can choose either a bundled or unbundled pension arrangement. With the former, a single provider deals with administration, investment and insured or trust services, whereas the latter involves using separate contracts to provide such services. Employers will also have to weigh up the pros and cons of funded or unfunded schemes. In some cases, there may be no benefit-in-kind tax levied on employees for an unfunded plan and, therefore, no tax liability for the employee until the benefit is paid out, at which point the tax position will depend on the member’s place of residence.

“I have come across US employers that have gone for the unfunded group simply because they worry about what the benefits or entitlements will look like at the point at which they are distributed,” says Mercer’s Price. “In some circumstances, there is no benefit-in-kind tax for an unfunded plan. It is mainly a deferral of the tax liability to the point at which the benefit is paid out.”

Big attraction

If employees are members of an IPP based in a jurisdiction other than Guernsey, they can take their money before the age of 55.

Nigel Gregg, director of Mac Financial, a corporate independent financial adviser on the Isle of Man, says: “That is the big attraction of these schemes. Here, on the Isle of Man, we relaxed the requirement to take an annuity a few years ago, so a member could retire and, instead of buying an annuity, elect for an income drawdown.”

Although a lot of planning is required to set up an IPP, the benefit could be just what gives an employer the edge when it comes to competing in the global economy.

Qrops option

Staff leaving the UK could opt to transfer their UK pension into a qualifying recognised overseas pension scheme (Qrops). These arrangements were introduced in April 2006. Qrops allow an individual to transfer their savings in a UK-registered pension scheme to a pension plan that meets the conditions to be a Qrops, free of UK tax.†

Mark Kiernan, director of Boal and Co, says: “The new legislation effectively opened up a third-country environment where you could domicile a pension plan in one jurisdiction and be resident in another. A number of jurisdictions have been quite buoyant in that market, specifically the Isle of Man, Guernsey and Australia.”

In the draft Finance Bill 2012, however, the UK government proposed revisions to secondary legislation that will reassess the conditions a scheme must meet to be a Qrops. These include: introducing an acknowledgement by the individual before a transfer is made, that tax charges may apply; introducing revised time limits for registered schemes to report transfers to Qrops; providing additional powers for HM Revenue and Customs (HMRC) to request information from a scheme manager; and revising the time limits for the reporting of payments by a Qrops to HMRC.

The design of international pension plans

Towers Watson’s 2011 International pension plan survey, published in November 2011, found that the size of international pension schemes varied from fewer than 10 to more than 4,000 members.

About half of plans do not incorporate vesting criteria in the scheme design, which means employer contributions vest immediately.

  • Where vesting rules do exist, employers are more likely to opt for a flat vesting schedule, indicating the employer contributions would become 100% vested after a fixed number of years. Members are not entitled to employer contributions if they have not met service criteria.
  • Most international pension plans have a flat contribution scale, often with one-to-one matching or no matching at all. At the lower end of the scale, employers contribute between 5% and 9%, while higher contributions can range from 10% to 14%.
  • Minimum staff contributions range from 0% to less than 5%, while† maximum contributions range from 6% to 10%, and can exceed 20%.†
  • About 40% of plans surveyed offer up to 10 investment funds and the rest offer more than 10 options. Nearly 40% offer lifestyle options, with more than 20% offering more than one lifestyle option.

Read more about international benefits