A-day may have been and gone, but employers will still have tasks to consider when it comes to pensions reform, says Ceri Jones.
Article in full
Employers have put in a great deal of painstaking work in preparation for A-day (6 April), but much is still incomplete as the final regulations were not issued until midway through March.
Most firms need to amend their rules to avoid unwanted consequences of the new regime. The most pressing is to ensure staff cannot make a claim for unintentional benefits such as cash lump sums. Exactly what changes are required will depend on the nature of existing perks and the wording of scheme rules.
To help, HM Revenue & Customs (HMRC) has introduced regulations that make overriding modifications to scheme rules for a transitional period until April 2011. These Modification Regulations provide breathing space until 2011, during which time existing HMRC limits, including the earnings cap, will continue to apply and any scheme rules relating to a benefit which would be unauthorised under the new regime, converts into a discretion to pay that benefit. Plans are also automatically deemed to contain a power to deduct the tax charge from the benefits of staff whose funds exceed the lifetime limit.
For some schemes, these regulations may enable trustees to defer making changes to scheme rules for five years. However, without an amendment, schemes will not be able to exceed current HMRC limits and take advantage of the new flexibilities such as paying out higher tax-free lump sums, or allowing spouses to convert their entitlement into lump-sum benefits. Yet some will undoubtedly face member expectation that they should enjoy flexibility post A-day.
Claire Altman, associate of law firm Sackers & Partners, says: "The problem was that for so much of the time we were working with draft regulations. Promises may have been made to members a year ago, but trustees have been grappling with a process that has been awkward, sticky and difficult."
Cherry picking which of the current HMRC limits to keep and which to remove can be achieved by incorporating all the limits into the scheme rules and then disapplying those you do not wish to preserve. It would be surprising, however, in view of the timescale and sheer volume of redrafting, if no scheme inadvertently let unintentional wording slip through the amendment process.
Roger Mattingly, director at HSBC Actuaries & Consultants, explains: "The first red light is that although there is a five-year window to make these changes, if you don’t hard-code current limits, there is a risk of creating an unexpected entitlement and elevating liabilities. Extreme diligence and care needs to be taken in the redrafting. One school of thought is that a scheme can accommodate everything in a Deed of Amendment, and the trustees can then decide what to allow and what not to allow. In a way, that is easier because it is more straightforward."
Several of the issues are tricky. For instance, technically, members will be allowed to contribute 100% of their earnings post A-day but this may make trustees nervous of a backlash should employees be boosting their pension at the expense of another financial outlay such as maintenance payments. A number of schemes are allowing this flexibility only so long as employees take independent financial advice.
Currently, many schemes pay less in cash entitlement than the 25% of pension rights allowable post A-day and, for the first time, cash can also be taken from Additional Voluntary Contributions (AVCs). Increasing tax-free cash payments under the main scheme will slightly lower its costs depending on its commutation rate, but if members decide to take all their cash from AVCs, leaving their stake in the main scheme, this will have a converse, slightly detrimental effect on the funding of that plan.
Trustees will also face an uphill struggle trying to police the recycling of lump sums, whereby a scheme member takes a lump sum from one scheme and invests it in another.
On dependents’ pensions, decisions must be taken about whether to allow a beneficiary to take a tax-free lump sum up to the lifetime allowance, which replaces the previous regime’s maximum of four-times salary. Despite the tax saving, most trustees will probably be loathe to create a situation where a dependant’s income depends on a lump sum being properly invested, and prefer instead a blend of tax-free lump sum and income for life.
Ultimately, certain rules will require amendments to bring them into line with the new regime and avoid schemes paying out benefits that will be classed as unauthorised. Examples of unauthorised payments include the payment of a children’s pension to a non-dependant stepchild and the payment of an ill-health early retirement pension where the new statutory ill-health condition is not met. A lot will be in the detail. For example, a scheme may historically have provided pensions for children in full-time education up to age 25, but this is restricted to age 23 under the new regime, although transitional provisions will cover pensions already in payment.
Flexible early retirement does not fall within the overriding provisions and most employers are switching to age 55 in 2010 in accordance with statute. Trustees also need to make decisions about whether employees should be able to draw their pension while continuing to work.
Some of the transitional protections at A-day will also be subject to the discretion of the trustees and may require a one-off exercise to calculate member entitlements. For example, members with lump sums at A-day in excess of 25% of their pension rights can retain that right for pre A-day accruals if their scheme allows them to do so. Trustees who decide to allow this may want to carry out an audit to calculate the protected cash lump sums as at A-day for all employees.
Member literature should also be revised as soon as possible, even if the trust deed and rules are not amended to reflect overriding changes. A whole raft of communications will require adaptation, from letters for retirement and early leavers to future employment contracts and benefit statements. Procedures on the refund of contributions and trivial commutations must be updated to reflect the changes, while pensioners’ P60s must show the percentage of the lifetime allowance crystallised so far.
Case Study: J Walter Thompson
Advertising agency J Walter Thompson is still going through the process of ensuring its schemes comply with the demands of pensions simplification.Its £55m defined benefit schemes closed to new members around 15 years ago so are now very mature.
John Heatly, chairman of the trustees of two of its closed schemes, says: "At a trustee’s meeting in January, it became clear we had to rewrite the rules because there are so many knock-on effects. We will probably amend the lump sum and death-in-service rules to take account of the 25% cash limit, but will not make our final decision until June.
Getting the trustees together in such a short timescale is difficult. The most irritating thing about pensions legislation is that no-one will be definitive and then suddenly new requirements are issued. Financial statements used to be annual and now are quarterly. The volume of extra bureaucracy and work seems to pile up endlessly, and take forever."
The work expected of the trustees has already got the better of one of their number who quit after more than four years’ service. "The legislative requirements were more onerous than he was prepared to take on. The volume of the legal and investment mathematics is mind boggling," adds Heatly.
One issue which was addressed immediately, however, was the lifetime allowance. "We went through all the active members to see if any were caught. A couple were close and were properly alerted should they be caught because of other pensions sources," he says.