Despite the arrival of new laws to untangle pensions, months after A-Day many employers are still tied up in knots, says Nick Golding.
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Pension managers may seem a little more sceptical than usual, as many are still battling to implement a myriad of changes relating to pensions tax simplification rules which came into effect on A-Day (6 April).
When pensions simplification was first announced, employers and their pensions’ advisers welcomed the plans for a more straightforward approach to occupational pension schemes. However, the sad reality is that the word simplification couldn’t be further from the truth.
Michael Mountford, head of compensation and benefits at soft drinks firm Britvic, explains: "Like anyone else, we are learning to live with it. It was dubbed simplification but it is far from simple.
"The whole thing is fraught with confusion and although, in the long run, it may cause simplification, at the moment it is very disruptive and complicated."
This isn’t helped by the fact employers have been, and still are, faced with a variety of deadlines by which to comply with the legislation. There are a number of measures, for example, with a deadline of 6 April 2009.
Prior to last April, employers that may have been confused and missed deadlines could take comfort from the fact that HM Revenue & Customs (HMRC) was able to use a certain level of discretion when pension rules were fallen foul of, and in some cases, could let small infringements of the law pass.
This discretion, however, has now been removed and employers that believe they will still be let off if they bend the rules, be it inadvertently or otherwise, are mistaken.
Alan Matthew, associate at Norton Rose, explains: "This is something that has certainly not sunk in yet. While companies used to be able to argue a good case and the Revenue was quite flexible, under the new regime the rules allow no room for this discretion."
Employers that make unauthorised payments, for example, a lump sum payment after three months, will find that staff may face high tax charges, adds Matthew.
"If it goes wrong, there doesn’t seem anywhere for employers to turn. The member will be charged [up to 55%], although the whole charge may come back to the employer if the member was not in the wrong."
Another area where employers can be caught out is the removal of the earnings cap. In the past, HMRC placed a cap on the amount of contributions that an employee could make to a pension pot per year, which varied according to the pension scheme they belonged to.
However, many employers are unaware that now these restrictions have been lifted there is a danger that high-earning members may take full advantage of this freedom, at great cost to their employer.
Ian Luck, director at Smith & Williamson, says: "The lid HMRC placed on individual pension contributions was taken off, so suddenly those individuals could be making contributions on a much larger salary."
The problem is that this can prove burdensome for employers, because at bonus time or as employees approach retirement payroll could be swamped processing large sums of money bound for pension pots.
Paul Macro, head of defined contribution pensions at Aon Consulting, says: "It will be interesting to see how company payroll systems cope."
Without a cap, some organisations may also end up paying pension contributions linked to salaries without any overriding limitation. Many have pre-empted these situations arising by incorporating their own earnings cap into the scheme rules.
"Most organisations have created some sort of capping system, but one or two haven’t and are finding themselves paying contributions on full salaries," says Luck.
Creating such a cap is easier than it may seem, as HMRC will continue to publish the caps that were in use before April as guidelines for employers, even though these will no longer be enforced.
Also emerging are issues around overseas employees. Companies which are unaware of the altered rules around seconded members and their pension arrangements may find themselves in hot water.
Before 6 April, employees who were sent abroad from a UK office were eligible to make contributions to their pension scheme as they would if they were still working in the UK.
Post A-day, however, staff who are seconded abroad must satisfy certain tests. For example, employees must either be a UK tax payer or have been a resident in the UK (which constitutes living in the country for at least 183 days in a tax year) during the past five years. If they do not fulfil this criteria, they can no longer be a valid member of a company pension scheme.
Even if they are eligible, employees seconded overseas are limited to contributing £3,600 per year to a pension. Employers can contribute up to 100% per year of the employee’s earnings, but the organisation’s tax relief is left to the discretion of their local UK tax inspector.
According to pensions and benefits consultants, however, a number of employers have yet to address the issue.
John Deacon, director at Truestone Employee Benefits, explains: "In March 2006, employers were making deductions and contributions on behalf of their employees based abroad, and what we are reasonably certain of is that those companies have made no changes to their schemes post April."
As with all of the changes that A-day has brought, there is a danger that if employers do not communicate the new rules to staff they could end up paying the price.
"If this doesn’t get nipped in the bud, it could potentially end up costing employers quite a bit of money, as staff will say that they have been disadvantaged. They may claim that the company should be aware of the changes, [which] could result in the organisation compensating for both loss of investment growth and tax liability," explains Deacon.
Changes around the options available to employees on retirement also seem to be causing confusion. Firstly, employers need to be aware of the timescale that is associated with the new retirement rules.
On 6 April 2010 the new pensionable age for all employees will be switched from 50 to 55 years for staff that are aged under 50, so it is vital employers ensure staff are aware of these changes as early as possible.
Those that fail to get to grips with the changes may not offer their employees all of the advantages brought about by A-day.
Richard Oliver, head of UK operations at Hewitt Associates, explains: "Employers need to go back to the A-day rules and validate their schemes for members."
One particular area that needs attention is around the amount of tax-free cash that an employee can now legally withdraw from a pension fund on reaching retirement age.
Simplification laws theoretically allow employees the opportunity to withdraw a 25% tax-free lump sum, yet experts say that many employers have not yet changed their scheme rules to allow them to do so. "Members are expecting 25% but because their pre A-Day scheme rules [may] say that 15% is the maximum, this will still be the case," says Luck. However, in 2011 a statutory override will come into play and all members will in any event be entitled to 25%.
Employers must also pay close attention to the new rules around protecting benefits for higher earners who could previously withdraw more than 25% in cash. The new legislation allows employees to move from one scheme to another within an organisation and protect the amount that can be withdrawn on retirement, but the withdrawal must be completed within a 12 month period of the pension switch. If it is not, the protection is lost and employees are limited to taking a maximum of 25% cash tax free.
But employers must make staff aware that those who wish to protect their pension benefits going forward must apply to HMRC before April 2009. As long as applications are received by this deadline, HMRC can still issue certificates granting protection at a later date. If they do not do so, a statutory override will kick in in 2009 and these members will only be entitled to 25%.
"Employers and employees have [about] three years to comply with the new rules. There will not be much scope on from that," explains Luck
Key dates post A-Day
Members must have registered for either enhanced or primary protection of their pension benefits to avoid losing pre A-day benefits. As long as applications are received by this date, HMRC may still issue certificates granting protection after the deadline. April 2010The deadline for the new pensionable age, which rises to 55. Although this is the absolute deadline, employers can raise their organisation’s retirement age before this date.
Total annual contribution allowances are set to rise gradually over the next four years, before reaching a maximum £255,000 in April 2010.
The lifetime allowance limit will rise to £1.8m
Members in schemes which have not been amended to allow them to take a lump sum payment of 25% will now automatically be able to do so.
Case Study: Britvic rethinks its caps
The principal aim for soft drinks company Britvic following A-Day has been to preserve members’ pension entitlement and position.One way was by allowing all employees who could withdraw more than a 25% tax-free lump sum to continue to do so after A-day.
Michael Mountford, head of compensations and benefits, explains: "For anybody who was in the situation whereby they could withdraw more than 25%, we have framed their position and preserved their expectations."
Britvic is also dealing with the removal of the earnings cap by introducing its own, using HM Revenue and Customs’ published cap as a guide to ensure that pension contributions for high earners do not escalate.