See-through pensions

Employer-sponsored pension schemes will be required to undergo significant changes as a consequence of the Finance Act 2004. However, the Pensions Act heralds further change, and all of these must be accommodated in schemes run on behalf of employers.

Retirement ages are undoubtedly going to rise to give the majority of people a chance to build up sufficient financial reserves on which to retire. After all, we’re all apparently going to live to a ripe old age.

The state retirement age for men and women is gradually being equalised, and women born after April 1955 will be unable to take their state pension before their 65th birthday.

Additionally, from 2010, people will be unable to draw privately-funded pension benefits before the age of 55.
However, from April 2006, an individual will not have to retire to draw pension benefits, which will make it easier for people to extend their working life through working part-time.

The Age Discrimination Act, which will be enacted from October 2006, also forbids age discrimination and prevents employers imposing compulsory retirement ages, although a default retirement age of 65 will be set.

Contributions and protection
Currently, the sponsoring company must make contributions to the pension scheme by the 19th day of the month, after the month to which they relate. If this deadline is missed, the Occupational Pensions Regulatory Authority (Opra) must be informed. Opra will be replaced by the Pensions Regulator from 6 April.

However, new rules are less stringent, so a one-off late payment will not have to be reported, whereas regular or deliberate late payments will. Trustees should notify members if a contribution is more than 60 days late and Opra should be advised if a payment is more than 90 days late.

A pension protection fund will be introduced to help safeguard the pensions of members of final salary schemes in the event their employer goes into receivership while the scheme is in deficit. Such a fund will be financed by a levy on final salary schemes. Any scheme with apparent funding difficulties will be considered high risk and will have to pay a higher levy. Not surprisingly, they would also come under scrutiny from the regulator.

In future all employers will be bound by the member nominated trustee process, which requires that at least one-third of the scheme’s trustees be chosen by members. Further, by 2008-09, there is likely to be a requirement for one half of trustees to be selected by the membership.

Trustees must have sufficient “knowledge and understanding” to fulfil their role. However, it is almost inevitable that the increasing complexities of pensions administration will mean more external professional trustees are appointed.

The main area that the HR staff who are responsible for pension schemes should be working on is alerting members to the statutory lifetime allowance (SLA) and the implications this can have on the projected pension value.

Should an employee’s pension savings look as if they could reach the SLA of 1.5m, it would be advisable to alert them so that action can be taken in good time to minimise any potential tax liability, which could be as high as 55% on funds in excess of the SLA. Bear in mind that this £1.5m figure includes all pension savings and potential death benefits, additional voluntary contributions and private pensions.

If action is left until the spring of 2006, the implications could be costly. It is worth remembering that it is not the current value of funds that is at issue but the projected value at retirement.

You will need to allow considerable time, even months, to establish the projected values of benefits, as advisers and product providers will be inundated with requests for information. With the deadline only 12 months away, HR departments should encourage staff to start this process as soon as possible.

There are two levels of pension protection for those with substantial pensions savings, and members must consider their position before April 2006:

  • Primary protection – the fund value on 6 April 2006 will be increased each year in line with the revised lifetime allowance. Any excess over this notional lifetime allowance at retirement is subject to an extra tax charge of up to 55%. This form of protection is only available if funds on 6 April 2006 exceed the SLA. Further contributions can be made.
  • Enhanced protection – the accrued fund, and any subsequent growth, is exempt from the SLA. The ratio of the tax-free lump sum to the accrued fund on 6 April 2006 applies to the revalued fund. The benefit of enhanced protection will be lost if any contributions are made after that date. This includes contributions to any money purchase plan and further accrual to a defined benefit scheme.

Employment contracts
Employees with substantial pension funds may conclude it is not worth investing further money into approved pensions arrangements, because of the constraints of the SLA.

Employment contracts that specifically detail contractual obligations to make pension contributions or a promise of ultimate benefits should be reviewed urgently, as the implications for employees and employers could be significant. Also, bear in mind that the introduction of age discrimination legislation may affect employment contracts.

Claims from a group life assurance scheme will also count towards the SLA. An employee who began employment after 14 March 1989 and receives an annual salary of more than £102,000 is most likely to be affected.

Many schemes’ rules, particularly those relating to a final salary scheme, should be updated in line with the new pension regime. For example, the definition of those who can receive a dependant’s pension will change.

Business changes
From this year, any gain or loss accruing to the scheme must be recognised in the profit and loss accounts of the sponsoring company. This could mean a company that, at first sight, appears profitable may indeed be operating at a loss. The implications could be significant when considering mergers and acquisitions.

Members of occupational schemes where employment is transferred will benefit from greater protection. However, the precise impact remains to be seen. This should be of value to pension scheme members but could involve employers in unquantifiable liabilities.

Those of you responsible for, or who are involved in, the maintenance of employer-sponsored pension schemes should consider these implications. The changes are intended to simplify pension provision, restore confidence and allow employees to make larger pension contributions in the future. Communicating and helping employees with this will be crucial to ensuring that members gain the full benefits the scheme offers.

While many of the changes should make for a simpler and more transparent pension system for corporate schemes, in the short-term, trustees and HR personnel will have to overcome many challenges, not least since those most likely to be affected are senior and key staff members.

The message is loud and clear. These are possibly the most far-reaching changes to the way that pensions operate in the UK and demand proper consideration. The only way to ensure that you will be fully prepared is to start planning now.

By necessity, this briefing can only provide a short overview and it is essential to seek professional advice before applying the contents of this article

Action now to stay legal

  • Consult your professional advisers – there are many changes beyond those that will make the headlines
  • Update pension scheme rules and documentation – many of the new rules will override existing scheme rules, but some will be superseded in a couple of years
  • Review your existing benefit arrangements – the benefits currently provided might be the most suitable at the moment, but this may not necessarily be the case after April 2006
  • Inform your employees of the changes that will affect them – the new rules should be good news for most of them – with increased contributions possible as well as greater flexibility
  • Make the most of the old rules – the opportunity still exists to make the most of the outgoing regulations. It might be possible for self-invested personal pensions and small self-administered schemes to buy a commercial property of greater value now than they will be able to after 6 April 2006

Peter Maher is director and head of pensions and corporate benefits at Smith & Williamson

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