Forthcoming
pensions legislation will make some radical changes, including allowing workers
to continue in a part-time capacity and limiting the amounts built up by top
executives. HR needs to prepare the ground now for some truly groundbreaking
changes to the system. Sarah Ball reports
Most
pensions commentators have branded the recent Department of Work and Pensions
(DWP) Green Paper Simplicity, Security and Choice a damp squib, which won’t
actually change anything. And HR folk may be tempted to put their feet up while
the pensions pack get on with another few years of worthy, yet incomprehensible
debate over areas of the private and state pension system that the Government
has failed to reform.
But,
as every HR director who has been around the New Labour legislative block a few
times knows, it is the employers who are usually expected to deliver through
good practice to avoid overly-prescriptive measures. The pensions path which
lies ahead is no exception.
When
the new proposals were launched in December last year, Andrew Smith MP,
Secretary of State for Work and Pensions said: "We believe that the
partnership between the Government, individuals, employers and the financial
services industry has long been a strength of the pensions system in the UK,
and that the proposals we are setting out today will renew this partnership and
reaffirm the responsibilities of each member."
Whether
there are enough incentives for employers to go the extra mile is an unresolved
debate beyond the scope of this article. But there is still enough food for
thought for HR to get its teeth into – especially as some of the legislation
could be in place as soon as this time next year.
For
the pensions purists, the platter promising the juiciest morsels is the accompanying
Treasury and Inland Revenue’s Green Paper – Simplifying the taxation of
pensions: increasing choice and flexibility for all. Chris Jackson, a solicitor
at Hammonds, says: "The tax proposals, due to be introduced as early as
2004, could be the radical reforms that actually do reshape UK pensions."
Colin
Singer, a senior consultant at Watson Wyatt, highlights how some of the
proposals are great news for HR directors currently reviewing their pension
scheme designs. All existing tax regimes for pensions will be replaced by a
single system.
He
says that under the current Inland Revenue (IR) rules, there is only so much
surplus a defined benefit scheme can accumulate. Since 1987, schemes have not
been allowed more than 105 per cent in their fund without being taxed. This is
really out of date – no scheme these days has anywhere near this much surplus.
Singer
outlines the possibilities: "An exciting avenue that may be opened by the
new regime is greater flexibility of design," he says. "This is
perhaps particularly so for ‘risk-sharing’ designs that lie between pure final
salary and pure defined contributions (DC).
"The
key to unlocking such designs will be the funding flexibility envisaged in the
regime which, if twinned with an appropriate mixture of guaranteed and
discretionary benefits, may result in a better balance between members’
guaranteed benefits and employers’ guaranteed costs than either of the polar
extremes of final salary or defined contributions."
Tom
McPhail, of corporate independent financial advisers Hargreaves Landsdown, says
an area of priority for HR directors in the tax proposals will be the changes
affecting your most senior and/or long-serving staff. "It is worth
applying some due diligence in this area now, just in case the proposals do
come in next April."
Contributions
by employers and staff would continue to attract tax relief, but the change
comes where the limits for this will extend to 100 per cent of earnings subject
to a £200k per annum ceiling. "This means that an employee can build up a
pension in very short space of time if they wish," says McPhail.
But
the really big news is that total pension fund accumulations will be capped at
a lifetime limit of £1.4m. Twenty-five per cent of the fund’s cash will be
available tax-free, and pension will be taxed as earned income.Â
"Some
transitional arrangements will protect people with pensions already over £1.4m,
but the new limits will otherwise operate retrospectively," McPhail adds.
"Funds that breach this will be subject to a 35 per cent recovery charge
on the amount over the limit and all benefits taken from the excess funds will
be fully taxable – an effective tax rate of 60 per cent."
This
is pretty steep, so senior staff will want up-to-date information on their
pensions to make informed choices.Â
Simon
Martin, head of research at Aon Consulting, warns the proposals will have a
divisive effect by giving senior staff a minimal stake in the company pension
scheme. "Pensions schemes work best when they include all employees,"
he says. "However, these new tax proposals are particularly penal on
senior executives. It should be
possible to have a fair tax treatment for all employees, but in this case the
Government has taken its objective of simplify the tax regime too far."
Getting
your administrative ducks into line is another area to review before next
April. Geraldine Brassett, a consultant at Hewitt Bacon & Woodrow, assesses
the costs employers need to be prepared for when it comes to implementing the
new IR and DWP proposals.
"One
of the aims of the proposals is, in the longer term, to drive down
administration costs. The simplification of the tax regimes should help to
achieve this, but this needs to be balanced against the flexibility around
payment of benefits and the fact that there will almost certainly be
substantial set up costs when the changes are introduced."
She
says the extent of these initial costs will obviously vary depending on the
existing scheme design, the age and capability of the current administration
platform and changes in communication around processes.
"Assuming
no changes to existing individual scheme designs – although we know this will
be likely for a large number of schemes – we estimate that the costs could be
in the region of £5,000 to £25,000 per scheme, although this could be more if
implementing these changes necessitates a significant one-off expenditure, such
as purchasing a new administration system."
Changes
required will not only be to software, but also to processes and procedures and
possibly member communications, and Brassett advises HR directors not to
overlook these areas.
Although
the tax proposals potentially contain more substance, the DWP’s Green Paper
does merit another glance from HR directors. In brief, it outlines the suite of
voluntary mechanisms the Government wants to employ, to help avoid the
so-called ‘pensions crisis’.
It
reiterates that our increased longevity means we cannot sustain the state
‘pay-as-you-go’ pension system unless we work longer or save harder, or both.
Of particular note is chapter 6, Extending Opportunities for Older Workers,
which looks at how to encourage and facilitate a larger proportion of people in
the 50-plus age group to remain economically active.
This
dovetails with the consultation paper that the Department of Trade and Industry
is due to launch this summer, regarding a new EU directive which will outlaw
age discrimination by 2006. Organisations can currently set their own normal
retirement ages, beyond which staff are unable to sue for unfair dismissal.
This is set to change.
James
Davies, a partner at Lewis Silkin Solicitors, thinks the Government will impose
a default normal retirement age of 70, and that it will be up to organisations
to justify anything below this. "Pre-established succession planning, or a
generous occupational pension scheme might be grounds for exemption, but these
are obviously matters for the consultation." Otherwise, staff who want to
carry on working will have the right to do so.
According
to research by Penna Sanders and Sidney, 93 per cent of employees would extend
their working lives if offered flexible working arrangements.
The
Green Paper on tax contains proposals to encourage flexibility, but for some
they have not been implemented soon enough.
Aon
Consulting’s Martin says: "At the moment, a full-time employee close to
retirement cannot switch to part-time work and start drawing a pension, but
they can do so if they leave to join a direct competitor. This is a ridiculous
imposition by the Inland Revenue, and is a major disincentive to companies
wanting to retain valued older employees."
Types
of pension scheme design
Defined
benefit (DB) or final salary schemes
Traditionally
the main type of scheme provided by large UK employers, typically related to
the employee’s final salary at retirement. The employer promises the employee a
certain proportion of salary at retirement and takes on the risk and cost of
providing it. Contributions from employer and employees are put into a fund
managed by trustees.
Career
average revalued earnings (CARE)
Another
form of DB scheme, but is based on average salary (adjusted for inflation) over
the whole career, rather than on final salary at retirement. The employer still
takes on risk and cost in the same way as for final salary schemes.
Defined
contribution (DC) or money purchase schemes
The
fastest growing type of company scheme in the UK (and elsewhere). The amount of
pension the employee eventually gets depends on various factors, including
money contributed by and employee and employer and annunity rate at date of
retirement.
The
company can set up its DC scheme under a separate trust, managed by trustees
(as for DB schemes), or can pay into a contract with an insurance company (see
Personal and Stakeholder Pensions below).
Stakeholder
These
special DC schemes came in during 2001, and in broad terms, employers who did
not then have an occupational scheme had to designate a stakeholder provider
for their employees. It aims is to increase private pension provision for
below-average earners.
Contributions
from both employers and employees are entirely voluntary, despite union
pressure for employer ones to be compulsory. The insurance provider’s
charges for administration is capped at
1 per cent.
Personal
pensions
These
are individual insurance contracts, usually taken out by employees outside of
work pensions and rarely used by employers. Broadly the same as stakeholder
schemes, but without the capped insurer’s charges.
Hybrid
schemes
These
combine DB and DC in a variety of ways –Â
a DB scheme might guarantee some modest level of final pay, but pays out
the value of an underlying DC pot if greater.
Group
personal pensions
A
version of personal pensions used by some employers. The provider bundles the
individual personal pensions together (on enhanced terms normally), and
presents them as an employer scheme using payroll deduction and worksite
marketing. Stakeholder pensions run by employers are also normally grouped in a
similar way.
To
see the first part of this two-part article on forthcoming pensions legislation
and for a fuller explanation of types of pension scheme, go to www.personneltoday.com/goto/19143
Legislation
checklist
You
will need to get advice on how your pension scheme(s) may be affected by:
Spring
2003Â Â Â Â Statutory Money Purchase
Illustrations introduced
Mid-2003Â Â Â Â Â Â Â Publication of consultation paper on
implementation of the age discrimination aspects of the EC Framework Directive
Mid-2003Â Â Â Â Â Â Â Next round of consultation on the
protection of pension rights on TUPE transfers
Dec
2003Â Â Â Â Â Â Â Â Extension of limit for
back-dating pay in equal treatment claims from two to six years
Dec
2003Â Â Â Â Â Â Â Â Latest date for UK Government
to ban discrimination in employment on grounds of religion or sexual
orientation (EC Framework Directive)
Early
2004Â Â Â Â Â Â TUPE regulations on future
pension rights expected
Oct
2004Â Â Â Â Â Â Â Â UK Government to remove
employment exemptions from Disability Discrimination Act 1995 (EC Framework
Directive)
Apr
2004Â Â Â Â Â Â Â Â Earliest date for
implementation of new simplified pensions tax regime
Jan
2005Â Â Â Â Â Â Â Â Â Full implementation of FRS17
required in relation to accounting periods ending on or after 1 January 2005
Dec
2005Â Â Â Â Â Â Â Â Estimated implementation date
for EC Pensions Directive
Sign up to our weekly round-up of HR news and guidance
Receive the Personnel Today Direct e-newsletter every Wednesday
Dec
2006Â Â Â Â Â Â Â Â Latest date for UK Government
to ban discrimination in employment on grounds of age (EC Framework Directive)
2010Â Â Â Â Â Â Â Â Â Â Â Â Â Â Minimum
early retirement age (other than for ill-health) increased from 50 to 55
