SPC has submitted its responses to the Green Paper - "Simplicity, Security and Choice : Working and Saving for Retirement" and the pensions taxation simplification proposals - "Simplifying the Taxation of Pensions"
Our responses in full are below :-
THE GREEN PAPER
General comments
We welcome the publication of the Green Paper. At present, there is an increasing gap between people’s expectations and the reality of pension provision. Longevity is improving rapidly. This means that either people need to work longer, or they need larger private pension provision, or both. State pension provision is increasing only for those on very low incomes, and private pension provision is generally declining, and yet the current generation of workers is expecting to retire at the same sort of age as the current generation of pensioners. This divergence needs to be addressed, so that people can plan realistically for their retirement.
Within private provision, individual pensions tend to be sold to those on higher incomes, so, for the majority of those on low and middle incomes, private pensions mean occupational, employer sponsored, pensions. At present, there are major difficulties facing occupational pension arrangements, and Government policy needs to take these into account.
Financial Stability
Almost all defined benefit pension schemes have a shortfall of assets relative to liabilities, and in many cases this shortfall is very substantial. A number of factors have contributed to this situation, but there are four which have had a very large effect. In order of importance these are
Each of these has had an impact of many billions of pounds on UK pension funds. As a result of the shortfalls, companies have increased their regular contributions to pension schemes, and also paid special contributions to reduce the shortfalls.
The well-publicised problems in some UK pension schemes have caused investment markets to downgrade the shares of the sponsoring employers. There is a risk that we may enter a vicious spiral, whereby falls in investment markets lead to shortfalls in pension schemes, which lead analysts to downgrade the stock of companies with large pension schemes, which leads to falls in the share prices of these companies, which mean bigger shortfalls for pension schemes and so on downwards. Such a spiral would be damaging to pension provision, and to financial stability and confidence more generally. It is therefore vital that the Government avoids any actions which might trigger such a spiral.
Individual confidence
Individual confidence in private pensions is at a very low ebb. It has been damaged by a continual stream of bad publicity, starting with Robert Maxwell, and continuing with personal pension mis-selling, the problems of Equitable Life, and high or inappropriate surrender penalties on retail pension products. More recently, poor investment performance has led to poor results for members of money purchase pension arrangements, and a general loss of confidence in financial markets as a repository for long term savings. (This is despite the fact that over the long periods, which are relevant for pension saving, the equity markets have given far superior returns to cash or bonds.) So far as occupational pension schemes are concerned, there was a perception that the Pensions Act 1995 had given full protection to members’ accrued benefits, whatever happened to investment markets. This perception was always incorrect, and a number of recent employer insolvencies have brought this home.
Individual confidence in pension provision will take time to recover, but we believe it will recover in time, and any specific government action is unlikely to help and may hinder such a recovery.
The position of employers
Employers have been hit hard by the rapid increase in cost of the traditional final salary pension scheme. Much of this has been caused by external factors, in particular the falls in stock markets and the improvements in longevity. However, the actions of successive governments have also added significantly to employer costs, and this has shaken employers’ faith in the pensions partnership with government. Employers have responded by reshaping their pensions provision – usually by closing their current schemes to new employees, and setting up new arrangements for new employees. These new arrangements are generally lower cost than the final salary schemes they replace, and are also designed to give employers greater control of their costs in future.
Despite the difficulties which have led employers to change their pension schemes, very few have abandoned pensions provision completely. Moreover, the great majority of employers are continuing to support their existing final salary schemes, despite the financial strain this involves. The commitment of employers to pensions remains strong, and this commitment must provide the foundation for private pension provision in the future.
Unlike individuals, employers do not respond rapidly to bad news. Their commitment tends to be solid. However, when their commitment is damaged, this tends to become embedded in their medium to long-term planning and the damage is difficult to reverse.
It is wishful thinking to believe that the government can wave a legislative magic wand and remedy all the problems we have referred to, but employer commitment, without which a flourishing private pension system cannot exist, would benefit greatly from a significantly simpler and more flexible framework of legislation.
Following the Green Paper, the government could deliver such a framework, but the Green Paper does not point decisively in that direction. There is no clear statement that the distinctions between personal and occupational pensions will be swept away (in contrast to the tax proposals, which remove all the tax discrepancies). There is an inadequate recognition of the failure of the Pensions Act 1995, which gave rise to significant complexity and additional cost, and also produced an expectation of member protection which it was never in fact going to deliver. Much of that Act should be removed.
Depending upon the direction in which each of the various outstanding issues is decided, the outcome could be solid assistance for employer-sponsored arrangements. But it could also be another layer of well intended tinkering with the existing legislation, which actually makes it more complicated, and more costly than it already is.
We now turn to some of the specific points in the Green Paper.
State pension age
The government has said it intends to keep the State Pension Age at 65, but offer greater incentives to defer the State Pension.
We understand the reasons for keeping the State Pension Age at 65. In practice over two thirds of people have already retired from work by the time they reach age 65, so any increase in State retirement age will just increase dependency on invalidity or unemployment benefits, which are generally means tested. Until people at 65 can actually get jobs, there is little point in the State trying to force them to work longer.
However, we believe that it is desirable to encourage people to work longer, and so there should be a real incentive for deferring the State pension. The proposal in the Green Paper, although an improvement on the current position, does not go far enough.
Means testing and compulsion
The current structure of State pensions is to be retained, with the element of means testing increasing over time. (it is already significant, as the basic state pension (BSP) is only £77.45 pw, while the Minimum Income Guarantee (MIG) is £102.20). The problem with means testing is that it acts as a disincentive to save for those who are affected by it. The Pensions Credit effectively introduces a taper on the means test, which makes the effect less severe on those who are caught by the means test. However, the taper does mean that more people will fall into the net of the means test. Current analysis suggests that there are only two ways to avoid the means test problem - either a higher State Pension (which will require higher National Insurance contributions or income tax), or compulsory contributions to private pensions.
Essentially, these are really the same solution - forcing people on moderate incomes to provide sufficient pension for themselves, so that they will be above MIG. The first approach uses the State as the benefit provider; the second uses the private sector.
This does, however, leave out of account the State Second Pension (S2P). Its effect is to slowly increase BSP. Apart from its extremely complicated structure, there are two main differences between BSP and S2P. The most important one is that S2P accrues from April 2002, which means that, by separating it from BSP, the government has avoided pressure to give it to current pensioners. The second difference is that S2P is more closely based on actual work history - the ability to earn credits while not working is much greater for BSP, than for S2P. However, the way in which S2P is designed means that it will not narrow the gap between BSP and MIG - it will simply slow the speed with which that gap widens, as BSP is price indexed and MIG is earnings-linked.
We do not support either of the options, we have referred to, for avoiding means testing, namely a higher State Pension or compulsory contributions to private pensions. Both would involve a substantial increase in the role of the State - either directly through the National Insurance system or indirectly through the control that would be imposed on any compulsory private provision. The effect is likely to be further damage to employer-sponsored schemes - the Australian experience shows that compulsory private provision leads to an extinction of voluntary company pensions - companies just reduce their pension contributions to the compulsory minimum. In our view the right approach is to encourage voluntary private provision, particularly employer-sponsored schemes - through a simple and helpful regulatory system, with appropriate incentives. We would also welcome new ideas from those with requisite expertise, of ways to ensure adequate support for those with low incomes, without huge increases in National Insurance contributions/income tax or compulsion.
The proposed new tax regime
The most important feature of the proposed new regime is that it is vastly simpler than the current regime. We support this. Our main reservation is that it enshrines the earnings cap, and indeed introduces the cap for all members. This reinforces the problem of the present system that decision-makers at major companies are effectively excluded from participation in the main company pension scheme, and so see the pension scheme primarily as a business cost rather than a source of benefits. It is also important to the longer term acceptance of any new regime that any limits which it embodies are appropriately indexed.
The harmonisation of tax rules for personal and occupational pensions is tremendously important. However, it will lose most of its value unless the DWP rules are harmonised with the tax proposals - which is not proposed in the Green Paper. The position on limited price indexation is the most striking example.
The role of the employer
The Green Paper gives the impression that the government sees the role of the employer as simply a contributor and a provider of information to employees. Many employers presently take a much greater role than this in assisting employees with their financial planning for retirement. Moreover, it is in that greater role that the employer provides a value to the employee over and above the cash contribution - which they could otherwise just give to the employee and let the employee choose what to do with it. Our impression from recent discussions is that Ministers, in fact, do see employers having the wider role to which we refer. The government's recently established employer-led task-force is an example and we would like to see the reach of this body expanded, to include inter-action with those who run pension schemes and with their advisers.
Contracting out
At present we have a series of complicated arrangements for contracting out. A rebate is given which barely matches the value of the benefit given up (indeed, if one regards the benefit as having a government guarantee, then the rebate is clearly inadequate, as it does not compensate for the surrender of security under the State scheme). A money purchase arrangement does not require any contribution in addition to the amount of the rebate. A defined benefit scheme has to provide substantially more than the benefit that can be bought by the rebate.
There is a general dislike (due to their constraints on benefit design and their added financial risk) of the contracting out arrangements. They also have a major effect on pension transfers and corporate transactions. Contracting-out on an individual basis calls for expert advice on complex and often financially finely balanced factors. The cost of the advice is usually unsustainable, so it is usually not available. Most new company schemes are contracted in. Reviews of existing schemes often lead to a decision to contract back in. However, the problem with removing contracting out is that it is likely to lead to a significant increase in costs for business, as companies with old defined benefit schemes would incur increased costs, either from leaving benefits unchanged in the absence of a rebate, or from restructuring benefits.
An option might be to build on the current structure for defined benefit schemes, and provide a National Insurance rebate for schemes which provide a reasonable level of benefit (80ths for defined benefit, and a commensurate contribution for money purchase). There would be no contracting out - simply an incentive for schemes to provide a suitable benefit. The exchequer cost of the incentive would be off-set by reduced expenditure on means tested benefits in the future (which is essentially the same as the present arrangement where the cost of the rebate is offset by future savings on national insurance benefits).
The new regulator
We welcome the proposals for a new regulator.
Pension provision spans the range, from retail products of commercial providers, to various forms of not-for-profit employer-sponsored arrangement. It is essential that the regulator is attuned to the latter types of arrangement and understands how their regulation needs to differ from that of commercial providers.
In developing the proposals, it is essential to ensure that they do not create or become an excessive cost burden, either because of the direct costs of setting up and running the regulator or because of the guidance which it introduces. Guidance could easily become legislation by another name and simply re-impose compliance costs which would otherwise have flowed from legislation. We therefore suggest that regulators' guidance should be subject to regulatory impact assessment.
We now move to comments on the technical paper accompanying the Green Paper.
Comments on the technical paper
Part 1 : Simplification
A. A new framework for scheme funding
No views are specifically sought and this part of the technical paper is very largely a re-statement of the position already reached by the consultation panel set up to assist with the establishment of a replacement for the Minimum Funding Requirement. (MFR).
It is now nearly two years since the government announced that MFR was to be replaced by a long-term scheme specific funding standard. The aim now must be to further address the uncertainty over its replacement. Much will hinge on the extent of the control of the trustees. Before the drastic step of winding up the scheme, there should be more moderate options, e.g reducing future accrual or giving lower priority to future accrual. The approach to funding in new actuarial guidance will also be very important.
It will be essential that the proposed Statement of Funding Principles, and key information provided to members, function as effective communications, rather than meaningless and confusing "disclosure".
Some of the specific issues which require further attention are :-
The relationship between the Statement of Funding Principles and the Statement of Investment Principles
The technical paper recognises that the two documents will need to complement each other. This will require the trustees and the sponsoring employer to agree on the underlying aims for each document, irrespective of which of them formally takes the lead in drawing them up.
We do not believe that the trustees should have the unilateral right to decide whether to combine the Statement of Funding Principles with the Statement of Investment Principles. The sponsoring employer might wish to keep the two documents separate and we believe that it should have the option to do so.
Setting the Contribution Rate
The technical paper allocates to the trustees responsibility for drawing up the Statement of Funding Principles. The statement will have a major impact on the contribution and existing scheme rules will often give the sponsoring employer the power to decide the rate. It is essential that this is allowed to continue. Employers will often regard having this power as fundamental to their willingness to continue to sponsor a final salary scheme.
The Statement of Funding Principles will need to be open for review from time to time.
Schedule of contributions
The technical paper is silent on the operation of the schedule of contributions. We suggest that it should be for the trustees, sponsoring employer and the scheme actuary to agree on the length of validity of the schedule and the circumstances in which it can be altered without the need for a valuation.
Debt on the employer
The technical paper is also silent on the role which the scheme specific funding standard will play in determining any winding-up debt on the employer. Since the standard is designed to govern long-term funding, it is debatable whether it would be appropriate to use it for determining a debt on wind-up, and that more regard should be given to the actual cost of fully securing benefits or parts of the benefit (e.g. ignoring statutory post-retirement increases).
If legislation is to cover partial wind-ups, affecting multi-employer schemes, there should be some flexibility on whether this would automatically trigger a debt on the employer calculation.
Transfer values
Once MFR is abolished, cash equivalent transfer values should not necessarily be based on a scheme's long-term funding basis, but on a basis, recommended by the scheme actuary, and reviewed from time to time.
B. Changes to Contracting-out
Survivors' Benefits
We support the recommendations in the Pickering Report and suggest that the government's unwillingness to introduce changes in this area, unless it had good reason to believe that the coverage of, and contributions to, occupational pensions would be higher than would otherwise be the case, is mis-placed.
The provision of survivors' benefits by existing occupational pension schemes is almost universal, despite its being a legal requirement only for contracting-out. It therefore seems unlikely that the removal of the legal requirement to provide survivors' benefits would lead to widespread abolition of these benefits in existing schemes. Nevertheless, such a relaxation would be consistent with a change to simpler, less costly, arrangements in future and would thus help to encourage private occupational provision on a contracted-out basis. It would also enable schemes to avoid any potential complexity and cost imposed by, for example, the future extension of the anti-discrimination legislation to cover same sex partners.
Many schemes now provide for the payment of a dependant's pension, rather than one payable to a legal spouse, or would like to do so. The requirement under the contracting-out legislation to pay part of the pension to a legal spouse adds to the complication of running a scheme and in practice significantly curtails the resources available for other dependants' benefits. At the very least, relaxation of the requirement, that a compulsory survivors' pension be payable to a legal spouse, would be welcome.
As the technical paper goes some way to recognising, the case for compulsory survivors' benefits is rooted in a time when far more couples were married and only one spouse, usually the male, worked. The technical paper gives some examples of the effect of withdrawing a survivor's benefit, but notes that the withdrawal would only apply in respect of future benefit accruals so that the full impact of the change would not be immediate.
If there was no requirement to provide survivors' benefits, there could still be a requirement to allow the member the option to surrender part of his or her benefits in favour of a dependant.
Limited Price Indexation
This is another area where we consider that the Pickering Report points the right way forward, i.e. that there should be no requirement for any scheme to provide limited price indexation (LPI) (as a condition for contracting-out or otherwise).
We support the argument in the Pickering Report that the requirement to provide limited price indexation presents an investment problem. While inflation is low, as at present, index-linked gilts constitute a suitable investment match to the LPI requirement. However, there is shortage of such gilts and a very restricted choice of term. When inflation is higher, and the 5% ceiling bites, there is no suitable matching asset.
Neither of the first two options listed in the technical paper :-
address this investment problem
The technical paper also illustrates the difficulties with an indexation threshold of the type discussed and we therefore strongly suggest that this possibility is not pursued.
There is long standing inconsistency in the application of the LPI requirement. Occupational pension schemes (except those securing pensions through an investment linked annuity) are required to provide indexation. Personal and stakeholder pension schemes are not (except in the case of protected rights). Research by DWP shows that individuals, when they have the freedom to chose under a personal pension, typically opt for a higher starting pension not subject to LPI. It should not be necessary to transfer to a personal pension to take a pension without LPI. Removal of the requirement across the board would end this inconsistency.
The Green Paper refers to the potential loss to scheme members arising from the removal of compulsory limited price indexation, on the basis of a comparison between a defined benefit with LPI and a defined benefit without it. However, in practice, the more likely situation would be the closure of the defined benefit scheme and its replacement by an inferior money purchase scheme. As the Pickering Report observed, a non-indexed defined benefit might be a better option.
Reference Scheme Test
We welcome the intention to introduce less stringent RST arrangements, in order to simplify the contracting-out process and reduce the costs involved. However, the proposal to move from 90% of middle band earnings to all earnings, while retaining survivors' benefits and LPI, would appear to make the proposed new test more, rather than less, onerous, even if the accrual rate falls from 80ths to 100ths, for schemes which retain the current salary averaging definition, and in many cases where the career average option is adopted.
We do, however, welcome the principle that career average earnings should be valid as a means of salary averaging. Indeed, if the intention is to encourage contracting-out via occupational defined benefit arrangements, the reference scheme test will also need to be sufficiently flexible to accommodate hybrid and cash balance schemes.
A suitably amended reference scheme test would need to be accompanied by a more realistic level of National Insurance rebate, which took proper account of the cost and risk involved in defined benefit provision and included a reasonable measure of financial incentive.
A possible rationalisation of benefits already accrued on the existing RST and earlier scales would be welcome. How far this is possible in practice will depend on schemes' own amendment clauses and Section 67 of the Pensions Act 1995 (as it stands, the section would effectively block most rationalisation). The scope for rationalisation will also depend on the extent to which restrictions on the payment of contracted-out rights are removed.
Simplification of Guaranteed Minimum Pensions
The current consultation on GMP simplification is extremely welcome, but it can, we believe, only go part of the way to identifying the right way forward.
The subject is exceedingly complex, and the interests of the government and schemes in seeking simplification differ in some respects, which in turn could affect some key decisions, e.g whether simplification should be compulsory (some schemes would, we expect, wish to leave GMPs untouched, having incurred the cost of coping with their administration, others would welcome the chance to simplify).
We therefore suggest that DWP should set up a small working party of officials and pension industry nominees, charged with working intensively, and with a low profile, to produce simplification proposals.
Discussion so far with DWP suggests to us that the actuarial conversion option appears to be the only possibility under serious consideration and we would welcome enabling legislation. Enabling provisions should extend to pensioners, since there are many current pensioners with unresolved equalisation issues. Other actions which should be considered are reintroduction of Accrued Rights Premiums for schemes in wind-up and a new style Limited Revaluation Premium (possibly available retrospectively), to leave schemes with GMP liabilities which increase at the statutory rate for excess over GMP (S52A) and also equalised payment age for GMPs. This would be a relatively simple approach which could reduce the equalisation problems for schemes without such widespread conversion.
If a scheme wishes to convert, we suggest that this should not require member consent.
It needs to be recognised that conversion might be fair overall, in terms of average value, but that there might be individual winners and losers (as a result of differential longevity/choice of new rate of post retirement pension increases, for example).
We would not expect schemes and employers to undertake an expensive one-off exercise unless it would provide a water-tight final resolution to the equalisation issue and would leave the scheme with cleaner administration for the future. They would also require a high level of confidence, before embarking on the exercise, that their conversion proposals would withstand legal challenge and any scrutiny by the New Regulator. There is currently considerable doubt on whether the equalisation issue can be resolved without resort to the courts.
The conversion terms would have to be generally accepted as "fair" - this would presumably involve an actuarial Guidance Note and possibly prescribed conversion terms (or principles for conversion). Prescription would give consistency between schemes and reduce the risk of subsequent litigation (which might reduce the availability of actuarial advice). The correct valuation of the current benefits could be called into question, given the uncertainties over equalisation issues.
There are many other issues to consider - the winding-up priorities after conversion and requirement to provide survivors' benefits for legal spouses. The disappearance of GMP might mean that schemes could not easily provide any benefit for other types of dependant. If GMPs disappear, anti-franking regulations would no longer be needed. One would need to decide how the effect of conversion would be communicated to members.
Other contracting-out proposals
Operation as a contracted-out mixed benefit scheme is an option, rather than a requirement. As such, the abolition of this facility would be hard to justify on the grounds of simplification. It would also be seriously disruptive to the schemes concerned.
We welcome the proposal to abolish safeguarded rights, but we would not favour retaining the residual inflexibility of the requirement that the total value of the pension share allocated to a former spouse must be used to provide pension benefits.
We suggest that Equivalent Pension Benefits should fall within the normal triviality provisions.
C. Greater Flexibility for Schemes
Simplifying the arrangements under which schemes are restricted from modifying accrued rights
If Section 67 of the Pensions Act 1995 did not exist, changes to scheme rules would still be constrained by their own amendment clauses and by the general requirements of trust law. This might well, in any case, rule out the type of drastic changes referred to in the technical paper in most schemes.
We therefore question whether, welcome as it is as some improvement on the currently unsatisfactory position with Section 67, the approach needs to be as cautious as is proposed.
The key question with what is proposed is whether it will be possible to make more than one amendment. If not, additional flexibility will be considerably diminished. One would have to keep track of which members had previously had a "5% amendment".
It will also be important to define a change to accrued rights. For instance, in item 5 below, is the change only to pension increases between 2.5% and 5%? If so, the value of the "lost" rights will probably be within 5% of the total.
The consultation paper seeks examples of the sorts of rule changes which schemes might wish to make, with an indication of whether or not the "5%" proposal would assist. Some examples are set out in the following table :-
| Description | Allowed under current law? | Allowed under "5%" proposed test? | |
| 1 | Broadening the class of "dependant" eligible to receive death benefits | May not be allowed if the effect might be to remove benefits from an existing dependant (for instance if the trustees wanted to pay a pension to a dependant rather than a separated spouse). | Yes |
| 2 | Reduction in age when children's pensions cease (for example, following scheme merger) | No | No, unless equivalent value given elsewhere. Could achieve this for active members at salary review |
| 3 | Change definition of pensionable pay (for example to tie in with new payroll practice) | Only by setting the old definition as an underpin | Unclear - especially if the test is on each individual member |
| 4 | Change date of pension increases | Difficult | Yes, as long as 5% limit not exceeded |
| 5 | Change structure of pension increases (for example, 5% LPI to fixed 2.5%) | No | Uncertain - see comment above |
| 6 | Replace pension increases with additional pension | No | No - will probably exceed 5% limit |
| 7 | Replace fixed revaluation (of deferred pension) with LPI and additional pension | No | Uncertain (as 5). For younger members will probably exceed 5% limit. |
| 8 | Restructure GMP to make it identical to non-GMP and then forget the distinction | No | Depends on 5 and 7. |
| 9 | Conversion of defined benefit rights into money purchase | No | Yes if within 5% limit |
Another problem with Section 67 as it stands is that breaches are a matter for OPRA. This heightens concern at making any changes which might be at odds with the section. It would be more appropriate for alleged breaches to be a matter for the Pensions Ombudsman.
Member-nominated Trustees : Less Prescription on Selection Processes
Many employers are happy to encourage member involvement. However, there is a danger that the disruption and disincentive to occupational provision that would result from the imposition of MNT arrangements upon reluctant schemes would outweigh any overall benefit. If, however, MNTs are to be a legal requirement in all schemes, the legislation should be simplified as far as possible. We have a general doubt (covering all pension legislation) about whether guidelines would in effect be anything more than legislation by other means, but any guidelines should only serve to help identify good practice, rather than assuming the status of implied legislation. The regulator should have the power to act in relation to complaints that the selection process was (materially) unsatisfactory, but there should not be a formal requirement for the arrangements to be 'fair and open' as this could encourage unjustified and time-consuming challenges on technical grounds. Schemes should be allowed to retain existing MNT arrangements, if desired, and existing employer opt-outs should be allowed to run their course to ease the transition.
Internal dispute resolution
More flexibility on the lines proposed in paragraph 41 would be welcome. A six month time limit would generally be appropriate, but there should be scope for limited extension in exceptional circumstances.
D. Preservation and Transfers
Preservation
Since the principles of preservation and revaluation are generally understood and accepted, there does not appear to be any case for major reform.
The exception is money purchase uniform accrual. The principle underlying the original defined benefit uniform accrual rules was to prevent employers from circumventing preservation requirements, to promise greater benefits for longer serving or older employees. The same rules have been applied to occupational money purchase arrangements, but in a way which is cumbersome and costly.
The requirements do not apply to stakeholder or personal pension arrangements. In a money purchase context, the legislation attempts to regulate the degree of age/service discrimination which is permitted. If this is to be done at all, it should be in a simple way which applies to all types of money purchase arrangements, e.g. a maximum average gradient of an age or service related to a contribution scale of x% per annum. However, we consider that it is for DWP to demonstrate that there is a real problem with employers over-favouring their older employees. If the evidence is not available, the money purchase uniform accrual regulations should be dispensed with. Even if there is evidence now, the prospective implementation of age-discrimination will stop certain age groups being favoured over others.
Transfers
We welcome the proposal that legislation should require that CETVs be calculated on a basis which is fair to all, and that the benefits granted in respect of transfer values received into the scheme should continue to be calculated in a consistent way.
E. Communication with Scheme Members
The main items which have to be provided automatically are basic scheme details (usually in the form of an explanatory booklet or announcements to members) and benefit statements (when benefits fall due and on an annual basis for money purchase schemes). These were commonly provided as a matter of good practice before this became a legal requirement. Most of the information specified is needed to give members a proper understanding of their benefits. If the requirements were relaxed, there would be increased risk of misunderstandings and/or an increased volume of individual queries to be dealt with in schemes which took advantage of such a relaxation to cut back the information provided automatically.
Substitution of 'within a reasonable time' for specific deadlines of 2, 3 or 6 months would not be helpful, as it could lead to legal disputes as to what is reasonable in particular circumstances. If any of the existing deadlines are too tight (for schemes that make a reasonable effort to comply) they should be relaxed (and 'standardised' so far as practicable, in the interest of simplification). Schemes should not be penalised for minor or occasional breaches of the deadlines, provided there is reasonable justification in the particular circumstances.
We would also encourage as much harmonisation as possible between the requirements for occupational, personal and stakeholder schemes, imposed by DWP, and those of FSA.
F. Pensions on Divorce
We welcome work to simplify the operation of pension sharing on divorce.
Any restrictions on the form of pension credit benefits which schemes choose to provide should be kept to a minimum.
We wish to see the extension of the "moderate earner" exemption, so that all members subject to a pension debit can rebuild their rights.
Part 2 : Protecting employees
G. Protection in the case of wind-up
Fairer Sharing of Assets
It is difficult to make a response without consideration of what the Government’s social objectives are in relation to all scheme members, not just those close to retirement. If schemes were left to make their own decisions, as was largely the case before 1997, the approach could be totally different. The current system involves the imposition of a single priority order on a wide range of benefit designs. This has given some appallingly unfair results.
Before considering the issue of fairness in detail, two opening remarks:
There is an argument that the starting point for the apportionment of assets should be in proportion to the cost of securing benefits, or in proportion to the liabilities, regardless of the current status of the beneficiary. The retirement cliff edge problem has arisen because of the perceived need to offer virtually full protection first to those who are no longer in work. The problem of striking the right balance when an insolvent scheme winds up would be eased if an adequate insurance system could be put in place.
There is a danger that any measure to alleviate the condition of those who are close to, but not yet, retired will only serve to reduce the security of those further away from retirement – the cliff edge will be moved back ten years, say, with the potential for a greater fall for those the wrong side.
That is why, if there is to be differentiation within those who have yet to retire, we support basing the level of protection on the number of years of pensionable service. We do not see why those who are close to retirement, but have pension from other sources by virtue of previous employments, should stand to lose proportionately less from the scheme in question than those who are further away from retirement but have only been in the one employment and by necessity have all their pensions eggs in one basket.
We also suggest that consideration should be given to extending this concept to those who are already in receipt of pension. A pensioner with income from many sources as a result of a lifetime of various employments should be able to withstand the shock of a reduction of income from one source. Under this proposal, pensioners would still have gained some protection, in as much as any benefits already taken, such as the tax-free cash sum, would not necessarily be revisited. We do accept, however, that such a proposal does present administrative problems such as the unravelling of annuity contracts.
The rationale for the £30,000 capping proposal on early retirement is unclear, and is certainly not consistent with the government’s simplification intentions elsewhere. If there is an issue, it is one which ideally should be dealt with in the area of corporate governance, from long-serving directors awarding themselves large salary increases with a geared effect on the pension scheme to any role of the trustees in granting generous early retirement terms. Further complicating already complex wind up rules is not the way to proceed. But one possibility would be to permit the trustees, or possibly some independent person, to select a crystallisation date which pre-dated the commencement of scheme wind up by, say, up to twelve months.
However this would not deal with the situation of those who had been able to take transfers away from the scheme. Perhaps, as a further protective measure, the trustees should be given the power to suspend transfer payments in certain prescribed conditions, so as to prevent scheme members, with special knowledge of the sponsoring employer’s financial condition, from effectively jumping up the priority queue.
We are also not attracted to the idea of capping all pensions in payment above £30,000, in an attempt for the better off to subsidise the less well off. A final salary scheme may deliver 1/60ths for each member, but 80% of the spend on such a scheme may go towards 30% of the members. It is in their nature to favour the higher paid and those who gain promotion late in working life. We see no case for a crude attempt to unravel this at the point of wind up. In any event the measure would be open to abuse, for example potentially affected individuals could temporarily opt out of the pension scheme to validate a transfer.
Amending the priority order of creditors
The debt on the employer legislation is largely ineffective insofar as the position on employer insolvency is concerned. It lacks teeth, because of both the trigger point (i.e. late in the day when the liquidator has been appointed rather than earlier on the appointment of an administrator) and the fact that the debt is unsecured and non-preferential. We support an earlier trigger point – on appointment of the administrator - but suggest that the calculation be capable of being determined ‘at any time’ after this point.
As to the priority in any liquidation, there would seem to be merit in making the debt preferential, just as is the case with unpaid wages, on the argument that pensions are deferred pay. A suitable transition period could address the issue of adverse economic consequences. But the principle should be accepted by businesses that it is wrong to take on additional unsecured debts, however expressed, when a scheme has a substantial deficiency. At present, in so doing, businesses in trouble can put at risk their current and former employees’ retirement incomes, which should have been secured by dint of service which has been rendered.
We do not support the case for the debt to be secured. For many employers this would be a step too far, because this would inhibit their ability to raise capital or loan finance, with serious consequences for their future. But some might wish to address securing the debt as part of a negotiation with the trustees, as has happened in a number of cases recently. We suggest that this be made an option for the trustees’ consideration where the employer is unable to meet a schedule of contributions commitment under the yet-to-be-decided scheme-specific funding standard, before giving the trustees an unfettered right to put the scheme into wind up.
We see little merit in the proposal to create a new category of creditor of the sponsoring employer, which ranks below preferential and secured creditors. Before considering whether to create such a class evidence should be obtained as to whether, for insolvencies which have taken place, it would have delivered any meaningful additional funds to the pension scheme.
Insolvent employers
Centralised clearing-house
We are not attracted to the idea of introducing a centralised clearing-house for the purchase of annuities – this would create a further layer of bureaucracy. The root of the problem is the lack of participants in the deferred annuity market and the high cost of guarantees. At present it is easier for small schemes in wind up to secure benefits than large schemes, so by combining together in this clearing-house the problem would seem to have the potential to get worse, not better. It would help if trustees were empowered to purchase insurance products without cast-iron guarantees, on at least part of the benefit.
Insurance arrangements
The great limitation of the existing pensions compensation scheme is that it does not pay out solely on the insolvency of the employer with an under-funded scheme. It is necessary to also prove misappropriation of assets. As a result, the Compensation Board is powerless to act in situations such as the ASW case.
This is a very long-standing problem, on which there has been much consultation already, but little research into the actual costs of insurance which recognises UK vesting requirements and investment patterns. The Green Paper takes us no further.
There were defects with some models, such as the US system, and we can clearly learn from these, if the will exists to implement almost certainly a mutual insurance solution, which, like other UK compensation schemes and pension insurance systems in other countries, does not have to grant full coverage in order to be valued and effective.
The alternative to insurance is to accept that an employer’s insolvency invariably leads to defined benefit promises being converted to money purchase at whatever funds are available, since even if the debt on the employer is made preferential it may not deliver the necessary protection.
Improved compensation arrangements
The proposal to improve payments from the compensation scheme misses the point that it is the perils being covered which need to be revisited rather than the level of the payout.
The government should examine its commitments under the Employment Insolvency Directive, implemented in the UK over 20 years ago. Article 8 of this Directive required member states to "ensure that the necessary measures are taken" to protect the pension rights of employees and ex-employees in insolvent companies. But, unlike Article 4, which enabled limits to be placed on the protective measures for unpaid wages, there are no limits mentioned in Article 8 of the Directive.
Previous governments have chosen to apply limits for pensions purposes. The counter argument is that the measures in the UK context comprise the existence of a separate trust fund, the MFR, debt on the employer and certain payments from the National Insurance Fund (whose payment is the only thing which flows directly from the Directive). But it is open to some doubt as to whether such measures are sufficient for the purpose of the Directive.
Solvent employers
In considering the position of solvent employers in relation to pension promises, an important issue is the change in the nature of the promises since they were made, in many cases in a different economic environment with stabilisers deliberately built into the design. The change to a low inflation economy, the fall in real yields, evidence of increased longevity, together with the imposition of LPI in the Pensions Act has removed many, if not all, of a scheme’s stabilisers. Unless a one-off mechanism can be found to enable employers to revisit benefits which having been promised, have now accrued and yet prove to be too expensive to fund, then the issue will either continue to be fudged, or, if it is tackled head on, will result in a dangerous window of opportunity for a massive closure of remaining defined benefit provision.
The Green Paper is clearly deficient in not mentioning the issue of solvency disclosure to scheme members once in its 176 pages. Disclosure of scheme-specific funding levels is not enough – members of final salary schemes should have the right to regular updates on the safety of their retirement income and the actuarial profession should be challenged to deliver this.
Speeding up winding up
We believe it unlikely that the imposition of additional reporting requirements and the ability of OPRA to make directions under the Child Support, Pensions and Social Security Act 2000 will have significantly speeded up the winding up process. In our view, the factors subject to government influence, which impede timely winding-up, include the following:
However, there are a number of factors outside the government’s control, such as the quality of scheme administration, the reluctance of insurers to quote for business and that many consulting firms do not actively seek to advise on winding up issues once the sponsoring employer has gone.
There may also be an argument for legislation to force a review of the trustee body once a scheme goes into wind up. The need to protect the pension scheme, through the appointment of an independent trustee, has long been accepted when an employer becomes insolvent. But in the more common case where a scheme goes into wind up with a solvent employer, there are no such protections. Trustees might find it difficult to exercise their heightened responsibilities in this situation – some form of independent trustee or other intervention, such as rebalancing the trustee board in favour of member-nominated trustees, might ensure that the right decisions are taken in a timely manner.
It is an anomaly under the Pensions Act that, when a final salary scheme winds up on or after 6 April 1997, the benefits for those who have yet to retire are effectively converted to money purchase (because the statutory wind up rules apply the available assets to the beneficiaries via liabilities measured on a prescribed basis and arranged in priority order) and yet the trustees are not explicitly permitted to secure the benefits via money purchase vehicles. Instead, unless they are able to persuade the former employees to take a transfer value to another arrangement, they often have to spend some time and considerable effort in finalising the fixed benefits which the insurer will provide for the monies which are available.
There is a way round the issue, which starts with section 74 of the Pensions Act, but this is not without problems. So the Pickering proposal, to allow liabilities on wind up to be discharged to a stakeholder pension or other defined contribution vehicle, provided the member does not object and provided he is over ten years away from retirement, is to be welcomed. If the member does object, we suggest that they ought to be required to nominate an alternative destination for the wind-up liabilities. This needs to be accompanied by more than adequate disclosure, starting with the scheme booklet, in order to guard against the potential for a future pensions mis-buying scandal.
H. Transfer of Undertakings (Protection of Employment)
This part of the technical paper appears to re-examine options already considered in previous consultations, on which the government must already have received numerous responses.
I. Member nominated trustees : Abolition of employers' opt-out
We have nothing to add to the comments above in relation to section C of the technical paper.
Part 3 : Promotion of pensions
J. Immediate Vesting and K. Transfers without consent
Taking these two parts of the technical paper together, we are unconvinced that their introduction would be an improvement on the current position. From a scheme's point of view there would be administrative gains arising from not having to process refunds and not having to complete S(F) forms and accounting for tax. On the other hand, there would be additional work in either retaining additional deferred benefits or processing transfers with or without consent. One reaction to the introduction of immediate vesting would probably be the introduction of waiting periods for membership, so as to avoid the need to administer benefits, whether within the scheme or by a transfer, for employees joining and leaving in short succession.
The proposals in the technical paper for the transfers of small amounts without consent are excessively complex. In particular, we see problems with the suggestion of a de minimis amount expressed in monetary terms. Firstly, experience suggests that, once set, the amount will be left unchanged for far too long, while the real value of the amount progressively erodes. Secondly, a limit expressed in monetary terms would create an additional administrative burden since defined benefit schemes would need to check whether transfer values fell within the limit. Paragraph 5 of section K seems to suggest that, even where the conditions for a transfer without consent were met, a member could, without asking for rights to be transferred elsewhere, stop the transfer going ahead. Additionally, the six month period for objections to transfers, referred to in paragraph 5, is too long (we would suggest three months). Finally, we are not sure that the emergence of possibly large numbers of small amounts for transfer from occupational schemes to stakeholder schemes will have a positive impact on the development of the latter.
We therefore suggest that, if the proposals in these parts of the technical paper are pursued, any de minimis limit should be expressed in terms of years of service (two years would tie in with the current vesting period) and that the process for defined benefit schemes should be that the scheme booklet contains a simple explanation of the effect of benefits on a transfer to a stakeholder scheme and a reminder at the time of leaving. If a transfer without consent is then made, trustees should receive a statutory discharge. One issue which would, however, need to be addressed is that under current FSA rules the transferee would have cancellation rights. So a situation could arise, where the trustees have received a discharge and the stakeholder provider is left with a transfer, in respect of which cancellation rights have been exercised.
As a separate issue, it is an anomaly that, in testing for triviality, all of an individual's personal and stakeholder pensions have to be aggregated. If the total exceeds the triviality threshold, none of the pensions can be treated as trivial, even if some or all could be so treated in isolation. Under occupational schemes each pension is assessed separately and this should also be the case with personal pensions/stakeholder schemes. Additionally, the triviality limits should be the same across all types of scheme.
L. Allowing compulsory scheme membership
We suggest that, with the passage of time, allowing compulsory scheme membership would no longer make a significant contribution to the promotion of pensions.
Employers are already permitted to make membership of an occupational scheme automatic unless the employee opts out. Generally, the take up of scheme membership is higher where employers operate on this basis. Automatic membership subject to opting out is straightforward to administer.
Going further, and allowing compulsory membership, but introducing rules allowing employees to opt- out of compulsion for various reasons could be less attractive than the existing facility for automatic membership and opt-out.
We would certainly agree with the view expressed in the Pickering Report that compulsory membership of an employer-sponsored scheme is only appropriate where there is a meaningful employer contribution.
THE TAX PROPOSALS
Introduction
We welcome the government proposals for simplifying the taxation of pensions. In the first part of this submission we deal with the major strategic issues with the proposals. In the second part we comment on the detail, and answer specific questions raised in the consultation document.
General
The proposals should lead to a substantial reduction in administrative costs for employers, pension funds, and pension providers. Even more importantly, for the great majority of people they will sweep away many of the regulatory restrictions which make pensions baffling and discouraging for many. Key areas of simplification are the removal of the absurdities in the current rules, such as
To gain the full advantages of its proposals, the government needs to
Impact on savings behaviour
One beneficial effect of the proposals is that people can make large pension savings towards the end of their working life, when other financial demands, e.g. a house or a family, might have lessened. However, this may create the risk that young people will simply not provide for their pension because they know they can do it later. Where there are good employer sponsored arrangements this is unlikely to be a major problem, as these will ensure a pattern of regular saving throughout the working life. Where such arrangements are not available, financial education is needed so that people do not put off saving for a pension until it is too late to build up a decent pension.
Another beneficial effect is that it would be easier for individuals to re-assess their circumstances, and move funds from short-or medium-term savings into longer-term retirement saving.
Indexation
At present, the lifetime limit of £1.4 million affects only a small number of people. We understand that it is the government’s intention that the number of people affected by the lifetime limit should not increase significantly over time. We strongly support this intention. If large numbers of people become affected by the limit, then the original simplicity of the regime will be undermined. This means that the indexation of the lifetime limit is important. If the limit is indexed only to price inflation, then more and more people will be caught by it, because earnings increase faster than prices, and the cost of pensions (which is affected by increasing longevity and interest rates) rises faster still. Much of the adverse press comment has been produced on the presumption that the limit will be indexed to price inflation. If the limit were linked to a more appropriate index, the rationale for most of the adverse comment would disappear.
Social Inclusion
We have one other concern about the lifetime limit, which is that those affected are likely to be the decision-makers within companies. The lifetime limit will effectively exclude many of these decision-makers from mainstream pension provision (accelerating a trend started when the earnings cap was introduced). They are then more likely to see such pension provision purely as a cost, rather than as a benefit. This impact could be mitigated if the recovery charge above the lifetime limit simply recovered the tax concessions that had been given, rather than being penal as is proposed.
Detailed comments
The lifetime limit
As noted in our general comments, the lifetime limit must be increased in a way which recognises the increasing cost of pensions over time, and the increase in prosperity which will be reflected in higher pensions in the future. One possibility would be to construct a special "pensions cost index" which should be the cost of buying, as an immediate annuity, a pension for a person on average earnings at age 65. Such an index would automatically take account of the changing cost of pensions over time. (Some smoothing would be necessary to remove the impact of short term interest rate fluctuations on annuity rates.) Alternatively, if a special index is not desired, then the lifetime limit could be linked to national average earnings, with rounding up applied each year which would most likely be sufficient to take account of increasing longevity. Another possibility would be to increase the limit with Bank Base rate, which would be reasonably appropriate.
The actuarial tables for converting defined benefit pension rights into capital values (referred to in paragraph 4.11) will clearly be crucial in determining how the lifetime limit will work. The factors should not favour one type of pension provision over another, but should protect against circumstances where market conditions might encourage individuals with defined benefits to switch to defined contribution provision shortly before drawing benefits.
Testing against the lifetime limit
The impact of the recovery charge, plus income tax, on amounts drawn above the lifetime limit, produces a tax charge of 60%. This appears penal, especially if the excess has been in a tax advantaged fund only for a short time, as may often be the case in practice. A charge similar to the tax on refunded AVCs (approximately 48% in total) might be more appropriate and would, we believe, be sufficiently benign to encourage all pension provision to be made through the "approved" arrangement.
The annual limit
We are not convinced that an annual limit is needed, as well as a lifetime limit. While we recognise the Exchequer risk which the annual limit is designed to address, the number of people in a position to take advantage is tiny and the number who would be prepared to do so smaller still. In the terms of introducing a system which is as simple as possible, this appears to be the tail wagging the dog.
If, however, the annual limit is to be part of the system, then we suggest that the test is unnecessary in the year in which benefits are taken. If, as is suggested, the purpose of the annual test is to secure against avoidance of the recovery charge, once benefits have been tested against the lifetime limit and any charge due paid, the rationale for the annual test falls away. It is not uncommon for people to receive a substantial benefit increase in the year of retirement – for example if they are retiring through redundancy or ill health.
There is an apparent inconsistency between paragraphs 4.7 and B49. Paragraph 4.7 suggests tax relief on employer contributions up to 100% of earnings, while paragraph B49 refers to no limit on tax relieved contributions from current or former employers.
Issues similar to those in paragraph 4.11 arise concerning the factors to be used to value the annual increase in defined benefit pension rights. The consultation is not clear as to exactly what is being valued, but we suggest that the effect of pay increases on previous years' accrual should be ignored. This would provide a reasonable measure of parity with defined contribution provision, where no account is taken of growth due to investment return.
With reference to paragraph 4.22, we understand that there would be a charge to income tax if the annual limit on value inflow were exceeded. We assume that it is not the intention to levy a charge to National Insurance (class 1A) but it would be helpful to have confirmation of this.
Our comments about indexation of the lifetime limit apply also to the annual limit.
Effect of the proposals on compliance costs
Provided that the proposals are implemented in the most effective way (see later) we would expect a significant drop in continuing compliance costs for occupational pension schemes, probably rather less for personal pension schemes. The existence of a single simplified regime should then stop costs ratcheting up, as they have with the current accumulation of approval regimes. More immediate, however, will be the additional administrative costs of transition to the new regime.
The flexibility in the proposals suggests that a specific additional voluntary contribution facility will no longer be necessary. We therefore suggest that the government should consult on whether the requirement to offer such a facility should end, once the proposals are implemented. This would bring a compliance saving.
Minimum benefit age
We do not believe that a convincing case is made for increasing the minimum age at which tax privileged pension benefits can be drawn, from 50 to 55. Experience would suggest that many people who start to draw pension at age 50 do so having been made redundant. People will continue to be made redundant before age 55, without any realistic prospects of re-employment, and could be left in financial limbo until they can take their benefits.
There will also be difficulties where employees have a contractual right to retire at age 50, consistent with existing tax rules.
On the timing of a change in the minimum benefit age, we would suggest a prescribed rise in the minimum benefit age, coming into force in 2010, possibly phased.
General benefit rules
With reference to paragraph 5.26, we believe that it would be helpful to explore the possibility of allowing full capital protection on death until age 75, along with a higher tax charge - say, 40% or 50%, as an incentive for pension saving.
Death benefits
Our understanding is that schemes will be able to provide a lump sum death benefit up to the lifetime limit, where pension has not started to be paid. In establishing the lifetime limit, we assume that funds from which pension has started to be paid, will need to be taken into account.
The consultation document is silent on whether there will be any transitional protection available in relation to death in service benefits, where these are valued at more than £1.4m. We suggest that this is necessary, as many people with A day funds below £1.4m will have life cover for capital values in excess of £1.4m. A straightforward course would be to ignore the value of dependants' benefit when testing the lifetime limit.
Under the new regime it will be possible for death benefits for young, relatively lowly paid, people to breach the lifetime limit. It would be extremely undesirable if the proposals had the unintended effect of undermining the attractiveness of dependants' benefits.
The age 75 rule
Despite the opening sentence of paragraph 5.45, our understanding is that it will no longer be required that an annuity is purchased at age 75, provided all pension funds are drawn as benefits by that age. It would therefore be possible to continue income drawdown after age 75, although no lump sum death benefits could be paid after that age. We support this approach.
Existing unapproved arrangements
The further consultation promised on the position of funded (and unfunded) unapproved retirement benefit schemes is essential. Until there are details of how, or the extent to which, these must be taken into account, the broader impact of the new regime cannot be known.
Is there a case for any special transitional rules for people in occupational schemes whose normal retirement age is lower than 50?
As a general principle, special rules are undesirable because they introduce complication. A large part of today’s complexity arises from successive layers of special rules. We would not support transitional rules applicable to normal retirement date. Special rules should, however, apply to ill health early retirements.
What sort of pension patterns might pension schemes and pension providers chose to offer under the proposed general benefit rules?
We cannot answer this question at this stage. The general benefit rules would be only one influence and the outcome of the consultation on the DWP Green Paper will be important. In relation to DWP requirements, the obligation to provide Limited Price Indexation on occupational (but not personal) pensions in payment runs counter to the simplicity proposed in respect of the tax rules. We urge the Government to act to bring all the rules for personal and occupational pensions into line.
Should index linked pensions take account of falls in the retail prices index?
This should be permitted, but not required.
Should the general benefit rules specify any further detail?
No.
Will the general benefit rules allow the annuity market sufficient scope to develop new products to meet users' needs?
We believe so.
Would there be value in allowing people with modest pension savings to aggregate all their savings, including protected rights, before buying an annuity?
Possibly, subject to DWP's preservation and transfer legislation and FSA advice requirements. We are not sure how commercially attractive it would be to offer an "aggregation vehicle".
When value protected pension benefits are available, is demand for guaranteed pensions likely to change?
We would expect that guaranteed pensions will remain attractive at higher ages, where the value protection is worth less than a guarantee. They will also remain relevant to defined benefit schemes.
How would operators and other users of pension schemes choose to design them if the tax rules imposed almost no limitation at all on the scheme design? What would be the objectives and advantages of this style of design?
New design features will probably emerge mainly in new schemes, due to the complexity of re-designing existing schemes.
Scope for flexibility in defined benefit schemes would have to take account of the need for funding purposes for certainty in the benefits being offered. However, design might become more flexible, since employees would not wish to use part of their tax-favoured contributions on the provision of benefits of no value in their personal circumstances. A more cafeteria type approach to defined benefits might become more common, especially in schemes with relatively high numbers of high earners.
If the concept of relevant benefits, enshrined in ICTA 1988, no longer existed, one might see other employee benefits, such as permanent health insurance, provided through the same vehicle as pensions.
There might be greater emphasis on building up capital value, rather than an amount of pension.
There might also be an effect on scheme investment. If a key aim in provision is avoiding a breach of the lifetime limit, investments might be chosen with a view to staying within the limit, rather than maximising returns.
Is it feasible to plan to implement the new tax arrangements by April 2004?
We do not believe that it is feasible to plan for implementation by April 2004. If the new regime does start in April 2004 there will be many administrative errors and inaccurate and confusing advice provided to pension scheme members. This would further damage people’s confidence in the pensions system generally.
Many schemes and providers will not wish to commit significant resources to implementation until the detail of the new arrangements is known. By that time, there will be considerably less than a year to April 2004 and in many cases this would be insufficient time to make the necessary changes to systems and processes. We believe an implementation date of April 2005 is the earliest that can reasonably be achieved.
The further away the implementation date, the less justification there would be for transitional measures.
Estimated administration savings
Until the detail of the new arrangements is clearer, we cannot be certain whether the estimate of 5% administrative savings for the pensions industry will be realised or possibly exceeded. Much hinges on the burden imposed on schemes by the mechanism decided for policing the lifetime and (if introduced) annual limits.
It is also essential that, once the transition to the new regime has been made, there is no need to maintain any systems needed for record keeping, monitoring and reporting in relation to current requirements.
One-off implementation costs
One-off costs will fall in the areas of systems, communications, legal documentation and re-defining of benefits (e.g. if expressed in scheme rules in terms of Inland Revenue maxima which no longer exist).
At this stage we cannot offer a cost estimate, but in the near term we would expect them to significantly exceed administrative savings.
What would be the impact on small businesses of bringing the special investment rules for SSASs and self-invested personal pensions in line with the prudential norm for other pensions?
These schemes often have investments closely allied to the needs of an associated business so there would need to be arrangements for unwinding investments without damaging the business.
However, we are not clear as to the tax rationale for imposing norms on investments when there are proposed to be lifetime and annual limits on tax privileged benefits and contributions.
Large pension rights at transition
We generally support the proposals covering large pension rights at transition. It will be important that the valuation procedures take account of salary progression to retirement.
Similarly, where a person has the right to retire before normal retirement date on favourable terms, the benefits at A Day should be valued on the assumption that the option will be exercised. Otherwise, many people might retire immediately before A Day to avoid the recovery charge.
For defined benefit schemes, the basis used to compare a member's notional fund with the lifetime limit will be crucial. If the value of the benefit is discounted to allow for investment returns until it comes into payment, A-Day protection is likely be eroded over time, unless the lifetime limit is similarly discounted. We suggest that no discounting should be applied in the calculation.
Administering the lifetime limit and the annual limit
It is essential that the administration of the £1.4 million and £200,000 limits is as smooth as possible. In particular, the great majority of people will never get anywhere near these limits, and so the administration for them needs to be extremely simple. The key goal is simplicity for the majority. This will mean getting the right balance between the roles of individual scheme members, Inland Revenue and schemes themselves. We suggest that further intensive work, focussed on this area, should be undertaken.
If administration systems have to be set up on the presumption that everybody is subject to a recovery charge, and checks have to be carried out to confirm that most people are, in fact, not, there will be little, if any, administrative saving for schemes.
Is a simple, but broadly fair approach to the transition, the most appropriate one?
Yes.
Is three years an appropriate period to allow for valuation of pre A-Day rights? Could this process be achieved more quickly?
We believe that three years should be allowed. Some schemes will probably complete the process in a shorter period.
Notification period for opting-out
We would suggest a three month period before A-Day for schemes to inform Inland Revenue that they intend to opt out of the new rules.
Suggestions on valuing defined benefits
The approach suggested appears to be appropriate and feasible.
Qualification of contributions for tax relief
The proposals appear to be appropriate and feasible.
Contributions to UK based schemes by non-residents
The proposals are inconsistent in that, where the net pay arrangement is in force, members would not receive tax relief on their contributions if they are not subject to UK tax. Where relief at source operates, they would receive relief.
Pensions on divorce
It would be fairer to allow the person transferring rights to re-build them back to the lifetime limit, if they can afford to do so. It would also be administratively more straightforward, avoiding the effective creation of a separate lifetime limit for people transferring pension rights on divorce.
25 April, 2003
JM/HMW 4.37