The following summaries of the DWP Pensions Green Paper ("Simplicity, Security and Choice") and Inland Revenue's tax simplification proposals ("Increasing Choice and Flexibility for All")
Have been prepared by Chris Bellers (Friends Provident), a member of the SPC News Editorial Committee
PENSIONS GREEN PAPER
The Government’s Pensions Green Paper was published on 17 December 2002. Its 168 pages were accompanied by a technical paper (101 pages), a consultation document from the Inland Revenue (64 pages) and a report of the Quinquennial Review of Opra (41 pages). This article summarises the proposals of the first two documents.
Summary
The Green Paper is entitled ‘Simplicity, Security and Choice: Working and Saving for Retirement’ and aims to:
The Green Paper is the Government’s response to a number of reviews: the Inland Revenue review on pension scheme taxation, the MFR review (following the setting up of a Consultation Panel in March 2001), the Sandler report into the UK long-term savings industry (published in July 2002), the Pickering report on pensions simplification (also published in July 2002) and the quinquennial review of OPRA. Responses to the proposals/options raised in the Green Paper are sought by 28 March 2003.
It is clear that the government has decided to give what it calls a "voluntarist" approach to retirement saving one last chance.
To monitor this approach, the government has established an independent Pensions Commission, headed by former CBI Director General Adair Turner. Its first task will be to look at the quality of information available to policy-makers, but its wider remit will be to keep the private pension system under review and in particular to monitor trends in both occupational and personal pension provision and the level of other saving. Based on this information, it will recommend to government "on whether there is a case for moving beyond the current voluntarist approach".
We look at the proposals under their three main headings of simplicity, security and choice.
Simplicity
Taxation
A single pensions taxation regime with a single lifetime limit on how much "somebody can save in a tax privileged pension". This is proposed to be £1.4m with a "light-touch compliance regime" of an annual "limit on increments of value to an individual’s pension fund" of £200,000.
Scheme funding
The government had already decided to abolish the MFR. The Green Paper sets out the conclusions of the consultation panel set up in March 2001 for its replacement, a scheme-specific funding method determined by the trustees. Schemes would still have to do valuations every three years, and schedules of contributions, but not annual recertifications.
The trustees must agree a Statement of Funding Principles, which is made available to the members. The trustees should have overriding powers to freeze or wind-up schemes (for example, if they cannot agree with the employer on contribution levels). The regulator will have the power to fine the employer if contributions are not paid in accordance with the schedule. There is no indication of when the MFR will be replaced.
There are no proposals to lessen the impact of FRS 17, as this standard "does not itself create pension liabilities, it merely seeks to make them clear in company balance sheets". The government does not believe that intervention in the issue of the ownership of scheme surpluses, as raised in the Myners report, would lead to less complexity, and therefore does not propose to legislate further.
Contracting-out
There is no suggestion that contracting-out should be abolished.
The government is not in favour of the Pickering proposals to remove the statutory requirements for survivor benefits, or LPI, unless it can be persuaded that this would result in greater coverage for occupational pension schemes. Three alternatives to LPI are offered (including an Indexation threshold where a pension of £30,000 or more would not require indexation).
The government proposes to reform the reference scheme test by:
Under the current test, no more than 10% of the membership should be provided with benefits less than those provided by the reference scheme. It is proposed to change this to 20%.
Views are invited on how to convert schemes on the current test to the new one.
The government acknowledges that a number of different ways have been put forward in the past (not least in a consultation document issued with the last Green Paper in December 1998) to simplify GMPs. Rather than put forward proposals now, the Government has signalled its intention to consult on this again with the industry.
The government recognises that the anti-franking rules are exceptionally complex, but again has no specific proposals (views are welcomed).
There are firmer proposals to remove the restrictions around the age at which contracted-out benefits can be taken and the removal of rules which prevent the payment of a lump sum from contracted-out rights (as proposed in the Pickering Report). However, the Government is concerned that allowing tax-free cash to be taken at an earlier age runs counter to the principle that contracted-out rights should replace lost state scheme benefits, and so invites views.
It proposes to increase the limit for trivial commutation from £260 a year to £520 a year but with an age restriction in line with the Inland Revenue’s proposals, under which those over 65 with funds of less than £10,000 would be able to take them as a lump sum.
It proposes to abolish COMBs (contracted-out mixed benefit schemes), and safeguarded rights arising from pension sharing on divorce (although benefits would still have to be taken as a pension). Finally, member consent should not be required to commute EPBs (although members should not object to this).
Greater flexibility
The government is not in favour of Pickering’s proposal to replace Section 67 of the Pensions Act with an ‘equivalent value’ test. Instead, it proposes clarifying the wording of the current legislation and allowing changes as long as the actuarial value of the change does not exceed 5% of the total accrued right. Where benefits are reduced, they should be replaced by something of equivalent value.
All schemes should have member-nominated trustees (subject to the current exemptions) and two options are put forward:
There would still need to be legislation to specify which types of scheme are exempt, to ensure that scheme rules are overridden, and to protect member-nominated trustees from being removed or from being excluded from certain trustee functions.
The government expects the regulator to issue good practice guidance on the nomination and selection procedures it would expect schemes to follow.
The current two-stage internal dispute resolution procedure should be replaced with one of the approaches suggested by Pickering (i.e. all schemes to have a procedure, but they can decide whether it is in one or two stages). Views are invited on whether decisions on complaints should be resolved within six months.
Preservation and transfers
No changes are proposed to the current preservation rules (although views are sought as to whether the rules on money purchase uniform accrual can be removed).
Currently, the minimum amount of a cash equivalent transfer value (CETV) is calculated using the same valuation method as that under the MFR. In line with the scheme-specific funding requirement proposed above, the government proposes that CETVs should be calculated on a basis that is fair to all.
On transfer legislation generally, comments are welcomed on any transfer requirements that may be unnecessary or too detailed.
Communication with scheme members
The government agrees with Pickering that there is a case for rationalising the legislation and for replacing many of the detailed time limits with a "within a reasonable time" approach.
Comments are invited on this approach and on what information should be provided automatically, and what on request, what information should have specific time limits, and what regulations can be removed without an adverse effect on members.
The government does not accept Pickering’s recommendation about money purchase illustrations (MPI’s) that the only requirement should be that they are provided, with the regulator giving guidance on what information should generally be included with the illustration. MPI’s should be consistent between providers and, in view of the April 2003 start date, now is not the time for further changes.
Pensions on divorce
As well as abolishing safeguarded rights (although benefits must still be taken in the form of income), the government is considering various options for simplification. These include:
Views are welcomed on these potential simplifications. The Green Paper notes that there have been fewer than 1,000 sharing orders to date.
Surplus
Following advice from the Law Commission, the government will not be going ahead with the Myners’ recommendation that the Law Commission looks into the ownership of pension scheme surpluses.
Security
A new Pensions Regulator
The government proposes a new pensions regulator, separate from, but operating alongside and complementing the FSA. It should be a proactive body which can focus on schemes where there is a higher risk of fraud, bad governance or maladministration.
The shape of the proposed new regulator is set out in the Quinquennial Review of the Occupational Pensions Regulatory Authority (OPRA), and it is assumed that it will be refashioned out of the current regulator. Certainly, it will not be combined with the FSA. The government estimates it will cost about £2.5 million to set up the new regulator and an additional £3.5 million a year to run.
Protection in the case of wind-up
The government proposes to retain a priority order in legislation, but welcomes views on the possibilities of increasing the priority for those approaching retirement age (e.g. within 10 years of retirement) or basing the level of protection on the number of years the individual has contributed to the scheme, irrespective of age.
An alternative approach would be to try to achieve a fairer sharing of assets between those with larger and smaller pensions, probably adjusted to reflect length of time in the scheme. Pensions for pensioners could be capped at £30,000 a year, whenever they retired, with any excess being treated as a non-pensioner priority, or this cap could apply to those who have taken early retirement in the 12 months before wind-up.
To address the problem that pension schemes are unsecured creditors when a company becomes insolvent, the government welcomes views on whether to create a new category of creditor. Care is needed to get a balance between the potential impact on business and the need to provide adequate protection for members.
Despite the fact that some form of insurance or centralised ‘clearing house’ arrangement have been looked into before and found to be impractical (namely, following the government’s consultation document on the MFR in September 2000), the government is once again seeking views as to whether these may be an approach to dealing with under-funded defined benefit schemes where the employer is insolvent.
The government proposes to remove the 90% limit under the current Pensions Compensation scheme, so that schemes with an insolvent employer can be compensated in full for losses due to acts of dishonesty. The additional cost would be met from an increase in the levy.
Where solvent employers wind-up schemes, the government welcomes views on whether employers should be required to provide sufficient funds to enable all deferred members (or perhaps deferred members close to retirement) to be bought out so as to guarantee their full pension.
Any suggestions as to how winding-up can be speeded up are welcomed (bearing in mind that regulations to speed wind-ups were introduced in April 2002). Views are also welcomed on Pickering’s proposal to allow liabilities on wind-up to be discharged to a stakeholder pension or other defined contribution arrangement, as long as the member does not object and they are more than 10 years from retirement.
Transfer of undertakings (TUPE)
The government issued a Detailed Background Paper in September 2001 setting out some possible options. There were some mixed responses and the government now seeks comments on two further options – allowing members with defined benefits to be placed in a defined contribution scheme where the employer pays a comparable contribution, or a contribution equal to at least a certain percentage.
The government is considering making it a requirement on employers to consult their employees before making changes to schemes.
Financial Services
The government believes that, with the reform of polarisation, there is an opportunity to develop a market for generic financial advice, to help those on moderate incomes to identify their financial priorities and to save "where it seems sensible for them to do so". The FSA is exploring the viability of an interactive financial planning tool for use by community or voluntary organisations.
The government will consider the differences between the current Stakeholder pensions and the pension product proposed by Sandler. The most significant is the fact that Stakeholder has a default investment fund but not a prescribed investment strategy. They will consult on the possibility of building Sandler style investment controls on Stakeholder.
The government will consult early in 2003 on Sandler stakeholder products ideas. In parallel, they will consult on the appropriate sales regime for these new products.
Legislation will be brought forward to require occupational defined contribution schemes to tell members about the benefits of the open market option (along the same lines as the rules that already apply to personal pension providers).
Following the Myners review, the government will be working with practitioners to define what expertise pension scheme trustees need in order to carry out their investment duties.
Choice
Employer task force
An employer task force is being set up, charged with developing and promoting the role of employers in pension matters.
Highlighting the value of pension provision
The government wants to encourage employers to adopt best practice in informing employees and prospective employees of the pensions. It will be discussing with employers how best to promote the issue of annual total benefit statements to help employees to recognise the commitment their employer is making by providing a pension.
The government also believes that it would be beneficial for employers to include information about employer pension contributions on wage slips and to include appropriate information on pension provision in recruitment adverts. It proposes to produce, in consultation with employers, an FSA-approved pension information pack for employers to use in communicating with their employees.
Other areas being explored are:
The government also welcomes views as to whether the self-employed should be able to opt to pay higher National Insurance contributions and accrue benefits under the State Second Pension.
Immediate vesting
The government proposes that (as recommended by Pickering) rights in all schemes should vest immediately (i.e. no refunds of member contributions allowed). This is subject to the proviso that it should be possible for small amounts (see next paragraph) to be transferred without consent into a stakeholder pension.
Transfers without consent
The trustees of occupational pension schemes should be able to transfer amounts below a certain limit to a stakeholder pension where members left more than six months before, as long as:
Views are welcomed on whether the limit should be £7,000 (as opposed to the £10,000 proposed by Pickering), or whether the period should be five years (rather than six months).
Compulsory membership
The government proposes to accept Pickering’s recommendation that employers should be able to make scheme membership compulsory for new employees. However, it invites views as to whether employees should be able to opt-out of the scheme if they are already contributing to a stakeholder pension and, if so, how much they should be contributing.
Opportunities for older workers
There are a number of proposals for encouraging older workers to continue in employment. These include allowing people to draw their occupational pension whilst continuing to work for the same employer and consulting on ways to ensure that scheme rules do not discourage flexible retirement.
There is no intention to raise the state pension age, primarily because most people have stopped work by the time they get to 65. However, the government wants to help people work beyond 65 if they want to. Currently, state pension benefits may be postponed past state pension age for up to five years. During the deferred period, they are increased by 1/7th% simple for each week of postponement, subject to a minimum increase of 1%. Following the Pensions Act 1995, the increase rate was to have become 1/5th% and the five year period was to be removed, both effective from 6 April 2010. The government proposes to bring these changes forward to 6 April 2006.
The government also proposes to offer a choice of either the increase in regular state pension payments or a taxable lump sum in respect of the deferral benefit (the Green Paper quotes a lump sum payment of £20,000 for a single person who defers a state pension of £100 a week for five years, in addition to the £100 a week). Views are being requested on this proposal.
Finally, proposals are being developed to outlaw age discrimination in employment by December 2006; this might make compulsory retirement ages unlawful.
PROPOSALS FOR A NEW PENSIONS TAX REGIME
HM Treasury and Inland Revenue consultation paper was issued alongside the DWP’s Green Paper on 17 December 2002. It proposes radical reforms and simplification of the contribution and benefit rules for pensions.
A new set of rules will be introduced from ‘A’ day. The changes are likely to be introduced in the 2004 Finance Bill, meaning that ‘A’ day could be as early as 6 April 2004. The Government will be consulting further on the proposals in 2003. If enacted, hundreds of pages of legislation and guidance notes could be scrapped.
The new regime
All pension arrangements will automatically come into the new tax regime from A-Day, apart from Old Code schemes (which are already closed to contributions) and schemes which choose to opt out.
Schemes which choose to opt out will be treated as Funded Unapproved Retirement Benefit Schemes. However, it is proposed that all benefits from these FURBS will be taxed. One assumes this is because tax relief will already have been given on contributions. It is not clear how existing FURBS (or new FURBS) will be treated, as funds under such schemes can currently be taken wholly tax free unless they are used to provide an income, in which case the income is taxed (but tax relief is not given on contributions).
Simplified contribution limits
With effect from ‘A’ day, there will be one lifetime contribution limit for all pension arrangements.
Tax relief will be given on personal contributions of £3,600 gross or 100% of UK chargeable earnings, if higher. Personal contributions can be paid above this limit, but will not attract tax relief.
Employer contributions are unlimited and both current and former employers will be able to pay contributions.
But there will be an overall annual limit on contribution ‘inflow’ of £200,000. The paper implies that this limit will be increased by inflation, rather than earnings. Further details are given about the annual ‘inflow’ limit further on.
Contributions by anyone who is not the member’s current or former employer will be classed as the scheme member’s own personal contributions.
Non residents
Individuals who are not resident and ordinarily resident in the UK and who are not chargeable to UK tax on their earnings may choose to contribute to a UK based pension scheme.
Their contributions are unlimited but will not attract tax relief.
Their employers (current or former) can make unlimited contributions, but they will only get tax relief if they are a UK resident employer.
There are more generous rules for individuals who are not resident and ordinarily resident in the UK, but have been resident and ordinarily resident or had UK chargeable earnings in the last 6 years.
Their contributions are also unlimited but only the first £3,600 gross will attract basic rate tax relief if their contributions go to a scheme which operates tax relief at source.
Their employers (current or former) can also make unlimited contributions, but they will only get tax relief if they are a UK resident employer.
The ‘lifetime limit’
There will be one single lifetime limit on how much a person may have invested in tax approved pension arrangements. This will be £1.4 million across all arrangements (including old code schemes and the capital value of any pensions already in payment before A-Day) and includes the value of any contracted out benefits. The amount will be indexed in line with inflation rather than national average earnings (NAE).
Schemes will be responsible for carrying out the test; the Inland Revenue will publish actuarial tables so that schemes can work out the capital value of a person’s defined benefits. There will also be a standard process to measure the capital value of pensions in payment.
According to the Inland Revenue, the £1.4 lifetime limit is based on someone aged 60 getting a full two-thirds pension (i.e. £64,800 which is two-thirds of the current earnings cap) with provision for a 50% spouse’s pension and indexation. However, the best annuity rate at the time of writing (around £380 per £10,000 for a male aged 60 with indexation) would only provide a pension of just over £53,000, so it could be argued that the limit is too low.
There has also been some press comment that the limit discriminates against women. Lower annuity rates for women means they need to build a bigger fund than men to achieve the same target income
Testing the lifetime limit
For people who choose to draw all their benefits at once, this will be a one-off test, with a recovery charge (see later) on any excess fund. People whose total pension rights at A-day, whether vested or not, exceed the lifetime limit, will get any unvested rights in full without any tax charge on those benefits, providing they are within limits at A-Day under their pre A-Day legislative regime (it is unclear from the wording used in the paper whether or not these members will be able to build up further rights).
To make this possible, there will be special one-off valuation procedures, including procedures to assign a capital value to pensions already in payment. Those rights will have to be registered.
Pension schemes will be given three years to value each person’s A-day rights. Unless each person’s rights are valued, it will not be known whether their rights (which includes their overall pension benefits and their tax-free cash) have to be registered. According to the government, only a very small minority of people will actually be affected by the new limits or required to register their pre A-day rights.
While overall benefits for most people will be less than £1.4 million, many people may be entitled to more tax free cash under their current regime than will be available under the new. Valuing each member’s A-Day rights within three years represents a considerable amount of work and brings into question whether the start date of 6 April 2004 is workable.
Once pre A-Day rights have been registered, there will be no requirement for schemes to keep track of pension rights under previous tax regimes.
Where a member takes his benefits in stages, the scheme will be required to check the lifetime limit each time a tranche of benefits is taken.
The paper proposes that schemes tell Inland Revenue and the scheme member the percentage of the lifetime limit they have used when they vest their pension.
Where individuals take all their benefits at once, the government are asking schemes and provider for feedback on how the lifetime limit can be monitored.
When a member uses less than 100% of his lifetime limit, the remaining percentage will apply to the lifetime limit which is current at the time each tranche of benefits is taken.
The recovery charge
Funds in excess of the lifetime limit will be taxed at a rate of one third (except where their pre ‘A’ day rights have been registered). The remainder of that part of the fund must then be paid to the person as a taxable income.
Compliance and the annual ‘inflow’ limit
There will be a ‘light touch’ compliance regime, including an annual limit on contribution ‘inflow’ which is likely to be £200,000.
The annual limit will include:
The annual inflow limit excludes any national insurance rebates.
Individuals will be responsible for checking their own ‘inflow’ against the £200,000 limit. Those whose inflow exceeds the limit must report the excess as a benefit in kind on their self assessment return. There will be a new income tax charge on the excess.
Self assessment returns will include a new worksheet to enable individuals to report their inflow.
The paper suggests that, since the employees exceeding the £200,000 limit will be on substantial remuneration packages, their employers may well have the relevant figure to hand for the requirement to report directors remuneration.
However, it suggests that schemes may want to automatically put the ‘inflow’ figure onto member’s annual statements.
Actuarial tables will be published to enable defined benefit schemes to work out the growth in the capital value of a member’s rights.
For simplicity, the tables will use factors which are unisex, assume a 50% spouse’s pension and RPI indexation to pensions.
Schemes wanting to use their own tables will need to have these agreed with the Revenue.
Beyond the contribution and lifetime limit, there will be no other controls on pension benefits, meaning the complex system of maximum limits will be abolished.
Incentives to save and other tax issues
The government considers that the existing tax reliefs already provide the right incentives to save, but they are often overlooked. As such, it will ‘rebrand’ tax relief on contributions to personal pensions/stakeholders to emphasise its value more, but there will be no change to the existing system of tax reliefs.
Schemes for employees may either use net pay arrangements or operate a ‘tax relief at source’ scheme (with the provider grossing up at the basic rate). Any scheme which includes a self employed member must operate on the ‘tax relief at source’ basis. Schemes must operate the same basis for all members.
Pensions paid from retirement annuity contracts will be taxed under PAYE.
Schemes may choose to structure themselves on a defined benefit basis within the new regime. These schemes may still pay any surplus to the employer, net of 35% tax.
Retirement lump sums
The maximum tax-free lump sum will be a straight 25% of the fund under any type of arrangement.
Any rights to a larger amount, built up before A-day will be retained.
The paper proposes that this is calculated on one of three bases:
Flexible retirement
‘Staggered vesting’ will be allowed under all types of pension arrangement. People will be able to remain in work whilst drawing their pension, provided the scheme rules allow it.
Minimum benefit age
From 2010, the minimum age at which a person can draw their pension benefits will be 55 under all types of arrangement. The paper asks whether this should be phased in? Special consideration will be given to members of the armed forces, police and fire service.
Early retirement due to severe ill health will still be allowed. Individuals are free to retire earlier than 55 if they can afford to do so using sources other than pensions.
The Government wants to consult on whether there should be special transitional arrangements for existing members of occupational schemes with a normal retirement age below 55.
There is no mention of the consultation including members of s.226 retirement annuity contracts or personal pensions with a low normal retirement age because of a ‘special occupation’. The paper simply states that the new minimum benefit age will apply from 2010 to individuals with special trades or occupations, such as professional sports people. This is on the grounds that these individuals often embark on a second career.
There are proposals to change the rules of public service pension schemes for new entrants to increase the age at which pension may be taken. Those who leave service without immediately drawing pension would have to wait until age 65, rather than age 60, for an unreduced pension.
General benefit rules
The paper states that pension funds must be used to provide a secure lifetime pension income (other than the tax free lump sum entitlement) by age 75 (although the rules will be more liberal). Whilst benefits must still be brought into payment by age 75, it appears that the requirement to buy an annuity has been removed.
The income must start no later than 75 and no earlier than 55 (from 2010) or 50 (before 2010). The income must be for a lifetime, paid in instalments at least annually, non-assignable, with a maximum guarantee of 10 years. It must lie within minimum and maximum income limits unless it is underwritten by an insurer or promised by an occupational pension scheme. It will continue to be taxed as earned income.
Death benefits
There may be an unlimited tax-free death benefit on death before vesting, together with an unlimited dependants’ pension, subject to the fund being within the ‘lifetime limit’. The £1.4 million limit will be applied across all schemes and arrangements, and includes any life assurance offered by a scheme.
Death while receiving benefits
Up to age 75, there may be a return of capital on death. This will be taxable at 35%. On death whilst drawing an income from age 75 onwards, there may be no return of capital, only an income for dependants.
Trivial commutation
The rules on triviality will become more generous. For people over 65, funds may be taken as a lump sum if funds from all arrangements do not exceed £10,000 (only 25% will be tax free - the rest will be taxed as earned income).
Serious ill health commutation
It will be possible to pay pensions from all sources as a tax-free lump sum on serious ill health.
Annuity reform
The government will legislate for two new types of annuity:
Removal of the Revenue’s discretionary powers
Schemes will need to register for tax relief with the Inland Revenue.
But there will be no need for prior approval of pension schemes or of rule changes. Inland Revenue’s discretionary powers will come to an end. Schemes will be able to determine for themselves whether they are suitable for approval because the legislation will be ‘clear and transparent’. (The Revenue describes this as a "challenging objective")
Schemes can choose how to amend their rules for the new tax regime.
SSASs and SIPPs
The government is proposing one prudential investment regime for all pension schemes.
It intends to consult further on what restrictions should apply to loans to employers, loans to members and investment in commercial property.
There will be transitional rules to protect schemes from having to make urgent disposal of assets which are not allowed in the new rules. The ability for any type of scheme to invest more than 5% in the shares of the sponsoring employer will be removed.
This apparently effectively means the end of SSASs; Inland Revenue says in the paper that SSASs are used primarily for tax planning rather than to help members build secure retirement incomes.