UK: Green Paper on Pensions

The long awaited Green Paper on pensions was published on 17 December. It is a lengthy and wide ranging document, and is accompanied by a technical paper setting out in more detail those aspects of the Green Paper involving the regulatory reform of occupational and personal pension schemes. The Inland Revenue consultation paper on simplifying the taxation of pensions was published alongside the Green Paper and puts forward proposals to replace the existing eight tax regimes with a single tax regime for future pension savings. In this summary we have focussed on the contents of the Green Paper.

The Green Paper is a consultative document, and in places the Government simply requests help on what it should do without setting out any firm proposals. The proposals for more consultation could defer any meaningful progress on many areas in pensions until after the next election.

We provide a brief bullet point summary of the main issues, and then describe some of the proposals set out in the technical paper and the Government’s proposals on flexible retirement in more detail.

The key proposals are to:

• introduce one tax regime in 2004 – under the new regime there will be a lifetime limit of £1.4 million on the amount of tax-privileged savings and an annual limit of £200,000 on inflows of value to a scheme member’s fund
• set the tax free lump sum at 25% of the value of the scheme member’s fund
• provide better incentives to defer taking the state pension
• reform the annuity market by introducing value protected and limited period annuities
• increase and widen the pension forecasting requirements
• raise the minimum retirement age from 50 to 55 by the year 2010
• establish a pensions commission to monitor whether individuals and employers should be compelled to save for retirement
• consolidate existing legislation
• introduce a new pensions regulator who will offer advice to schemes as well as policing them
• replace the MFR with scheme-specific funding requirements
• simplify the contracting-out requirements
• provide better protection for scheme members where the scheme winds up
• provide full compensation to scheme members for acts of dishonesty by insolvent employers
• introduce immediate vesting of pension rights – and allow trustees to transfer de minimis amounts to stakeholder schemes
• allow individuals to work and draw a pension at the same time
• raise the retirement age in public service schemes from 60 to 65 for new entrants
• abolish compulsory retirement ages in occupational pension schemes
• allow employers to make pension scheme membership a condition of employment
• consult (again) on how to extend TUPE protection to private company transfers

Replacement of the Minimum Funding Requirement

In March 2001, the Government announced its intention to replace the MFR with scheme specific funding requirements. These proposals have been developed in the Green Paper, as follows:

• The introduction of a requirement for scheme trustees to draw up a statement of funding principles, based on advice from the scheme actuary, and agreed with the sponsoring employer. This statement would set out the scheme’s strategy for funding its pension commitments and its recovery plan for eliminating any deficits.
• Trustees will be required to obtain a full actuarial valuation of their scheme at least every three years, based on a funding approach (including actuarial assumptions) agreed with the employer following advice from the scheme actuary.
• After each valuation the trustees will be required to put in place a schedule of contributions, prepared in accordance with the statement of funding principles, setting out when and how much the employer and employees will pay into the scheme.
• If the valuation shows a funding shortfall, the scheme actuary will advise on the level of contributions needed to eliminate the deficit, on the basis of the actuarial assumptions adopted for the valuation. The trustees can set the period over which the deficit can be eliminated, with the agreement of the employer.
• More effective communication with scheme members is proposed. A copy of the statement of funding principles would be available on request. The Government also proposes that trustees should be required to send regularly updated information to scheme members containing key information about the funding position of their scheme.
• The duties of the scheme actuary will be consolidated into a new Guidance Note to be prepared by the Faculty and Institute of Actuaries.

The Government has proposed that where the trustees and the employer cannot reach agreement on the statement of funding principles or on the level of contributions needed to eliminate any deficit, the trustees will be given overriding powers to stop future accrual under the scheme or wind the scheme up. We would envisage this particular provision being the subject of some debate as it would potentially give employers the ability to lever trustees into closing or winding up the scheme, thereby avoiding taking the unpalatable decision themselves.

The Government has proposed that the requirements relating to transfer values should be less prescriptive. It suggests that trustees should, on the advice of the scheme actuary, decide the way in which the cash equivalent transfer value is calculated. This would be without reference to a statutory underpin, in line with the introduction of scheme-specific funding arrangements. It proposes that legislation should require cash equivalent transfer values to be calculated on a basis that is consistent, and fair to all.

Insolvent employers

The Government is seeking views on making changes to the existing statutory priority order for the distribution of assets where a scheme is under funded on a wind up. Currently pensioners have priority, and all non-pensioner members rank equally. The Government has put forward the following changes to the current priority order for consultation:

• increasing the priority given to people who are approaching retirement age, for example, those within 10 years of retirement age would be given priority over younger members; and/or
• basing the level of protection for non-pensioner members on the number of years the individual has contributed to the scheme, irrespective of age.

The Government is also considering trying to achieve a fairer division of assets between those with larger and smaller pensions. They put forward two different methods of achieving this. The first method is to introduce a capping system to discourage directors from taking early retirement shortly before the scheme winds up. This would involve pensions of such early retirees being fully protected up to a certain level, but amounts above that level being returned to the fund if assets in the scheme are insufficient to meet all liabilities. For example, the pensions of people who had taken early retirement in the 12 months preceding the wind up would be capped at £30,000, their pension would retain their pensioner priority status up to £30,000, but for the excess over £30,000 they would be treated as a non-pensioner member. Alternatively, the Government is considering capping all pensions for this purpose at £30,000, regardless of when the pensioner retired.

The Government is also considering moving pension schemes up the order of priority for payment from the assets of an insolvent sponsoring employer. At present, certain sums due to pension schemes are included with other unsecured creditors at the bottom of the list of creditors. The Government suggests creating a new category of creditor for pension scheme members which would rank above other unsecured creditors, but below preferential and secured creditors.

The Government has suggested the following further possibilities where a scheme is under funded and the sponsoring employer is insolvent:

• a centralised arrangement or "clearing house" into which people whose employer became insolvent could pay the funds they receive on a wind up. The clearing house could then seek to buy the best available annuity from an insurance company on their behalf; or
• a form of insurance – possibly a Central Discontinuance Fund.

Solvent employers

The Government has put forward two possible alternative changes aimed at providing scheme members with greater protection where a scheme is wound up and the sponsoring employer is still solvent:

• a "full buy-out" where employers would be required to provide sufficient funds on a wind up to allow all scheme members to buy annuities which would guarantee their full pension; or
• a "partial buy-out" where the amount of money in the scheme would provide full protection for pensioners and those nearing retirement. Younger members would still receive cash equivalent transfer values.

The Government has stressed that it is keen not to increase the overall burden on employers providing pensions, stating that "we need to strike a careful balance between the potential impact on business and the need to provide adequate protection for members". It appears unlikely, therefore, that we will see the introduction of full buy-out requirements.

Limited Price Indexation will stay, but the Government has asked for views on the possibility of limiting compulsory indexation of pensions up to £30,000 a year.

The Government has expressed its intention to simplify the current contracting-out system. The main elements proposals are set out below:

Reference scheme test – the Government has stated that they want to provide schemes with a more appropriate benchmark. However, the Government has said it will not abolish the requirement for survivors’ benefits unless it has evidence that coverage of, and contributions to, occupational pension schemes would be higher as a result. Proposed changes to the reference scheme test include changing the pension accrual rate from 1/80ths to 1/100ths and a broadened definition of pensionable salary. The Government is also seeking views on their proposal to permit the conversion of accrued benefits on an actuarially equivalent scheme wide basis into benefits under a reformed RST, and on how this conversion could be achieved.

GMPs – the Government intends to undertake further consultation on simplifying GMPs.

Anti-franking – the Government intends to simplify or abolish the anti-franking requirements. However, no new, firm proposals on how to simplify anti-franking have been put forward by the Government.

Payment of contracted-out rights – the Government is seeking views on the removal of the restrictions on the age at which contracted-out rights are payable, and the removal of rules that prevent the payment of a lump sum from contracted-out rights.

Trivial commutation – the Government proposes to increase the amount of the trivial commutation level, possibly coupled with restrictions, based on age, as to when the trivial pension can be commuted.

Contracted-out mixed benefit schemes – the Government is considering the abolition of contracted-out mixed benefit schemes, and have asked for views on whether existing COMPS should be allowed to contract out on a mixed benefit basis, or whether they should be required to convert their benefits into either defined benefits or defined contribution benefits.

Pension sharing on divorce – the Government is considering the abolition of safeguarded rights arising from pension sharing on divorce, subject to retaining the requirement that the total value of the pension share allocated to a former spouse must be used to provide pension benefits.

Section 67 of the Pensions Act 1995 prevents changes being made to the rules of an occupational pension scheme that would reduce a member’s accrued pension rights without the member’s consent. It preserves not just the value of the member’s rights, but the rights themselves. The Government is proposing to simplify the requirements of section 67, without removing the requirement altogether. It states its aim is to "ease the restrictive nature of section 67, so that schemes can make some changes to their rules which would help them to adapt to changing circumstances". It proposes to do this by:

• allowing schemes to make changes providing the actuarial value of the change does not exceed a certain percentage limit of a member’s total accrued rights, for example five per cent (the de minimis approach); and
• requiring that where the modification results in a reduction in the value of a member’s accrued rights, the rights foregone must be replaced by something of actuarially equivalent value.

It is intended that the de minimis approach would put a limit on the scale of the changes being made: schemes would be able to make limited restructuring but would be prevented from making wholesale changes, for example converting from defined benefit to defined contribution.

The Government remains committed to abolishing the employer opt-out route and is consulting on the possibility of:

• requiring all schemes to have a minimum of one third MNTs; and
• backing this up with guidance issued by the pensions regulator on good practice for nomination and selection arrangements.

The Government is also consulting on whether to introduce a statutory requirement that arrangements for nominating and selecting MNTs must be "fair and open".

The Government is seeking to simplify the internal dispute resolution procedure to require schemes to have a published formal dispute procedure, but allow schemes to choose the number of stages. It is also considering introducing a prescribed time limit of six months for a decision to be reached under the IDR procedure.

The Government is intending to replace many of the detailed time limits for providing information with "within a reasonable time". The new pensions regulator would then give guidance on time limits. The Government is also seeking to reduce the number of items provided to members automatically.

The Government has set out two alternatives for consultation:

• Where the transferor has a defined benefit or a defined contribution scheme, the transferee provides either a defined benefit scheme, with set minimum benefits, or a defined contribution scheme with a comparable contribution to the transferor; or
• Where the transferor has a defined benefit or a defined contribution scheme or a GPP or stakeholder arrangement, the transferee provides a minimum contribution to a stakeholder or a GPP.

The Government is also consulting on how to simplify the legislation on preservation and pension sharing on divorce.

Currently tax rules allow people to work and draw an occupational pension, but only where they no longer work for the sponsoring employer of the scheme paying their pension.

The Government is proposing to allow schemes the option of offering their members the opportunity to both work for the sponsoring employer and draw a pension from its pension scheme at the same time.

The Government states that sponsoring employers need to ensure now that their pension rules do not discourage flexible retirement, and should:

• ensure that people are offered a fair return for deferring their pension,
• allow people who are working past normal retirement age to continue to build up their pension, and
• ensure that final salary schemes treat fairly those who go part-time or step down responsibility near the end of their careers.

© Herbert Smith 2002

For more information on this or other Herbert Smith publications, please email us.