UK: Chancellor Confirms Reforms To Pensions Systems In Budget

The Chancellor’s Budget statement has confirmed a number of changes to the UK pensions system.

Final salary schemes: new growth objective for the Pensions Regulator

The Chancellor reaffirmed the Government’s commitment to lightening the regulatory burden on final salary (defined benefit, DB) occupational pension schemes. He recognised that employers with DB schemes have been under financial pressure in recent times.

The Government proposes to give the Pensions Regulator a new statutory objective to “support scheme funding arrangements that are compatible with sustainable growth for the sponsoring employer” within the framework of the existing statutory funding regime. The relevant legislation will be published later in the Spring, and the Regulator will revise its own guidance material accordingly.

It remains to be seen how this new objective will affect the operation of pension schemes. It may be that it will send out a signal to trustees to adopt a pragmatic approach to scheme funding, since the ultimate recourse for trustees in difficult funding negotiations is to approach the Regulator. This could mean that the balance of interests between employers and schemes is, in the event of a conflict, struck less in the direction of obtaining maximum funding on a short timescale and more in the direction of allowing the employer to grow and flourish so as to offer the scheme a more secure future.

The Government is also consulting on the prospect of making some State regulators subject to a duty to promote economic growth. It is considering applying this duty to the Pensions Regulator.

The Government will not be proceeding with an earlier proposal to “smooth” the asset and liability figures used in the periodic valuations of DB schemes. This proposal would potentially have resulted in schemes’ valuation figures – and hence employers’ funding obligations – fluctuating in a less volatile way from one valuation to another. The proposal has been abandoned in the light of adverse feedback from the consultation process, from actuaries and others.

The State pension

The Chancellor has confirmed that the new flat-rate State pension will be introduced from 2016-17. This single-tier pension will replace the current Basic State Pension and the State Second Pension (previously known as SERPS).

In tandem with this reform, contracting-out from the State Second Pension will be abolished. This means that employers will no longer be able to claim the NI contracting-out rebate in return for providing a contracted-out pension scheme. This rebate amounts to 3.4% for employers and 1.4% for employees for earnings between the lower earnings limit and the upper accrual point. In order

to recoup some of the lost rebate, employers will be able to reduce future-service benefits offered to scheme members.

Scheme investments

The Government will be consulting on changes to pension scheme investment rules to encourage the conversion of unused space in commercial properties. The details of these changes are not yet known.

Pension drawdown

When an individual retires with a pot of pension savings, s/he has a number of options as to how to draw down those savings, aside from the traditional option of buying an annuity to provide a regular pension for the rest of his or her life. In particular, s/he can draw money out of the pension pot, in a similar manner to a bank account, without needing to buy an annuity.

One way of doing this is through an arrangement known as “capped drawdown”. Under capped drawdown, there is a limit to the amount that can be drawn down from the individual’s pension pot in each year. This is to prevent pensioners from becoming impoverished and depending on State benefits. Currently, an individual can only draw down a sum equal to the value of an equivalent annuity. The Government proposes to raise this limit to 120% of the value of an equivalent annuity. It will also update the tables that it uses to calculate annuity values for this purpose.

Clyde & Co Comment

Overall, the Budget represents a pause for breath among the series of recent changes in the UK pensions system, including the introduction of automatic enrolment and the announcement of the reforms to the State pension.

The abandonment of the proposal to introduce “smoothing” for DB scheme valuations may come as disappointing news to finance directors. One of the principal challenges posed by DB pension schemes is not merely the cost of funding them, but the volatility of the funding obligations. Strongly fluctuating pension deficits can have a serious impact on a company’s financials and its business plans, and “smoothing” might have eased this problem.

On the other hand, the CBI has welcomed the proposed introduction of the duty for the Regulator to promote sustainable growth on the part of scheme employers. The practical effects of this duty will become clear in due course. It may, for example, feed through to the stance that trustees adopt when considering scheme funding requirements, and this may in turn impact on the dynamics of funding negotiations between trustees and employers. Nevertheless, the statutory funding regime will continue to apply in all cases, and this will continue to offer protection to members in respect of the funding of their benefits.

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