The Government's latest proposals for occupational pensions are likely to throw up fresh complications for trustees, individuals and employers, and intermediaries will need to ensure the right advice is given
Action on occupational pensions was the document published by Andrew Smith, Secretary of State for Work and Pensions, on 11 June when he made his statement to the House of Commons. The title appears to be carefully chosen, because inaction was what he had been accused of after last year's Pensions Green Paper.
These new proposals are extremely significant. Some advisers may think this has not much to do with them because they only work with money purchase pensions, but this is a massive boulder that has been dropped into the pensions pond and its shockwaves will reach every corner. The specific proposals from the document are listed in the box above, and I will consider the implications of the most important ones in turn. I will also consider related publications from the Inland Revenue and the actuarial profession issued on the same day.
The finances of the PPF look somewhat precarious. The bigger the claims, the more levies will have to go up, and the more defined benefit employers will seek to avoid them or pass on some of the levy to scheme members through higher employee contributions, lower benefits or lower pay rises.
Perhaps the Department of Work and Pensions (DWP) thinks that defined benefit employers are a captive levy base, because the only action to avoid being a defined benefit employer is to wind up the scheme, and suddenly the cost of that has gone through the roof. This is because the DWP will make regulations, backdated to Andrew Smith's statement on 11 June, requiring a solvent employer to meet any shortfall between the scheme's assets on winding up and the costs of buying out with a life office 100% of the promised benefits.
Looked at from the viewpoint of a member of a private sector defined benefit scheme, these proposals give comfort about the accrued benefits because they make it more likely that they will be paid, but perhaps it worsens the prospects for future defined benefit accrual.
Also, if an employer becomes insolvent before the start date of the PPF, the member might gain from the revised priority order being brought in this autumn, but might lose, since all this does is divide up the same cake in a different way. Looked at from the point of view of a defined benefit employer, it is as if the employer now finds itself running a life office subsidiary, and one which in most cases is currently grossly insolvent by any standard that the FSA would apply to 'official' life offices.
After all, the Government has just decided that the defined benefit is a guarantee payment for the member's entire lifetime as a pensioner. It gets worse ' most defined benefit schemes are heavily invested in equities, which in the last three years have proved to be a very unreliable match for the pension liabilities.
Then, of course, there is the prospect of levies that will surely rise as other defined benefit employers go bust. Some employers may even go bust because of the existence of the PPF. If defined benefit employers ' and their shareholders ' are not horrified by this, they clearly have not understood what has happened. Watch out for employer incentives to members to transfer out of the scheme.
Extending TUPE protections to private sector workers will create a niche pension market when a group of workers is transferred between employers in the private sector. In essence, if the group of workers had access to a pension arrangement with the old employer, the new employer must offer them (at least) a stakeholder pension where the employer will match employee contributions up to 6%.
There will be a new approach to vesting
Employees who have been scheme members for at least three months, but leave before completing the minimum period for preservation (two years or less), must be offered the choice of a refund of contributions, less tax, or a cash equivalent transfer value, which they must transfer out of the scheme to another occupational scheme or personal/stakeholder pension of their choice.
Since 1997, accrual in an occupational pension has been subject to Limited Price Indexation. This means that when the pension comes into payment it must go up each year by (at least) the lesser of 5% and the change in the Retail Price Index. The Government has decided to reduce this cap to 2.5% as a counterbalance to the cost of PPF levies. This is a small sop to defined benefit employers, but, of course, at the potential expense of pensioners for future years of inflation above 2.5%.
There will be increased flexibility for schemes to rationalise the structure of their benefits. This relates to the infamous Section 67 of the Pensions Act 1995, which has acted as a straitjacket on any change to the structure of past service accrual. This will be changed so benefits can be restructured provided the scheme rules allow it, defined benefits do not become defined contributions, the trustees approve, the total actuarial value of members' rights is maintained, pensions already in payment are not reduced and members are consulted before the change.
The Government also confirms that it will continue to develop the concept of a web-based 'retirement planner' for people who want to look at their retirement prospects online.
There are also to be more options for flexible retirement. The Government has confirmed that it will legislate (as it must, because of a European directive) to stop employees being forced to retire on grounds of age, also that the earliest pension age will rise from 50 to 55 by 2010, and that moving from full-time work to part-time to full retirement will be possible as 'a more smooth and gradual process'.
The Government has also reaffirmed its determination to move from a normal pension age of 60 to 65 by the end of 2006 for new staff. This will be extended to existing staff while protecting the value of accrued entitlements. Also on 11 June, the Inland Revenue confirmed that the start date of its new simplified tax regime will be 6 April 2005. This is a great relief to most of us, because 6 April 2004 was almost impossibly short notice given that we do not yet know the details of the new regime.
This does, of course, mean that there will be a new simplified tax regime. This was only an option at the time of the original Inland Revenue consultation paper.
Exposure draft 51 (EXD51) is a consultation paper from the actuarial profession, also published on 11 June, about changes to what actuaries must include in their regular reports to trustees of defined benefit schemes. It is proposed that the actuary must disclose the true solvency position ' this is the reserves required given an equivalent security to that offered by a life office for the same benefits. One way to satisfy this requirement will be to use life office buyout rates.
The Government is seriously considering requiring the trustees to pass on this information to the members in their yearly benefit statement. This may create pressure from the members on the employer to fund the scheme to a higher level. On the other hand, the members may take comfort from the proposals for the PPF ' if they believe the PPF will still be around to pick up the pieces when their need arises.
The Government continues to pretend that the state pension issue has been resolved in a satisfactory manner. It has not. Sooner or later it will undergo major change.
So the need for specialist pensions advice is going to be very significant for as long ahead as we can see. This may take the form of advice to individuals, employers and trustees. There will be a lot of adapting to do, including switches from defined benefit to defined contribution and, where a defined benefit scheme continues in some form, investment control and expense control.
Changes to the pension regime will lead to some members gaining and others losing out as the cake is divided differently on winding up.
The pension protection fund will increase the amount of contributions paid by employers.
There may be pressure from members on the employer to fund schemes to a higher level.
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£80bn funds under calculation