As the trend towards closure of final salary pension schemes accelerates, it is important that clients who have relied on the permanency of these benefits understand their rights
John Monks, general secretary of the Trades Union Congress (TUC), was quite right when he argued that the recent closure of final salary schemes by Ernst & Young and Iceland are only the tip of a very large pensions iceberg. Unfortunately for the unions, the law is very much on the side of the employer.
As the trend towards closure of final salary pension schemes accelerates, it is important that clients who have relied on the permanency of these valuable benefits understand their rights and options if their employer takes this controversial step.
For an industry not noted for its brevity, pension schemes disclose very little information on the employee's contract of employment. In most cases, all you will find is a reference to your client's right to join the scheme. For the nuts and bolts, you will need to refer to the scheme rules and handbook.
Mark Grant, a pensions lawyer with CMS Cameron McKenna, says: 'This booklet will explain how the employee's benefits build up under the final salary scheme. It will also confirm the employer's right to amend or discontinue the scheme at any time provided the company gives an appropriate period of notice.'
Typically the notice period can be anything from three to six months.
The right of the employer to take this step was considered as part of the major review of occupational pensions that followed the Maxwell scandal, when £400m went missing from the Mirror Group pension schemes. The Pension Law Review Committee, headed by Professor Goode, concluded that the employer should retain the right to close a scheme and did not withdraw this right in the Pensions Act (1995).
In considering the alternatives, the committee felt that forcing a company to continue this expensive benefit could push it in to insolvency. Under current law it is therefore rarely a breach of contract of employment ' or of constructive unfair dismissal for that matter ' for an employer to discontinue or amend a pension arrangement.
In most cases, the contract of employment for senior employees will follow this pattern. Occasionally however, a very senior executive may have a separate contract that specifies and guarantees the accrual rate. If your client is in this position, you will not be able to prevent the closure but may be able to negotiate compensation if this leaves your client materially worse off.
The position of higher earners is interesting. Any employee who joined the company after 1989 may be affected by the earnings cap, which restricts the amount of salary on which pension contributions and benefits can be based to £95,400 (in 2001-2002). There is no legal requirement for an employer to provide a pension for earnings above the cap but in practice, many do so via an unapproved pension scheme. Clients who have a funded or unfunded unapproved retirement benefit (Furb or UURB) attached to the contract of employment should have their pension promise more carefully stated. These should remain intact even if the main final salary scheme is closed. Besides, in most cases Furbs are set up on a defined contribution basis.
Older employees may find that while they are not capped under the final salary scheme, the very act of joining the new money purchase scheme may trigger the cap rules. This will not be an explicit intention on the part of the employer ' but it may be an irreversible consequence of the transfer of membership.
Colin Singer, an actuary and partner with consultant Watson Wyatt, says: 'The implications of the earnings cap will depend on the method used to establish the new scheme. If it is an occupational money purchase scheme ' such as a contracted in money purchase scheme (Cimp) ' the trustees may use the same trust as the original final salary scheme. In this case the Revenue would not treat it as a transfer of membership to a new scheme.'
However, while it may be possible to add a Cimp to the old trust deed, this would not be possible with a stakeholder scheme or group personal pension because these operate under a different tax regime.
In this case, a client who earns above the cap could face restricted pension benefits for future service.
It will be clearly be imperative to assess the damage and seek compensation ' either in the form of an unapproved scheme or extra salary to allow the client to build up additional investments to make good the prospective shortfall in the retirement income.
Smaller firms of advisers that need an expert opinion or calculation to help assess a client's position might go to a member of the Society of Pension Consultants (www.spc.uk.com) or one of the professional services and employee benefits firms that are likely to be members of the Association of Consulting Actuaries (www.aca.org.uk).
Some employers ' Ernst & Young for example ' acknowledge the loss of guaranteed pension benefits for future service by offering enhanced contribution rates to those who join the new money purchase scheme. There is usually a time limit so the decision to join must be made quickly. In Ernst & Young's case, members of the old final salary scheme who do not join the money purchase scheme by March 27 2002 forfeit the right to the enhanced terms, which offer a contribution matching facility of up to 5% in addition to the regular employer contribution.
If the employer does not offer enhanced contribution rates, older clients in particularly will need to pay more in to the new money purchase scheme than was required under the final salary arrangement.
Where a final salary scheme is closed, one of the most important considerations is to decide what to do with the benefits built up to date. Final salary pensions are valued in years because under a typical scheme, the employee's benefit builds up at the rate of one-sixtieth of salary per annum up to a maximum of two-thirds of final salary (forty sixtieths).
The scheme actuary converts these years into the cash equivalent, which is broadly the amount the employee would need to invest today to buy an equivalent pension at retirement. However, if the client decides to transfer out there is no guarantee of what the money purchase fund will buy.
Some employers that close their final salary scheme may offer enhanced transfer terms to encourage members to switch all their past service benefits to the new money purchase scheme. Transfers ' particularly those with enhancements ' may be worth considering in certain cases, but older employees should think very carefully before they give up a guaranteed salary-linked pension, even where it only covers part of their career.
Advisers also need to find out what will happen to the death and disability benefits that are guaranteed by the old scheme. The new scheme may offer less valuable insurance policies.
This broad guide outlines what a client can do with the benefits built up to the date of the scheme closure, but it is essential to refer to the scheme rules and to consider any transfer enhancements your employer may offer. If an employee was in the pension scheme for less than two years he or she may be able to get a cash refund of contributions (employee, not employer), less certain deductions, including a tax bill to pay back the tax relief. After two years the options are as follows:
l Leave the benefit in the closed final salary scheme. This is known as a preserved or deferred pension and is linked to the employee's salary at the time of the scheme closure, increased by retail prices up to a maximum of 5% per annum (limited price indexation). This is usually the best choice.
l If the employee is over age 50, it may be possible to take early retirement, although not if the intention is to continue employment with the same company. Unless the scheme closure is linked to a voluntary redundancy programme that offers enhanced terms the pension will be significantly reduced.
l Take a transfer of benefits (the transfer value) to the new money purchase scheme.
l Transfer to a new employer's final salary scheme on changing jobs. However, an increasing number of trustees refuse to take in transfers from new recruits even if the final salary scheme is still open to new members.
l Take a transfer value to a stakeholder scheme or to an individual personal pension that is separate from the employer's money purchase scheme.
Despite the loss of the final salary guarantee, there are special circumstances when a transfer to a personal pension might be appropriate.
John Hough, managing director of the consultant Aspen, says: 'A key issue may be the need to draw on these benefits fully or partially on early retirement.'
A personal pension would confer this flexibility. Also, single employees with no dependents might benefit from this move because the final salary scheme includes quite a generous allowance to cover the spouse's and children's pensions and death benefits and this will be reflected in the transfer value.
A growing number of clients will be barred from making contributions to their final salary scheme for future service.
It may be possible to seek compensation for loss of pension rights for senior executives, particularly where they are capped in the new money purchase scheme.
It is vital to check the clients position on disability and live cover under the new scheme and to top up with private insurance where necessary.
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