On 22 February 2000, the Government issued its draft regulations for the new defined contribution (D...
On 22 February 2000, the Government issued its draft regulations for the new defined contribution (DC) regime which will apply to all personal pensions contracts, including stakeholder, issued from 6 April 2001.
The Government's press release says: "Tax relief for waiver of contribution insurance will be simplified and broadened to circumstances other than ill health, such as unemployment." But will these twin objectives be achieved as the proposed legislation stands?
In the regulations themselves, the Government seeks to achieve this simply by withdrawing subsection (2) of S633 of the Taxes Act 1988. This allowed pension plans to include insurance against a customer's inability to pay contributions as a result of sickness or accident, also known as waiver of contribution. So the new simplicity is to be achieved by preventing the benefit from being provided under pension policies and, instead, having it provided through a stand-alone policy outside the pensions regime. Unfortunately, as we have found in the past, simplification in pension legislation does not always lead to greater simplicity for customers or providers.
The current regime, which will continue to apply to existing contracts and increases to those contracts after April 2001, simply allows the benefits of the plan to be maintained as if premiums had been paid, even though they have been waived during a period of disability.
Tax relief is granted on the total pension contribution, including the part that pays for waiver benefit, but the gross contribution is credited to the plan during claim with no tax relief or gross-up on this notional contribution.
The new regime will have the benefit provided under a separate policy which will not qualify for tax relief on its premiums. However, it need only insure the net contribution due as the contribution will be grossed up when paid. This is possible because the new regime will allow everyone to pay contributions and have them grossed up, even if they do not have relevant earnings and/or do not pay tax. The clear advantage is that insurance can be provided against risks other than just sickness or accident - so, for example, redundancy could also be covered.
While the redundancy cover aspect is a clear benefit, there remain a great many issues to be addressed before we can conclude that the new regime is, in fact, a simplification.
These issues fall broadly into two groups.
Customers will now take out a policy to cover the net contribution due under their pension but, as tax rates change, the cover will need to be adjusted to ensure that the benefit received in a claim is sufficient to meet the due contribution. This is because the pension contract is for an agreed gross contribution, which generates a variable net contribution as tax rates change. For example, if I were to insure for a net benefit of £78 a month to enable me to pay a grossed up contribution of £100, at a time when the tax rate is 22% and, in future, the tax rate is reduced to 15%, my benefit of £78 will only be grossed up to £91.76 instead of the total contribution due of £100.
If a customer wants to cover any pension contributions paid into their plan by their employer, they will have three choices. They could choose to pay themselves, or their employer can either pay the premiums due for a policy entered into by the employee or take out a policy and pay the premiums but pass the benefits to the employee.
However, if the employer pays the employee's waiver plan premiums, the employee will become liable to tax as it becomes a 'benefit-in-kind'. If the employer takes out the policy to cover the contributions, then on paying the benefit on to the employee, both tax and National Insurance will become due on the payments.
It is also difficult to see how this approach would work in the case of redundancy because the then ex-employee could not be paid by the employer. In addition, any payment from the employer would again be classed as income for DSS benefit calculation purposes.
The Government has said that the net cost of the premium will not change, as the customer need only insure the net contribution although he or she would now be paying gross. For example, if waiver costs 3% of contribution, it represents £3 gross or £2.34 net to cover a £100 contribution.
Under the new proposals it will only be necessary to cover the net contribution of £78 at a gross premium of £2.34. However, this assumes that providers will be willing or able to issue separate policies for premiums which might typically be only £2 per month, instead of being able to deal with it as an additional benefit under the pension contract.
Secondly, under present regulations the benefits of the waiver policy are considered to be income in the hands of the customer when determining eligibility for state benefits. A customer might, therefore, find that their benefits are reduced by the same amount as the policy benefit.
It is suggested the Department of Social Security (DSS) may change its rules to avoid this, provided the policy benefits are paid direct to the pension provider. But this could cause problems as the pensions regulations make no provision for contributions to be paid by anyone other than the employer or employee and for grossing-up only to apply to employee paid contributions.
As for premium payment, changes to the standard rate of tax will cause problems in the event of a claim. The net benefit under the waiver policy may initially be sufficient to meet the net pension contribution but become insufficient as tax rates fall in the progress towards the target of a 10% standard rate target.
There could also be problems in the opposite direction in that, in the event of increased tax rates, customers may want only enough of the benefit paid to the pension provider to meet the net premium, with the balance paid to them.
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