Top of the agenda

1. Further DC flexibility measures proposed, in relation to death benefits

The Government stated in the Budget 2014, that it would review the tax charge on DC pension funds held in a drawdown product at death or uncrystallised after age 75, as the current rate of 55% may be too high when the flexibility measures come into force in April 2015.

The Chancellor has now announced that the 55% tax charge will be "abolished".

Uncrystallised funds

Currently, where a member is under age 75 and has any "uncrystallised" DC funds (i.e. funds that have not been touched by being put into drawdown or used to buy an annuity) , the uncrystallised funds may be paid tax free (up to the member's Lifetime allowance).

However, if the member is aged 75 or over on death, any uncrystallised funds are subject to the 55% charge.

Crystallised funds in a drawdown account

Where the DC funds are held in a drawdown account, a 55% tax charge applies where the funds are paid in the form of a lump sum death benefit, regardless of the age at which the member dies.

If a pension from uncrystallised funds or from crystallised funds remaining in a drawdown account is paid to a spouse/ civil partner or a child under age 23, the recipient is taxed on the pension at their marginal rate.

The proposed new system

Under the new system, from April 2015:

  • Anyone who dies below age 75 can leave their unused DC funds to be distributed to their beneficiaries tax free whether the funds are uncrystallised or held in a drawdown account.
  • Anyone who dies on or after age 75 can pass on their DC funds to a nominated beneficiary to be accessed flexibly, subject to tax at the beneficiary's marginal rate of income tax on any withdrawals. Alternatively it can be paid as a lump sum subject to a 45% tax charge. The Government is, however, proposing to engage with the pensions industry to enable this 45% charge to be reduced to the individual’s marginal rate from 2016/17.

These changes will not affect the position in relation to annuities or scheme pensions. DB schemes will also not be affected (although this is subject to any further changes the Government may decide to introduce to allow DB schemes to offer members a flexible access option).

No draft legislation has been issued in relation to the proposals and further details of the proposals will be announced in the Autumn Statement (which is expected to be delivered on 3rd December this year).

Comment

In practice the proposals may make little difference for individuals who currently can afford to defer crystallisation of all or a substantial part of their DC funds. However it will remove any concern that by accessing savings through a drawdown arrangement any unused funds will be vulnerable to a 55% tax charge in the event of the member's death. This is likely further to encourage the use of flexible drawdown arrangements, at the expense of annuities.

2. Scottish “no” vote – what now for pensions?

On 18th September 2014, Scottish voters voted “no” to an independent Scotland, with a majority of 55.4% voting to stay in the United Kingdom. UK pension schemes with English and Scottish members will breathe a sigh of relief as the outcome as a “yes” vote for an independent Scotland could have meant that such schemes would have to have complied with the requirements of the Cross-Border Regulations which implement the requirements of the European Union's Pension (IORP) Directive 2003/41/DC. These Regulations currently require cross-border schemes to be “fully funded” on the basis set out in the Scheme Specific Funding legislation under the Pensions Act 2004, which would have meant significant cashflow and administrative burdens for the sponsoring employers of those schemes (see below for recent developments in relation to the IORP Directive, however).

There were also concerns over the impact on schemes with asset-backed funding (“ABF”) structures in place for scheme funding. ABFs typically use Scottish Limited Partnerships in order to get round the restrictions in relation to employer related investments in the Pensions Act 1995, but this relies on Scotland being part of the UK. A yes vote would have required pension schemes to review those arrangements.

Devo-max

A no-vote paves the way for progression of “Devo-max” (also known as maximum devolution) under which the UK Parliament would devolve some of its powers over the UK to the Scottish Parliament. This has already happened, firstly in 1998 and again in 2012 (although many of the 2012 measures apply from a date in the future). The precise proposals for devolution going forwards could depend on which political party is in power – Labour, the Conservatives and the Liberal Democrats have all pledged proposals. On the day that the results of the referendum were announced, the timetable for Devo-max was also announced: details of the proposal will be unveiled in November and draft legislation will be issued by the end of January 2015 but with no legislation being put through Parliament until after the next General Election.

The issues for pension schemes will be narrower and far less reaching than under an independent Scotland with the main focus likely to be on the tax consequences and the extent to which the tax regime in Scotland will diverge from the regime elsewhere in the UK. More tax powers for the Scottish Parliament could, depending on how the powers are exercised, affect the tax relief given on pension contributions and the tax payable on pension payments. A different set of tax rules for Scottish members and non-Scottish members would create additional administrative burdens for pension schemes e.g. the impact on PAYE tax deduction. There are also concerns that Devo-Max could result in a different State Pension Age in Scotland (as life expectancy is lower in Scotland) than elsewhere in the UK.

The IORP directive and Cross Border schemes

The IORP Directive is currently being reviewed by the European Union. Calls have been made on the Commission to remove the requirement for cross-border schemes to be fully funded but there was no change to the funding requirement in the first cut of the revised directive. The first "compromise text" for the new revised Directive issued by the Italian Presidency of the Council of Ministers on 17 September 2014 relaxes the requirements on cross-border schemes to be fully funded so that cross-border schemes only have to be fully funded “at the start” – if "these conditions are not maintained" during the course of cross-border activity (i.e. a deficit against "technical provisions" develops) a deficit recovery plan should be put in place. However the amendments are in flux; it will be interesting to see what changes are finally made to the funding requirements in the final version of the revised IORP directive.

Pensions Ombudsman

3. Past practice in relation to early retirement does not give a protected person a right to that benefit

In McQuade (PO-323), the Pension Ombudsman has not upheld a complaint by a member of the FACEO 2007 Pension Scheme that the practice of granting an unreduced early retirement pension in the previous schemes of which she was a member entitled her to an unreduced early retirement in the Scheme on account of her “protected persons” status.

Facts

Some members of pension schemes in previously nationalised industries (such as electricity and rail) are given "protected persons” status which, broadly, entitles them to accrued pension benefits on the same basis as they enjoyed before privatisation.

Mrs McQuade was a “protected person” and a member of the South of Scotland Electricity Board Pension Scheme.  She was entitled under the Electricity (Protected Persons) (Scotland) Pensions Regulations 1990 to benefits of no worse off than those provided by the Scheme (on 31st March 1990) from any successor pension schemes. This meant that in any successor scheme of which she became a member, she was entitled to a transfer of her past benefits and to pension benefits at least equivalent in value, on the basis of good actuarial practice, to the rights transferred.

Following the transfer of her employment to new employers (which happened several times), her past benefits were transferred firstly to the Scottish Power Pension Scheme and then the Alstom Pension Scheme. However, on a subsequent transfer of her employment to Cegelec Limited, the trustees of the Cegelec Scheme refused to accept a bulk transfer as they believed that the transfer amount in relation to the transfer was “inadequate”. Mrs McQuade therefore had deferred benefits in the Alstom Scheme and became an active member of the Cegelec Pension Scheme from 2002. The benefits that she accrued in the Cegelec Scheme were transferred to the FACEO 2007 Pension Scheme when her employment was transferred to FACEO FM UK Limited. However, following discussions between the trustees of the Alstom Pension Scheme and the FACEO Scheme, it was decided that a potential bulk transfer of benefits from one scheme to the other would be put on hold. FACEO, however, provided a guarantee that if the combined total of the benefits from the Alstom Pension Scheme and the FACEO Scheme were less than the amount due in accordance with the Regulations it would fund a “top-up” of the affected member’s benefits.

After being made redundant in 2011, Mrs McQuade applied for an immediate payment of her benefits from the FACEO Scheme without any reduction for early payment claiming her protected person status entitled her to it. She claimed that she was entitled to the benefit as an early retirement pension without reduction had always been awarded in the earlier schemes (although there was no absolute right for it under those schemes; the benefit was discretionary and required the employer's consent). Her application for an unreduced early retirement pension under the FACEO Scheme was refused by the employer as the scheme was in deficit.

Determination

The Ombudsman dismissed Mrs McQuade’s complaint insofar as her claim for an unreduced early retirement pension was concerned. The fact that the earlier schemes routinely granted the benefit did not mean that successor employers and pension schemes were also required to do so. FACEO and the trustees were also entitled to take the scheme’s financial condition into account in refusing her the benefit. However, given that FACEO took 15 months to provide a substantive response to Mrs McQuade’s complaint, Mrs McQuade was entitled to modest compensation of £200 for the distress and inconvenience she had endured as a result of FACEO’s delay.

Comment

Claims to the Pensions Ombudsman by members with protected persons status in relation to their benefits are not unusual. In this case, the Ombudsman made it clear that any past practice observed by previous schemes in relation to members with protected person status does not bind successor schemes and their employers to adopt the same practice. A similar point about past practice (although the member in this case was not a protected person) was argued in the recent determination of Thompson (PO-1203). In that complaint, the member argued that he was entitled to discretionary pension increases as these had always been awarded in the past which had given rise to “reasonable expectation” that the benefit will continue to be awarded. The Ombudsman dismissed the Complaint on the basis that past practice did not give rise to future expectations that the benefit would be granted, especially where the benefit was discretionary rather than an absolute right that was being curtailed or limited. For an update on that determination, click here.

4. Deputy Ombudsman holds there was no duty on an employer or the trustees of the receiving scheme to advise a member of their tax liability on a transfer of benefits

In Ramsey (PO-3290), the Deputy Pensions Ombudsman has refused to uphold a complaint by Mr Ramsey against the trustee of the Honeywell UK Pension Scheme (“the Trustee” and “the Scheme”), Honeywell Normalair-Garrett Limited (“the Company”) and Towers Watson, the administrator of the Scheme (“the Administrator”). Mr Ramsey complained that all three had failed to advise him that by taking benefits under the Scheme he would exceed his annual allowance therefore incurring the annual allowance tax charge.

Background

The annual allowance is the maximum pension saving which can be made in one year without attracting tax liability. The annual allowance was reduced from £255,000 to £50,000  on 6 April 2011. Previous years’ unused allowance can be “rolled over”. Exceeding the annual allowance attracts an annual allowance charge of 55%.

Prior to 1998, Mr Ramsey had been employed by the Company and was a member of one of its defined benefit schemes.  In 1998 the Company was sold, the DB scheme was closed to future accrual and Mr Ramsey became a member of the Company’s defined contribution scheme. The Company promised that if, when they left the Company, employees’ benefits under the DC scheme were less than they would have been if they had continued to participate in the DB scheme, they could transfer their benefits in the DC scheme to the Honeywell Scheme, a defined benefit arrangement. This was known as the “Special Arrangement”.

Mr Ramsey chose to take his benefits under the Special Arrangement and joined the Scheme in May 2011, after the reduction in the annual allowance had come into effect; the transfer triggered an annual allowance charge of £7,553.43. Mr Ramsey was unaware of this until the Trustee wrote to him on 31 December 2012.

No duty to inform of tax consequences

Mr Ramsey claimed that the Trustee, the Company and the Administrator were under a duty to warn him that his decision to transfer his benefits would result in him exceeding the annual allowance and incurring the annual allowance charge. He argued that if he had known of the potential tax consequences he would have transferred his benefits earlier (before the annual allowance was reduced) and avoided the liability. He relied on the fact that the Trustee, the Company and the Administrator were aware in May 2011 that there was a potential issue and were in correspondence with HMRC to clarify the position.

The Deputy Ombudsman rejected Mr Ramsey’s complaint on three grounds. Firstly, there was no legal obligation on the Trustee, the Company or the Administrator to inform Mr Ramsey of the tax consequences of his decision. At the time Mr Ramsey decided to exercise his rights under the Special Arrangement he was not yet a member of the Scheme and therefore the duty of trustees to act in the best interests of members did not apply. Under common law, the Company was not obliged to inform Mr Ramsey of the benefits of exercising his entitlement before April 2011, and the Administrator’s only duty was to provide an annual pensions savings statement to members exceeding the annual allowance in the relevant period (which it had done).

Secondly, the letter from the Administrator to Mr Ramsey on 11 May 2011 explicitly said that the provision of the retirement estimate did not constitute advice from the Trustee, and that if Mr Ramsey required financial advice he should contact an independent financial adviser. The Deputy Ombudsman found that this indicated that the Trustee was not giving Mr Ramsey advice in respect of his decision to transfer his benefits.

Thirdly, the Trustee, the Administrator and the Company were unsure of the tax implications of the Special Arrangement in May 2011. The correct position was only confirmed to the Company by HMRC in late 2012. They could not therefore have reasonably been expected to inform Mr Ramsey that he would definitely incur a charge under the Special Arrangement.

The Deputy Ombudsman also found that on the balance of probabilities, if Mr Ramsey had been informed of the potential tax liability prior to May 2011, he would still have exercised his rights under the Special Arrangement given that the disparity between his benefits under the Scheme and the DC Scheme was “very considerable”.

Comment

In reaching her decision, the Deputy Ombudsman placed considerable reliance upon the disclaimer in the letter from the Administrator to Mr Ramsey, and the recommendation that members seek independent financial advice. This highlights the importance of having suitable disclaimers and pointing members to the need to obtain independent advice, especially where members are required to make decisions on the basis of information supplied.

Pensions Regulator

5. Pensions Regulator to require more information from schemes in the Scheme Return

The Pensions Regulator is asking for further information from pension schemes on its 2014 Scheme Return. Three key areas where additional information will be required are as follows:

Technical provisions for schemes in surplus: additional information about technical provisions for schemes in deficit is already required in the Scheme Return. The Regulator is also now requiring information about technical provisions (the liabilities of the scheme expressed in actuarial terms) from schemes that have declared a surplus as at the most recent actuarial valuation date. The information required is as follows:

  • Discount rates;
  • Discount rate structure;
  • Pay increase assumptions; and
  • Inflation assumptions used (such as the retail price index and the consumer price index)

(Schemes ought to be able to access this information from the Scheme's most recent actuarial valuation and its Statement of Funding Principles)

Value at Risk (VaR) information, a VaR calculation is used for assessing the size and likelihood of various risks occurring over a defined period of time. Typically it is used to estimate the additional deficit which could arise over a period of time and with a certain level of probability. Some trustees will calculate and use the VaR measure to review and monitor risks within their pension schemes.

The Regulator requires this information so it can better understand the risk characteristics of the overall DB pension landscape and refine its risk assessment of DB Schemes.

(Actuarial Valuations and reports, investment advice and investment monitoring reports are likely to contain information about the VaR).

Asset-backed contribution (ABC) structures: schemes that have ABC arrangements in place for funding are required to provide information relating to the structure, valuation and terms of the ABC. As the Regulator has stated in its guidance on ABC arrangements, when considering the valuation of a scheme's funding plans, the Regulator would look behind the net present value attributed to the scheme's interest in the ABC and will instead consider the aggregate funding stream provided under any recovery plan and the ABC. Further information that will now be required on ABCs includes:-

  • Value of the Scheme's interest in the ABC as at most recent scheme valuation date;
  • The type of assets made available to the ABC (and their value); and
  • Whether the assets or cash flows to the ABC come from within the employee group or not.

The Regulator's checklist for the additional information required alongside an example of the 2014 Scheme Return can be found on the Regulator's website.