Pensions Lessons for Trustees Extra-Curricular Activities September 2016
In recent months we have seen how Defined Benefit (DB) pension provision has the capacity to cause a drama and frequently "struts and frets his hour upon the stage... full of sound and fury". In this section we raise two specific DB pensions issues that merit trustee attention to avoid becoming future dramas in their own right. We begin with The Mousetrap which has been running in the West End of London since 1952. We hope that any scenes attaching to contractingout abolition will not play out for this length of time...
The Mousetrap Contracting-out A change in legislation from 6 April 2016 affected pension plans that ceased to contract out on that date where the plan provides revaluation of Guaranteed Minimum Pensions (GMPs) on a fixed rate basis. Before 6 April 2016, GMPs were revalued by reference to increases in average earnings ("section 148 orders") for the period from 6 April 1997 until the member ceased to be in contractedout service and thereafter the trustees/trustees and sponsoring employer had the option to switch to "fixed rate" revaluation (set at 4.75% per annum) up until the member's GMP Age. From 6 April 2016, new legislation requires GMPs to be revalued on the section 148 order basis until the member leaves pensionable service in the plan. This may result in a revaluation underpin arising for the period between 6 April 2016 and the date on which a member leaves pensionable service. Depending on the rules of the pension plan (and administrative practice), members may need to be given the better of section 148 orders and fixed rate revaluation for this period. Trustees have a new statutory power to amend their pension plan's GMP rules with retrospective effect to prevent an underpin from arising. The new power may be exercised at any time before 6 April 2017. 1. Action. Trustees of pension plans that ceased to contract out on the abolition date should check their pension plan rules and consider exercising the statutory power before 6 April 2017.
A View From the Bridge Bridging Pensions
A bridging (or levelling) pension is often available under the rules of a plan to allow a member to take early retirement benefits in a way that provides a level income throughout the member's retirement. This is achieved by providing a higher initial pension, which reduces when the member reaches state pension age by an amount broadly equivalent to the state pension.
Trustees have been grappling with the implications for bridging pensions following the change in state pension age and also the switch to a single tier state pension. The Department for Work and Pensions has issued a reminder to trustees to check that they can still operate their plan rules.
Tax legislation previously referred to the two-tier state pension system when calculating the maximum reduction permitted. The Finance Act 2016 updates this but we are awaiting the detail in regulations which are expected to be retrospective to 6 April 2016.
2. Action. Trustees should review any bridging pension provisions or other plan provisions referring to state pension age and/or to the state pension to check that they are still capable of operation.
This section is recommended reading for trustees with any element of money purchase provision in their pension plan. This includes those with a money purchase Additional Voluntary Contribution (AVC) arrangement, or a DB pension plan with a money purchase underpin or top up. If in doubt, trustees should assume that their pension plan may have money purchase benefits and read on...
"It is a truth universally acknowledged that a trustee board in possession of a money purchase plan must be in want of good governance". Maybe not the exact words of Jane Austen, but this premise is the foundation of the Pensions Regulator's (the Regulator's) material on money purchase governance.
Wuthering Heights New Standards of Money Purchase Governance
The Regulator's revised and updated Code of Practice on Governance and administration of occupational trust-based schemes providing money purchase benefits came into force on 28 July 2016 and replaced the previous code. The code sets out the Regulator's expectations of how trustees will meet the applicable legal requirements and is accompanied by a series of Guides which expand upon the code and set out "best practice" in key areas.
In terms of money purchase AVC arrangements, the Regulator says that the "approach taken should be proportionate to the significance of the value of AVCs relative to the members' overall benefits in the scheme." Although there is comment on what may constitute a "proportionate" approach to good governance, we anticipate that the question "how much is enough?" will continue to be a difficult one for trustees to answer.
Establishing "security of assets" is acknowledged as a difficult issue for trustees, with the protection offered by the Financial Services Compensation Scheme being a "last resort" which can only be ascertained on a case-by-case basis. The Regulator also emphasises the role of legal advisers in investment governance, for example, to review the terms of investment agreements and to assist in the negotiation of investment contracts.
3. Action. We recommend that trustees work through the code and guidance material, using the scheme assessment template as appropriate, focusing initially on areas of risk, or matters that have not received sufficient attention in the recent past.
Brave New World Mandatory Fines
The Regulator is required by law to fine trustees who fail to produce a chair's statement within seven months of the scheme year end, even if immediate remedial action is taken.
Plans whose only money purchase benefits are AVCs do not need to produce a chair's statement but the interpretation of the law is not so clear cut in other circumstances. For example, where a pension plan has a money purchase underpin the Regulator expects that a statement will be produced if the underpin applies in relation to at least one member.
4. Action. Trustees should ensure that the chair's statement is produced within the statutory timeframe. If in doubt, seek legal advice on whether a statement should be produced.
The Thirty-Nine Steps More Charge Capping Requirements
A ban on member-borne commission was added to legislation on 6 April 2016 and required trustee action on or before 5 July 2016. Where a pension plan is used as a qualifying scheme for automatic enrolment purposes and has an element of money purchase provision (including AVCs within a DB pension plan), it is defined in legislation as a "specified scheme" to which the ban on member-borne commission applies. Trustees should have given notice to money purchase service providers (for example, scheme administrators and AVC providers) that their pension plan satisfies the statutory definition. Service providers should by now have confirmed to trustees that they do not levy charges banned under the new legislation. Trustees need to state on their 2017 scheme return to the Regulator that all service providers have given the required confirmation.
5. Action. If action has not yet been taken this should be done without delay.
Catch-22 Underpins and Top Up Benefits
On 24 July 2014 the definition of money purchase benefits was changed, with retrospective effect to 1 January 1997. In particular, pension plans that contain benefits previously thought to be money purchase but which are, in fact, defined benefit, have become subject to the DB statutory funding regime and are also caught by the PPF levy requirements.
Whilst transitional regulations were introduced to maintain the status quo in relation to benefits that had already been paid out or transferred on a money purchase basis, trustees are beginning to find that the new legislation and transitional provisions do not sit happily with plans that operate money purchase underpin or top up benefits. Is the member's benefit always treated as being DB, with a potential for an excess element that is money purchase, or could the whole of the member's benefit be either DB or money purchase, depending upon whether or not the underpin or top up bites at the time at which the benefit is being determined? The importance of (and difficulty with) correctly categorising the benefit has become particularly apparent following the introduction in 2015 of the new notification and disclosure requirements in relation to benefits that are "flexible" benefits (i.e. money purchase and cash balance benefits). Trustees need to know whether any element of the benefit at any given time constitutes a flexible benefit.
6. Action. Trustees of plans offering money purchase underpin/top up benefits should be aware that these types of benefits are difficult to categorise. If in doubt, we recommend legal advice is sought.
The Debating Society
Recent consultations may prove to be the catalyst for change in different areas of the pensions spectrum. The students of our debating society set out their stance below. On which side of the debate do you sit?
This House Believes That 21st Century Trusteeship Requires Some Reform The Regulator's discussion paper 21st Century Trusteeship and Governance asks a series of questions on how to raise standards of governance and administration in occupational pensions. This could be the catalyst that changes the requirements for individuals being eligible to serve on trustee boards. Amongst the discussion points: Should the chair of trustees be required to meet minimum
standards? Should new trustees be required to pass all relevant modules in
the trustee toolkit within six months of appointment? Should trustees be required to have qualifications? Should they be
subject to a framework of Continuing Professional Development? The Regulator is also exploring solutions for pension plans (particularly small pension plans) where the trustees are unwilling or unable to deliver good governance and good member outcomes. 7. Action. Trustees should be aware of developments. This House Believes That Reform Should not be Restricted to One Pension Plan The government has consulted on proposals for amending and separating the British Steel Pension Scheme from its principal employer. One proposal involved an amendment to legislation to disapply section 67 of the Pensions Act 1995 (in respect of the British Steel Pension Scheme only) in order to allow amendments to reduce revaluation and indexation rates to PPF levels (or slightly better). Another proposal was to amend preservation regulations to allow a bulk transfer of assets and liabilities to a new pension plan providing lower levels of indexation and revaluation. This easement would be extended to pension plans with over 100,000 members (but members would have the opportunity to opt out). The original British Steel Pension Scheme would then enter a PPF assessment period.
Squire Patton Boggs, in accord with many others in the pensions industry, considers that it would be disproportionate to introduce legislation to reduce the liabilities of one pension plan. It may be more appropriate to introduce legislation allowing all pension plans to be amended to replace RPI with CPI (or the new CPIH) where increases in line with RPI inflation are currently hardcoded into the rules, subject to certain safeguards.
8. Action. Trustees of pension plans potentially affected by the proposals should monitor the outcome as it is possible that this consultation could result in a further legislative change.
This House Believes in Accessible Financial Advice for Members
The government is consulting on Introducing a Pensions Advice Allowance to make financial advice more accessible and affordable for members with money purchase pension pots. It is intended that from 6 April 2017 pension savers will be able to use 500 from their money purchase pot to pay for the cost of regulated financial advice. This will be an authorised payment for tax purposes. The government plans that individuals will be able to make use of this facility more than once and it will be available to those below age 55.
The government does not intend to make it mandatory for trustees to offer this facility to members.
The government will also improve the income tax and national insurance exemption for financial advice on pensions where the advice is arranged by the employer this will be for the first 500 of the advice. This will come into effect from 6 April 2017.
9. Action. Trustees of pension plans with money purchase benefits should monitor developments. When the details are finalised, trustees should consider whether this facility should be offered to members and seek legal advice on whether the rules allow this.
French for Beginners
Our junior students attempt to perfect their French, but are working in "Franglais" at present. A light-hearted view of European matters may not be quite la mode right now, but we can still celebrate our geographical and cultural connections, however the political divisions may transpire.
La Carte Data Protection
The General Data Protection Regulation (GDPR) will have direct effect in all European Economic Area countries from 25 May 2018. Although the GDPR builds on the existing data protection legal structure, it extends obligations in a number of key areas and it will have a significant impact on pension plan trustees. See our newsletter for further details.
In particular, trustees should note the new obligations placed on data processors and the need to address these requirements in new and existing contracts with service providers (i.e. pension plan administrator and payroll processors), and other contracts where personal data is passed on (such as buy-in contracts with insurance providers, or where third party consultants and/or financial advisors are appointed for liability management exercises).
Penalties for non-compliance will increase significantly for the most serious breaches, penalties for trustees can be up to 20 million. (Sacr bleu!)
10. Action. We recommend that trustees start preparing now by formulating an action plan to ensure data protection compliance. Trustees should seek legal advice when entering into contracts/ amending contracts with service providers.
Separately, the alternative to the "safe harbor" framework, the "privacy shield", has been adopted by the European Commission but it is likely to face further challenges in the courts by those who believe that it does not provide sufficient improvements to the former regime.
11. Action. Trustees should take legal advice where pension plan data is transferred to or held in the US.
Fait Accompli? Le Brexit
The Regulator issued a statement warning trustees against knee jerk reactions to short term market volatility vis--vis the Brexit vote. The key messages to monitor investments, funding, and the employer covenant is not new the backdrop of Brexit is the unknown factor in the equation.
In particular, trustees of DB pension plans should review their employer covenant, assess the impact of leaving the EU on the employer's business, consider the impact of market volatility on the funding position, and assess whether contingency plans are still appropriate. Trustees should have "an open and collaborative discussion with the employer" to understand their views and their risk appetite. Trustees of money purchase pension plans should review the suitability of investments made available to members and those that underlie the default fund.
12. Action. Trustees should act in accordance with the Regulator's statement and continue to monitor the position of the fund and the employer covenant as plans to exit the EU become clearer.
Building on the above, there are a number of specific steps that trustees can take now to ensure compliance with their investment duties. Proactive management should help to instil confidence in members and sponsoring employers that trustees are au fait with their investment responsibilities and are taking appropriate steps to manage the uncertainty.
In our view it would be sensible for trustees to consider whether to classify the Brexit vote as a material change for the purposes of monitoring and reviewing the Statement of Investment Principles.
Risk registers should be updated to note measures taken or to record emerging risks.
Trustees could ask for details of investment managers' Brexit procedures and policies, and discuss the adequacy of these with their investment consultant.
Trustees should be aware of any "gating" clauses in investment funds which can be activated by fund managers to suspend redemptions. (See our blog for more information.)
L'Eurovision IORP II, Nul Points
The text of IORP II has been finalised and is expected to come into force in Autumn 2016.
Importantly, the requirement for a solvency based funding regime, which would have increased the funding burden on UK DB pension plans, has been dropped.
Cross border plans must be fully funded if they fall below full funding a recovery plan will need to be put in place, approved by the national regulator of the country in which the plan is established. Cross border transfers of part, or all, of a pension plan must have prior approval by the regulator in the member state in which the receiving plan operates and, once transferred, the law of the original member state will still apply in respect of the pension transferred.
Member states must implement the provisions of IORP II within 2 years of it coming into force. Whilst the UK remains part of the EU it will have to implement IORP II. (Quelle horreur!) Note that if the UK adopts the EEA/Norwegian model post Brexit then the cross border funding rules might continue to apply to the UK. Additionally, if there were a second referendum in Scotland and it were to become independent from the UK (but were to remain or re-enter the EU) then Anglo-Scottish pension plans would become cross border plans and subject to the higher funding requirement.
14. Action. Trustees should monitor IORP II developments and the implications of the UK's exit method from the EU and be prepared to take action if required.
Inspired by popular TV, students in the gymnasium school ballroom perform some taxing moves as part of their dance class. In this section, Her Majesty's Revenue and Customs (HMRC) meets Strictly Come Dancing.
Tapping Out Clarifications With a Flourish HMRC Update
Newsletter 78 contains useful clarifications on the circumstances in which a pension plan should provide a member with a pension savings statement for 2016 to 2017 onwards. HMRC confirms that pension savings statements are unaffected by the introduction of the tapered Annual Allowance.
In this newsletter, HMRC also clarified the position for members who apply for Individual Protection 2016 or Fixed Protection 2016 using the interim application process but fail to follow this up with an online application. "We can confirm that providing these individuals have not lost their protection, their pension savings will continue to be protected and there will be no tax consequences."
An online service for members to apply for Individual Protection 2016 and Fixed Protection 2016 has replaced the interim process for all applications made after 31 July 2016. HMRC asks that trustees encourage members to complete the online application process it is developing a "lifetime allowance look up service" for pension scheme administrators to check the protection status of members which is expected to be available later in the year the new system will only recognise permanent reference numbers.
15. Action. Trustees to note and to follow up with pension plan administrators and members if necessary. Lacking in Choreography and Co-ordination Pensions and VAT
HMRC's guidance on the treatment of VAT on supplies made to pension plans was due to be issued in July. This has now been put on hold. HMRC has announced that the current arrangement which allows for partial recovery of VAT will continue until 31 December 2017. We are aware of some clients entering into "on-supply" agreements, in line with HMRC's October 2015 briefing. An onsupply agreement is where the trustees agree to perform "taxable supplies of pension scheme services" to the employer. These types of arrangements are not without complications and we recommend that trustees seek advice before entering into such an agreement.
16. Action. Any action is likely to be driven by the sponsoring employer. Trustees should be prepared to discuss VAT arrangements as necessary.
A Bit of a Fandango Taxation of Death Benefits The legislation surrounding the taxation of lump sum death benefits is not straightforward and has undergone a number of changes in the last few years, most recently in April 2016. For example, before 6 April 2016, for a defined-benefits lump-sum death benefit to count as an authorised payment it had to be paid within two years of the earlier of (1) the day on which the administrator first knew of the member's death, or (2) the day on which the administrator could reasonably have been expected to have known of the member's death. When the payment is made on or after 6 April 2016 and is not paid within the two year period already described, the payment is subject to income tax in the hands of the individual recipient i.e. it is no longer an unauthorised payment. The circumstances are different if the member was over age 75 at the date of death, or if the payment is not made to an individual recipient. 17. Action. Trustees should ensure that prompt action is taken to pay any lump sum death benefits to avoid possible tax consequences. Although we would expect third party administrators to be conversant with the details of changes to the taxation of death benefits, trustees should be aware of key issues affecting their pension plan. Pension plan rules and member communications may need to be updated.
We continue with a lecture in the sports hall, where the PE teacher explains that the timely and precise execution of certain manoeuvers makes all the difference between success and failure.
Breaking Away From the Peloton Excepted Life Policies An increasing number of employers are considering using excepted group life plans for providing lump sum death benefits. This can be a tax efficient way of providing death benefits for members who might otherwise breach their Lifetime Allowance (although it is not without complications and legal advice is advisable). 18. Action. If the sponsoring employer intends to provide lump sum death benefits for some or all pension plan members through a separate excepted group life arrangement, trustees should review the rules of the existing pension plan. In particular, any provisions granting lump sum death benefits may need to be amended so that there is no double counting otherwise it is possible that a lump sum death benefit may be payable from both the pension plan and the standalone excepted group life plan (but it is likely that the benefit will only have been insured once).
Avoiding the Red Flag Maladministration Prevention
The Pensions Ombudsman recently determined that a pensions administrator was guilty of maladministration even though the administrator had done everything required (and within the appropriate time limits). In this case, a member had sought a transfer to an overseas pension plan. The administrator confirmed that the transfer would be implemented within statutory time limits and at this point the overseas pension plan was on HMRC's list of Recognised Overseas Pension Schemes. However, when the administrator was about to make the transfer, the overseas plan was no longer on HMRC's list. The Pensions Ombudsman said that the administrator was correct not to implement the transfer, because it would have constituted an unauthorised payment, but still awarded compensation of 500 for distress and inconvenience to the member.
19. Action. Trustees may wish to include wording in transfer communications that the transfer will not proceed if it would constitute an unauthorised payment at the point of implementation.
Assessing Core Strength People with Significant Control (PSC) Requirements
From 6 April 2016, pension trustee companies were caught by the requirement to keep a register of PSCs. Failure to do so is a criminal offence.
20. Action. Trustee directors should make sure that compliance procedures are in place.
Perfecting the Approach Updated Tracing Service
The Department for Work and Pensions has updated its pensions tracing offering to help members find pensions contacts associated with former pensions arrangements.
21. Action. Trustees may wish to include this on their website or in member communications.
Staying Within the Boundaries Duties on Bulk Transfers Without Consent
The High Court has ruled that a scheme actuary, when considering whether to give a certificate on a bulk transfer without member consent, should not take into account the security of members' benefits in the receiving plan. The actuary should only consider the actual value of benefits in the receiving plan immediately post transfer when assessing whether the transfer credits to be acquired for each member under the receiving plan would be broadly no less favourable than the rights to be transferred. The security of benefits in the receiving plan is an issue for the trustees in deciding whether to agree to a bulk transfer.
22. Action. Trustees should note that it is their duty to consider the security of members' benefits in a pension plan to which a bulk transfer is to be made. (This is not the role of the scheme actuary in providing the certificate.)
Maintaining Synchronicity Principal Employer Substitution
Trustees have a duty to know the identity of the pension plan's principal employer. A recent case has confirmed that even if a plan's trust deed and rules permit retrospective substitution of a principal employer, the substitution will only be effective from the date on which the necessary formalities, stipulated in the deed and rules, have been satisfied. This will usually be the date on which a deed of substitution has been executed. Whilst the new principal employer is able to assume liabilities prior to the effective date of a substitution, the old principal employer may not be released from its liabilities retrospectively.
23. Action. Trustees should seek legal advice if they have concerns about the validity of a deed of substitution or if they need assistance to establish the duties owed by any current or former employer of the pension plan.
The school news team has a round-up of some further pensions developments on the horizon. It is never too early to focus on retirement savings, after all...
Master Trusts will have to demonstrate that they meet strict new criteria before entering the market and taking money from employers or members. The Pensions Bill 2016 will contain greater powers for the Regulator to authorise and supervise master trusts and take action where necessary.
Legislation is expected to come into force in 2017 to cap early exit fees for new and existing members with flexible benefits (broadly those with money purchase benefits or cash balance benefits).
The government intends to introduce "secondary annuities" from April 2017. Legislation will allow an individual who holds an annuity in his own name to assign the income stream from that annuity to a third party. The income stream will be payable by the annuity provider to a third party investor for the remainder of the original annuity holder's life. This development is likely to generate interest and enquiries from pensioners.
The government announced that a "pensions dashboard" will be available in 2019. Eleven organisations have agreed to work together to build a prototype by March 2017. This will be a digital interface allowing individuals to view all their retirement savings in one place, and will be designed, funded and launched by the pensions industry.
HMRC is consulting on the future of salary sacrifice. The consultation proposes treating any benefits that are provided by the employer as a result of a salary sacrifice arrangement as being a benefit in kind on which both tax and Class 1A employer national insurance contributions will be payable. HMRC proposes that the new tax treatment for benefits provided through salary sacrifice will become effective from 6 April 2017. HMRC's consultation does not impact on salary sacrifice arrangements in respect of pension contributions and these will continue to be tax and NI free.
We await with interest a Court of Appeal decision which should help to clarify the action that trustees of pension plans can be required to take in relation to bankrupt members of occupational pension plans.
For further information on any of the points raised please contact any of the partners listed or your usual contact in our pensions team.
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