1. State pension offset
The Social Welfare and Pensions Act 2013 inserted a new section 59H into the Pensions Act 1990. This new provision gives trustees the statutory power to amend pension scheme rules in order to address the potential for schemes to become non-integrated due to the abolition of the State pension (transition) on 1 January 2014.
However, it would perhaps have been preferable for this new section to require the trustees to operate the scheme as if the State pension offset continued to apply rather then creating a statutory power of amendment.
The proposed section 59H does not appear to provide a solution for schemes which provide bridging pensions which do not actually require an amendment to their rules but which, because of the change in State pension age, appear to fall foul of the prohibition present in Section 59B on reducing bridging pensions once they come into payment.
Action: Decide whether there is a need to amend the rules of the scheme in order to address any potential non-integration issues.
2. Changes to the Priority Order
Prior to the enactment of the Social Welfare and Pensions (No.2) Act 2013 if a scheme is restructured or wound up pensioners retained their full pension entitlements. The surplus, if anything, would then have been divided up between the employees who have yet to retire and those members who have ceased working for the employer and have deferred their pensions until retirement age.
Pursuant to the new legislation, the automatic 100% priority for pensioners has been eliminated. Pensioners may no longer be entitled to their full payment if the scheme falls into difficulty. In contrast, active members paying into defined benefit (“DB”) schemes now possess an increased level of protection should the scheme be wound up or restructured.
In addition to ensuring a fairer distribution of DB scheme assets on wind up, the new legislation also places all defined contribution (“DC”) assets in joint first priority with additional voluntary contributions.
Under the terms of the new legislation two potential scenarios can now arise in the context of a pension scheme wind up:
- ISingle insolvency
In a single insolvency, the proposed new priority order would be broadly as follows:
- Additional voluntary contributions and DC assets.
- Pensioners get 100% of their pensions for those on pensions of €12,000 or less, 90% for those on pensions between €12,000 and €60,000 and 80% for those on pensions of €60,000 or more.
- The first 50% of active and deferred member benefits are secured.
- The remaining pensioner entitlements are secured.
- The remaining active and deferred member entitlements are secured.
- Double insolvency
This would be in a scenario where, on the Scheme going into wind up, all of the employers participating in the Scheme are insolvent.
In a double insolvency, the proposed new priority order would run broadly as follows:
- Additional voluntary contributions and DC assets.
- Pensioners receive the first 50% of their entitlement.
- Actives and deferred members receive the first 50% of their entitlement.
- Pensioners get the remainder of their entitlement, but capped at €12,000 only.
- Pensioners receive the rest of their entitlements, excluding post-retirement increases.
- Actives and deferred pensioners receive the rest of their entitlements excluding post-retirement increases.
- Any remaining benefits, including post-retirement increases.
The benefits which scheme members receive in a wind up will depend upon the scheme assets which are available for distribution.
However, section 48A of the Pensions Act 1990 (introduced by section 10 of the Social Welfare and Pensions (No.2) Act 2013) provides that in a double insolvency, if the scheme does not have enough assets to pay for the benefits under priorities (ii), (iii) and (iv) listed above, the Minister for Finance will provide the necessary money to make up the shortfall, subject to certain specified criteria.
Action: Decide whether it would be prudent to amend the scheme rules to reflect the new statutory priority order.
3. Benefit reductions under Section 50 of the Pensions Act 1990
The Social Welfare and Pensions (No.2) 2013 amends the Pensions Act 1990 so as to enable section 50 reductions to be applied to pensioner benefits currently in payment and not just future increases in pensioner benefits.
The new legislation institutes limits on any such reductions:
A minimum floor of €12,000 applies. No reduction may be made from an annual pension of €12,000 or less and no reduction may be made which reduces an annual pension below €12,000.
If an annual pension is over €12,000 and less than €60,000, a reduction may be made by a percentage no greater than 10% and to an amount which is no less than €12,000.
If an annual pension is €60,000 or more, a reduction may be made by a percentage no greater than 20% and to an amount which is no less than €54,000.
Though the 10% and 20% are statutory ceiling thresholds, the extent of the reduction will depend upon the particular scheme deficit and will be a matter for the scheme trustees.
Action: Factor in the possibility of reducing pensions in payment above the €12,000 level to any negotiations including on a section 50 restructuring of the scheme.
4. Standard Fund Threshold (“SFT”)
Budget 2013 announced the introduction of a €60,000 limit on the amount of annual pension in retirement which will be tax incentivised. This new lower limit was to be introduced from 1 January 2014.
Instead of introducing an express €60,000 per annum cap, the Minister has instead reduced the SFT or lifetime allowance from €2.3 million to €2 million effective from 1 January 2014 and introduced new age-related factors for valuing defined benefit pensions for this purpose.
As before, grandfathering arrangements will apply to individuals who have pension rights in excess of the new SFT of €2 million on 1 January 2014. They will be able to claim a Personal Fund Threshold (“PFT”) by notification to Revenue. PFTs approved under the previous regime should not be impacted by the new lower SFT cap.
For DB schemes, the new age-related valuation factors are being introduced for DB pension rights accrued after 1 January 2014. They will range from a factor of 37 for those aged 50 and under to a factor of 26 for 65 year olds reducing down to 22 for those aged 70 and over. The standard capitalisation factor of 20 will continue to apply to calculate the capital value of DB pension rights accrued up to 1 January 2014.
The new age-related valuation factors are, according to the Minister, being introduced to help improve the equity of the SFT regime as between DB and DC arrangements and between those who retire at an early age and those who retire at an older age.
The introduction of the age-related factors should help to put a capital value on accrued DB pension rights which is closer to market annuity costs. However, this change will have limited impact in the immediate term as DB rights accrued up to 1 January 2014 will continue to benefit from the existing valuation factor of 20. The calculation of DB pension rights for SFT purposes will also prove more complicated under this new regime given that there will be different calculation methods for DB entitlements accrued pre and post 2014.
Action: Assess to what extent members of the scheme are potentially impacted by the SFT changes, and explore possible options to ease the tax consequences (such as opt outs).
5. The Valuation of Defined Benefits
The Finance (No.2) Act 2013 clarifies that from 1 January 2014 it is the pension before the application of any commutation that is valued in the capitalisation calculation. Until now it was the pension and lump sums actually received that were taken into account. The manner in which a lump sum entitlement is treated for tax purposes will now depend on how the scheme is structured.
In certain schemes the lump sum and pension entitlement are provided separately. Most often this is found in the public sector where a gross retirement lump for civil servants was introduced by the Superannuation Act 1909 as compensation for the reduction of pension accrual from 1/60th to 1/80th. The lump sum is not obtained by way of commutation and is calculated to a maximum multiple of one and a half times pensionable salary. On that basis the members of such schemes are not materially affected.
However, the most common method of managing lump sum entitlements in the private sector is for the fund to provide a benefit with a right to surrender or commute pension to secure that lump sum. With a DB scheme the lump sum and remaining pension is calculated with reference to commutation factors, a standard commutation or conversion factor being 9:1. In practice this will lead to a result that the pension is valued at between 20 and 30 times the annual amount for taxation purposes, but the member only receives 9 or 10 times that amount.
Action: Consider if the structure of your pension scheme will mean that the tax treatment of members’ benefits will be affected by the clarification of the law in this area.
6. The Element 6 Case
The judgement of the Irish High Court in Greene and Others v Coady and Others delivered on 4 February 2014 provides a bench mark test for assessing what considerations pension scheme trustees should take into account in deciding whether to make a contribution demand against a sponsoring employer. It also clarifies the Irish law on conflicts of interest and on wilful default.
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Action: Consider if a review of the trustee decision process is required. Assess if there are proper procedures in place to deal with conflicts, the documenting of relevant matters taken into account and the advice sought in the context of making a complex or perhaps controversial decision.