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State pensions and mandatory schemes
Do employers and/or employees make pension contributions to the government in your jurisdiction? If so, briefly outline the existing state pension system.
The government provides a state pension. Until April 2016, the state pension comprised a basic flat-rate element and an earnings-related top-up. Since April 2016, this has been replaced by a single-tier flat-rate pension.
The state pension is funded by employer and employee contributions known as ‘national insurance contributions’ (NICs). Both employer and employee NICs are calculated as a percentage of the employee’s earnings and, in the case of employee NICs, are deducted from the employee’s salary in the same way as income tax.
An individual’s eligibility for the state pension and the amount of state pension paid depend on the number of years in which NICs have been paid in respect of the individual.
Can employers deduct any state pension contributions from their taxable income?
Yes. Employers can deduct the amount of employer NICs paid when calculating their taxable income.
Are there any proposals to reform or amend the existing system?
The age at which individuals can take their state pension is currently 65 years old for men and 64 to 65 years old for women. The state pension age for all women will be equalised to 65 years old by November 2018.
The state pension age will then increase for both men and women to:
- 66 years old between 2019 and 2020;
- 67 years old between 2026 and 2028; and
- 68 years old between 2037 and 2039.
Other mandatory schemes
Are employers required to arrange or contribute to supplementary pension schemes for employees? If so, briefly outline how the scheme is enforced and regulated.
Under ‘automatic enrolment’, employers must:
- enrol certain employees (‘eligible jobholders’) into a qualifying pension scheme;
- grant certain other employees (‘non-eligible jobholders’) the right to join a qualifying pension scheme; and
- grant all other workers the right to join a registered pension scheme, although not necessarily one to which the employer contributes.
The automatic enrolment duty applies to an employer from its ‘staging date’ – a date between 2012 and 2018 (the larger the employer’s April 2012 payroll, the earlier the staging date). Jobholders who have been automatically enrolled have a statutory right to opt out within one month.
In order to be a qualifying pension scheme for automatic enrolment purposes, a scheme must meet certain prescribed quality requirements. These differ depending on the types of benefit provided by the scheme. Qualifying pension schemes must also generally be registered pension schemes. A registered pension scheme is a scheme that is registered with Her Majesty’s Revenue and Customs and meets certain prescribed requirements in order to receive favourable tax treatment.
The Pensions Regulator is responsible for enforcing and regulating the automatic enrolment regime. It has a number of powers in this respect, including the power to:
- issue compliance notices which require the recipient to take or refrain from taking particular steps; and
- issue fixed and escalating monetary penalty notices.
Occupational pension schemes
Types of scheme
What are the most common types of pension scheme provided by employers for their employees in your jurisdiction?
There are two main types of pension scheme in the United Kingdom: defined benefit schemes and defined contribution (or ‘money purchase’) schemes.
Defined benefit schemes typically offer one of three types of defined benefit:
- final salary – where members are promised a percentage of their final salary for each year of pensionable service;
- career-average re-valued earnings – where members are promised a percentage of their average salary over the period of their pensionable service for each year of pensionable service; or
- cash balance – where members are promised a retirement pot of a pre-defined amount for each year of pensionable service.
In a defined contribution scheme, employers and employees contribute a set amount each year to a member’s retirement account, which is then invested. These schemes do not promise members a particular level of benefit or guarantee the size of the account when the member retires.
As well as promising retirement benefits, both defined benefit and defined contribution schemes typically provide survivors’ benefits when a member dies, whether before or after retirement.
Is there a statutory framework governing the establishment and operation of occupational pension plans?
Pension schemes in the United Kingdom are subject to a number of pension-specific statutes, as well as numerous regulations made under those statutes.
The Pensions Act 2008 sets out the requirements that a scheme must satisfy in order to be a qualifying pension scheme for purposes of the automatic enrolment regime. The Finance Act 2004 sets out the requirements that registered pension schemes must meet. The Finance Act 2004 and the Income Tax (Earnings and Pensions) Act 2003 govern the tax treatment of contributions to, and payments from, pension schemes.
The other principal statutes include the Pension Schemes Act 1993, the Pensions Act 1995 and the Pensions Act 2004, which between them impose a wide range of requirements on pension schemes, including:
- investment restrictions;
- minimum scheme funding requirements (for defined benefit schemes);
- protection for early leavers;
- disclosure and reporting obligations;
- dispute resolution requirements; and
- scheme termination rules.
The Pensions Act 2004 also established the Pensions Regulator, which is responsible for the regulation of pension schemes used by employers, and the Pension Protection Fund, which acts as a lifeline for underfunded defined benefit schemes whose employers become insolvent.
Further, the Equality Act 2010 imposes non-discrimination requirements regarding entry to, and the terms of membership of, pension schemes.
What are the general rules and requirements regarding the vesting of benefits?
Under statute, benefits under a trust-based pension scheme vest after the member has completed:
- two or more years’ qualifying service in a defined benefit scheme or in a defined contribution scheme if the member joined the scheme before October 1 2015; or
- 30 or more days’ qualifying service in a defined contribution scheme if the member joined the scheme on or after October 1 2015.
‘Qualifying service’ is membership of the scheme plus membership of any scheme from which a transfer payment has been accepted in respect of the member. Schemes can provide for members’ benefits to vest after a shorter period of qualifying service than that required under statute.
Members with vested benefits are entitled to a deferred benefit, which is payable from the scheme’s normal retirement age and calculated using the same formula as the benefit payable on retirement from active service at that age.
Members with less than two years’/30 days’ qualifying service (as applicable) are entitled to a refund of their contributions. Members with statutorily vested benefits are not entitled to be offered a refund of their contributions.
Benefits under a contract-based pension scheme vest immediately, subject to a 30-day ‘cooling-off’ period during which the member can cancel the pension contract and receive a refund of any contributions made.
What are the general rules and requirements regarding the funding of plan liabilities?
If a defined contribution pension scheme is a qualifying pension scheme for automatic enrolment purposes, statutory minimum employer contribution rates apply; the scheme must satisfy one of four prescribed contribution structures. If an employer maintains a defined contribution scheme that is not a qualifying pension scheme, the employer need not contribute to the scheme (ie, contributions are discretionary). However, employers that maintain such schemes typically make monthly contributions, which are usually expressed as a percentage of the employee’s salary.
Statutory scheme funding requirements apply to defined benefit pension schemes. Schemes must have sufficient and appropriate assets to cover the value of their liabilities as calculated by the scheme actuary on a prudent (not merely a best estimate) basis. They must carry out a valuation of the scheme’s assets and liabilities every three years, and if that valuation shows that the scheme is in deficit, a recovery plan must be put in place, including a schedule of contributions which sets out:
- the level of employer deficit reduction contributions to be made to remove the deficit; and
- the level of employer and member contributions to fund any future service benefits – these are usually expressed as a percentage of the members’ salaries.
A one-off employer contribution, which may be substantial, is typically also required if:
- an employer withdraws from a defined benefit scheme;
- the scheme terminates; or
- an employer becomes insolvent.
Employers are responsible for deducting member contributions from their salaries and must pay those contributions (and any employer contributions) over to the scheme within a statutory timeframe.
What are the tax consequences for employers and participants of occupational pension schemes?
Pension schemes that are registered with Her Majesty’s Revenue and Customs receive favourable tax treatment under the Finance Act 2004, including tax relief on employee and employer contributions and on investment income and capital growth. Employer contributions are also exempt from national insurance contributions. However, registered pension schemes are subject to a number of restrictions, including the following:
- There are annual and lifetime limits on the level of tax-relieved pension savings that can be made by a member of a registered pension scheme.
- A registered pension scheme cannot generally pay benefits to a member before he or she is 55 years old (unless the member is suffering from ill health), and payments from a registered pension scheme may be made only in certain prescribed ways.
Benefits taken from a registered pension scheme are generally subject to income tax, but up to 25% of an individual’s benefits can be taken as a tax-free lump sum.
Unregistered pension schemes do not receive the tax advantages available to registered pension schemes, but are not subject to the restrictions imposed on registered pension schemes. As a result of the unattractive tax treatment of unregistered schemes, employers rarely use such schemes.
Is there any requirement to hold plan assets in trust or similar vehicles?
Pension schemes in the United Kingdom can be set up under either trust or contract.
Trust-based pension schemes (also known as ‘occupational pension schemes’) are established by an employer for the benefit of its employees, and are governed by a trust deed and rules. Trustees are appointed to administer the trust and are the legal owners of the trust’s (ie, the pension scheme’s) assets. The trustees hold the assets for the purposes of the scheme (ie, chiefly in order to fund the benefits promised to the scheme members) rather than for their own personal benefit. Trust-based schemes can provide defined benefit or defined contribution benefits.
Trustees are subject to a wide range of legal duties, including fiduciary duties. These include a requirement to exercise their powers for the purpose for which they were conferred (sometimes described as a duty to act in the best interests of the scheme’s members). Employers are also subject to fiduciary duties (albeit less stringent duties than apply to trustees). The key fiduciary duty for employers requires them, when exercising their rights and powers under the employment contract and under the pension scheme, not to undermine the relationship of mutual trust and confidence that should exist between employers and employees.
Contract-based pension schemes (also known as ‘personal pension schemes’) are an individual contract between the member and the pension provider (normally an insurer). The pension provider is responsible for administering the scheme. Contract-based schemes generally provide only defined contribution benefits. Employers can set up a group contract-based pension scheme by selecting a pension provider – each employee will then have an individual contract with that provider. Providers of contracted-based schemes must be authorised by the Financial Conduct Authority (FCA) and are therefore subject to the rules and regulations made by the FCA.
Are there any special fiduciary rules (including any prohibited transactions) in relation to the investment of pension plan assets?
In a trust-based pension scheme, the trustees are responsible for the investment of the scheme’s assets. Legislation gives trustees wide investment powers, but also requires them to take into account a broad range of factors when making investment decisions and imposes a number of restrictions, including on a limit on the level of employer-related investment and a prohibition on employer-related loans. Trustees are also subject to fiduciary duties under trust law, including a duty to invest assets in members’ best financial interests. Further, trustees must comply with any investment restrictions set out in the scheme’s trust deed and rules.
A trust-based pension scheme may not provide for the employer’s consent to be required to the exercise by the trustees of their investment powers, but the trustees must consult with the employer on the scheme’s investment strategy. In a defined benefit trust-based scheme, members have no involvement in scheme investment. In a defined contribution trust-based scheme, the trustees are responsible for selecting the range of investment funds available under the scheme and for keeping the range under review, while members are responsible for selecting from that range.
In a contract-based pension scheme, the pension provider determines the range of investment funds on offer and the member is responsible for selecting from that range. The employer may work with the provider to select a bespoke range of funds for the scheme from the wider range offered by the provider. There is no duty on the employer to monitor the scheme’s performance, but some employers choose to do so. The provider must comply with FCA rules in the investment options that it makes available to members.
Is there any government oversight of plan administration and/or insurance coverage for plan benefits in the event of an employer’s insolvency?
Assets held in a trust-based pension scheme are legally owned by the trustees – they are therefore legally segregated from the employer’s assets and cannot be called on in the event of the employer’s insolvency. In the event of its insolvency, an employer that participates in a defined benefit scheme becomes liable to fund its share of any deficit in the scheme. For these purposes, the scheme’s liabilities are calculated by reference to the cost of securing those liabilities by annuity purchase. The scheme becomes a creditor of the employer in this respect and is entitled to share in the distribution of the employer’s assets by the insolvency practitioner in accordance with the statutory corporate insolvency order of priority.
The employer’s insolvency will also trigger a Pension Protection Fund (PPF) assessment period, during which the PPF will assess whether the level of funding in the scheme qualifies the scheme for entry into the PPF (taking into account any distribution received by the scheme under the statutory corporate insolvency order of priority). Should the scheme be accepted, the PPF will take over responsibility for the scheme and will pay compensation to the scheme’s members based on the benefits payable under the scheme, subject to a statutory cap.
If the scheme is in deficit but too highly funded to be eligible for PPF entry (essentially where it has sufficient assets to buy annuities that exceed PPF compensation), the scheme will generally be terminated and wound up and reduced benefits will be secured for members in accordance with the statutory order of priority.
Assets held in a contract-based pension scheme are legally owned by the scheme provider and likewise therefore are not available to the employer’s creditors. The funds held in a contract-based scheme are not legally segregated in the event of the provider’s insolvency, but compensation may be payable from the Financial Services Compensation Scheme.
Are employees’ pension rights protected in the event of a business transfer?
On a business transfer, legislation provides for the employment contracts of the transferring employees to transfer to the buyer automatically. Although this does not extend to terms and conditions relating to trust-based pension schemes (subject to some exceptions relating to enhanced early retirement rights), where the transferring employees are members of a trust-based scheme, the buyer must provide replacement pension provision that meets standards prescribed in legislation.
Where the transferring employees are members of a contract-based pension scheme, the terms and conditions of their employment contracts relating to pensions are transferred to, and must therefore be replicated by, the buyer.
Pension benefits accrued before a business transfer are unaffected by the transfer.
Deferred compensation agreements
Deferred compensation plans
Do any special tax rules apply to these types of arrangement?
Generally, deferred compensation arrangements are taxed when they are eventually paid. Special rules apply in relation to payments to directors, where amounts can be taxed before they have been paid in certain circumstances, particularly where the deferred amount is no longer subject to forfeiture.
Do these types of arrangement raise any special securities law issues?
No. Regarding share-based deferred compensation, there are generally exemptions available where awards are made to employees. If awards are made to non-employees (eg, consultants or non-executive directors), care must be taken to find an appropriate exemption.
What are the most common types of share option plan in your jurisdiction? Please outline the rules relating to each scheme.
There is a significant degree of flexibility in the design of share option plans in the United Kingdom. Plans where the exercise price is the market value at the time of grant or nil (or the par value of the shares in some cases) are both common. There is freedom to structure vesting conditions and exercise periods in accordance with commercial requirements, although there are more restrictions on the tax-advantaged arrangements.
Tax-advantaged option schemes are as follows:
- Company Share Option Plan (CSOP) ‒ this is a discretionary option plan, in that the company can choose who participates. Options must have an exercise price of at least the market value at the date of grant, and the value of shares under option to any one person (valued at the date of grant) cannot exceed £30,000. Generally, options must be exercised after the third anniversary of the date of grant for the tax benefits to be obtained. There are various conditions to be complied with for a CSOP, and the company must self-certify to the tax authority that the plan meets the relevant conditions. The company whose shares are used cannot be under the control of another company. Multinationals based outside the United Kingdom often adopt a CSOP sub-plan for UK employees.
- Save As You Earn (SAYE) ‒ this option plan is an all-employee plan and must be offered to all UK tax-resident employees of participating companies, with certain exceptions. The plan involves the grant of options alongside a savings arrangement, under which deductions from salary are paid into the savings plan each month, and on maturity of the option the savings are used to exercise the option. Three and five-year options may be granted, with three-year options being the most popular. The exercise price cannot be less than 80% of the market value of the shares at the date of grant, and the deductions from salary are limited to £500 a month. There is little flexibility regarding the terms of these plans and the company must self-certify to the tax authority that the plan meets the relevant conditions. US companies sometimes use SAYE option plans to replicate the economics of an employee stock purchase plan.
- Enterprise management incentive (EMI) options ‒ while attractive, these options are aimed at smaller growth companies and there are restrictions on the types of company that can offer EMI options, including:
- gross assets for the group must be less than £30 million;
- the total number of group employees must be less than 250;
- certain trades are not permitted (eg, banking, farming, property development and provision of legal services); and
- the company cannot be under the control of another company, with no arrangements in place such that a company may obtain control.
Individual participation is capped at £250,000 market value of shares at the date of grant per person.
What are the tax considerations for share option plans?
There is no tax charge on the grant of a share option to an employee.
If the option is not tax advantaged, the gain realised by the employee is subject to income tax, and if the shares are tradeable at the time of exercise or certain other conditions apply, this tax must be accounted for by the employer, and national insurance contributions (NICs) will also be due. With the agreement of the option holder, employer NICs can be recovered from the option holder.
For the tax-advantaged arrangements, assuming the options are exercised in accordance with the relevant requirements, there is no income tax due on exercise (save that, in the case of EMI options, if the exercise price is less than the market value of the shares at the date of grant, that discount is subject to tax on exercise). The employees may be subject to capital gains tax (usually at lower rates than income tax) on the sale of the shares, and the first £11,300 (tax year 2017/18) of gains is tax free. Holders of EMI options may be able to benefit from entrepreneurs' relief, which reduces the capital gains tax rate from 20% to 10%.
Generally speaking, the employing company gets a deduction from its profits subject to corporation tax equal to the gain realised by the employee on exercise. This applies regardless of whether the employee pays income tax on exercise.
Share acquisition and purchase plans
What are the most common types of share acquisition and purchase plan in your jurisdiction? Please outline the rules relating to each scheme.
A share incentive plan (SIP) provides a flexible and tax-efficient way to offer shares to employees. Participation must be offered to all UK tax-resident employees of participating companies, subject to certain exceptions. There are four types of award:
- Free shares – the employer may award up to £3,600 of shares free of charge to each employee.
- Partnership shares – bought by way of deduction from pre-tax salary, with a limit of £1,800 a year (or 10% of salary if lower).
- Matching shares – partnership shares can be matched by the company at a ratio of up to two free matching shares per partnership share.
- Dividend shares – dividends paid in relation to shares held in the SIP may be reinvested into dividend shares.
Shares must be held in a specially established trust for five years for the employee to obtain full tax benefits.
A combination of partnership shares and matching shares is often used by US companies to replicate employee stock purchase plans for UK employees, but with better tax breaks (as the shares can be purchased from pre-tax income). However, the amounts that can be invested are lower.
What are the tax considerations for share acquisition and purchase plans?
Assuming that shares are held in a SIP for the full five years, no tax needs to be paid in relation to the acquisition of the shares, and there is no capital gains tax to be paid on any rise in value of the shares when held in the SIP. If shares are withdrawn early (eg, if the employee leaves the company), tax may be paid, but there are certain good leaver circumstances which remain tax free.
Phantom (ie, cash-settled) share plans
What are the most common types of phantom share plan used in your jurisdiction? Please outline the rules relating to each scheme.
Both phantom share options (where the employee participates in the rise in value of the share) and phantom shares (where the employee participates in the whole value of the share) are common where the company does not want to use real shares. There is considerable freedom to structure these arrangements in accordance with commercial requirements.
What are the tax considerations for phantom share plans?
Tax and NICs are deducted from the cash amount at the time of payment in the same way as for the payment of a cash bonus.
Special rules apply in relation to payments to directors, where amounts can be taxed before they have been paid in certain circumstances, particularly where the deferred amount is no longer subject to forfeiture.
Are companies required to consult with employee unions or representative bodies before launching an employee share plan?
Provision of insurance
What is the health insurance provision framework in your jurisdiction? For example, is it provided by the government, through private insurers or through self-funded arrangements provided by employers?
The National Health Service (NHS) provides medical services and treatments that are generally free for individuals who are ordinarily resident in the United Kingdom, regardless of nationality. Services and treatments are also generally free for residents of other European Economic Area (EEA) states, provided that they hold a European health insurance card. However, charges are payable by both UK and EEA residents for certain medical services and treatments, unless an exemption applies. The services and treatments for which a charge is levied by the NHS vary across the United Kingdom.
The NHS is funded from taxation as well as from employer and employee NICs. Both employer and employee NICs are calculated as a percentage of the employee’s earnings and, in the case of employee contributions, are deducted from the employee’s salary in the same way as income tax.
Some employers offer private medical insurance to their employees as an additional employee benefit, but there is no obligation to do so. If such insurance is offered, income tax and NICs are payable on the value of the insurance premium.
Do any special laws mandate minimum coverage levels that must be provided by employers?
Can employers provide different levels of health benefit coverage to different employees within the organisation?
Yes ‒ provided that this does not amount to direct or indirect discrimination on the grounds of the employee’s age, disability, gender reassignment, marriage or civil partnership, pregnancy or maternity, race, religion or belief, sex or sexual orientation. If the provision of different levels of health benefit coverage amounts to direct or indirect discrimination on the grounds of the employee’s age, or indirect discrimination on any of the other grounds above, it is nonetheless permissible if the employer can demonstrate that it is a proportionate means of achieving a legitimate aim.
Are employers obliged to continue providing health insurance coverage after an employee’s termination of employment?
No. Not unless they have entered into an agreement with the employee to do so.