1. Finance Act 2014 temporary easements: schemes may need to change their rules if they wish to take advantage of them

The Finance Bill 2014 received Royal Assent on 17 July 2014, becoming the Finance Act 2014. The Act incorporates the changes announced in the Budget 2014 that took effect from 27 March 2014 under the temporary budget resolutions, notably:

  • The increase in the limit for a trivial commutation lump sum (from £18,000 to £30,000).
  • The increase in the maximum size of a "small pension" pot that can be taken as a lump sum from a single pension arrangement from £2,000 to £10,000.
  • The changes in the limits relating to income drawdown.

For further details on the Budget 2014 measures, click here.

Certain temporary rules have also been introduced under the Act.

Temporary extension of period when a PCLS can precede a pension and repayment of a PCLS

Under normal rules, once a PCLS sum has been taken, the member must take their associated pension (i.e. as an annuity or a scheme pension) within six months of being paid the PCLS if the PCLS is to remain tax free.

This rule is being temporarily relaxed so that a member who has taken a PCLS before 6 April 2015 can wait until 6 April 2015 before deciding what to do with the rest of their pot. This easement is only available if the PCLS has been taken from a money purchase arrangement or a cash balance arrangement. Other conditions also apply and the PCLS must have been:

  • paid on or after 19 September 2013 (but before 6 April 2015); or
  • paid before 19 September 2013 where a lifetime annuity contract is entered into, and on or after 19 March 2014 that contract must have been cancelled.

The temporary provisions allow an individual who meets the above conditions to also return the PCLS to the scheme which paid it, providing the repayment is made before the member becomes entitled to his associated pension and in any event before 6 April 2015.

Trivial commutation lump sums paid after an intended PCLS

Where an individual has taken a PCLS before 27 March 2014, and the member has not taken their remaining pension or cancelled an associated annuity contract, rules have been introduced to allow individuals to take the remaining fund as a trivial commutation lump sum using the higher trivial commutation limit of £ 30K. Various conditions apply for benefits to be taken in this way, including the following :

  • The further sum must meet the requirements of a trivial commutation lump sum;
  • The further sum must be paid on or after 6 July 2014 but before 6 April 2015.

As the PCLS taken earlier ("the intended PCLS") will not meet the conditions to be a PCLS, the earlier lump sum is treated as a "Transitional 2013/14 lump sum" under the Act. The Transitional 2013/14 lump sum will, like the intended PCLS, be tax free. The remainder taken as a trivial commutation lump sum will, broadly, be subject to the marginal rate of income tax.

For the purposes of calculating the value of the individual's total pension rights to see if they are no more than the £30,000 limit for a trivial commutation lump sum, the earlier lump sum taken is included in the value of the individual's total pension savings.

Small pots paid as lump sums after an intended PCLS

A temporary easement, similar to that in relation to that available for a trivial commutation lump sum (above), has also been introduced in relation to small pots (although this easement only applies to members' DC pots). Individuals who took a PCLS before certain dates may take the remainder of the pot in the scheme as a "small pot" lump sum providing the remainder of the pot has a maximum value of £10K. Various conditions apply, including that the lump sum paid as a small pot must be paid before 6 April 2015.

Comment

We expect that not only DC schemes (to whom these changes largely apply) but also DB schemes (in relation to the easements for trivial commutation lump sums) will wish to make these easements available in order to discharge liability in relation to members' benefits particularly to avoid having to maintain, or buy out, trivial benefits.

In some cases, these changes will be automatically incorporated into the rules (depending on how the rules are currently worded) in which case schemes would need to ensure that their administration systems are able to accommodate these new temporary easements. In other cases, rule amendments may be required if schemes are to make these temporary easements available to members.

2. Change to the statutory definition of ‘money purchase benefits’ now in force – action points for schemes

Legislation relating to the change to the statutory definition of "money purchase benefits" came into force on 24 July – for our e-bulletin on the implications of the changes for pension schemes, click here.

For the most part, the effect of the new regime on pension schemes is prospective. Schemes that have in the past treated benefits affected by the new legislation as money purchase will need to reclassify them as defined benefits in their next actuarial valuation or annual update to the valuation and fund for them as defined benefits.

In two narrow cases, the provisions have retrospective application - where an employer debt was triggered before 24 July and certain benefits were treated as money purchase when they would now be defined benefit, the debt may need to be recalculated. The benefits in question relate to a money purchase underpin to a defined benefit i.e. a money purchase underpin to a lump sum death benefit or what the legislation calls "top-up benefits" – (for further explanation, see our earlier bulletin).

It is not uncommon for schemes to have some money purchase underpins (e.g. a value for money test) and for some schemes to have "top-up" benefits. To the extent that schemes have any, it would be unusual if these have been treated as money purchase rather than defined benefit, but scheme trustees should double check that this was not the case.

PPF valuations

The PPF will be writing to all schemes currently eligible for PPF protection requiring them to direct the scheme actuaries to gauge the impact of the amended definition of money purchase benefits on their schemes. If the effect of the change is "material", trustees should commission an out-of-cycle Section 179 valuation and submit it on Exchange by 31 March 2015. "Material" for these purposes is where there is a 10% increase in the deficit of the latest Section 179 valuation, or a 10% reduction in surplus, or such increase or decrease is £5 million in absolute terms. The valuation must have an effective date between the appointed day and 31 March 2015. The PPF has said that the actuary may be able to conclude whether the impact is material without incurring much cost, for example by inspecting high level data such as scheme accounts or a summary taken from the administration system. In other words, a full audit of the scheme is unlikely to be required.

Regulator guidance

The Pensions Regulator has also issued short guidance in relation to the changes. The guidance expects scheme trustees to notify the Regulator "immediately", if having reviewed their schemes, trustees find that the scheme offers benefits previously classified as money purchase but now recategorised as defined benefit and which have the "potential" to result in a funding deficit.

3. Treasury confirms “radical” proposals for taxation of DC and DB benefits

HM Treasury has responded to its consultation on the more ‘radical’ measures announced in the Budget 2014 - (For our summary of the Budget 2014 measures, click here)

DC pots may be taken at marginal rate of income tax

As expected, the proposals allowing members to take their money purchase pots as cash subject to the marginal rate of income tax (as opposed to 55% for full withdrawal) will go ahead. This change will apply in relation to money purchase benefits, cash balance schemes and AVCs (where scheme rules allow). There will still be a right to take a tax free Pension Commencement Lump Sum.  To give a simple example, once these measures are in force, a member with a DC pot can take their entire DC pot as cash, 25% of it tax free as a PCLS and the remainder subject to the marginal rate of income tax.

Private DB to DC transfers allowed

Although the Government had proposed introducing restrictions at the consultation stage on transfers from defined benefit (DB) to defined benefit (DC) schemes in the private sector, it has been persuaded that the ban is not needed. DB to DC transfers will therefore continue to be allowed, apart from in relation to pensions in payment, where the current effective restrictions on transfers will continue to apply.

Safeguards will however be introduced in relation to DB to DC transfers, as follows:

  • A statutory requirement on receiving schemes to ensure that an individual has taken independent financial advice before accepting the transfer.
  • Guidance will also be issued for trustees on the use of existing powers to delay transfer payments and to take account of scheme funding levels when deciding on transfer values.

The Government will also consult on measures so that DB members will not need to transfer first to a DC scheme in order to access their savings flexibly. DB scheme members will continue to be able to take advantage of the new limits for trivial commutation lump sums (£30K) and small pots (£10k) announced in the Budget (and now enshrined in the FA2014).

Transfer from public sector DB schemes to DC schemes

Transfers from unfunded public sector DB schemes to DC will be banned. (The Pension Schemes Bill 2014, contains a regulation-making power allowing the Treasury to prevent individuals transferring their accrued rights from public sector DB schemes to DC schemes.) Transfers from funded public sector DB schemes (such as the Local government Pension Scheme) will, however, be allowed but with safeguards similar to the ones for transfer of DB benefits from schemes in the private sector.

Statutory override

These flexibility measures will not be mandatory. Instead a ‘permissive’ statutory override will be given that will enable schemes to rely on the statutory rules over their own rules (i.e. where schemes do not wish to make changes to their own rules around flexibility but nevertheless want to make the flexibility measures available).

Transfers between DC arrangements

Members will be able to transfer between DC schemes up to the point of retirement - at the moment, a statutory right to a cash equivalent transfer ceases a year before normal retirement date.

Lifting of restrictions to enable providers to devise new and innovative products

Providers will be given greater freedom to create new and innovative products which more closely meet consumer needs by removing some of the current tax restrictions in relation to (DC) lifetime annuities as follows:

  • Allowing lifetime annuities to decrease - this would allow providers to offer products that enable an annuity payment to be reduced, for instance where an individual starts receiving their State Pension.
  • Allowing lump sums to be taken from life annuities so long as this is specified in the contract at the point of purchase.

Provisions will also be made allowing beneficiaries to take a full lump sum payment from an annuity where the guaranteed annuity is £30,000 or less in value.

As new drawdown products develop and are offered to consumers, the Government will work closely with the Financial Conduct Authority, the Prudential Regulatory Authority and the Pensions Regulator to make sure that the regulatory regime is robust enough to protect consumer interests.

Anti-avoidance measures

Restrictions will be introduced to stop people from abusing the system by diverting their salary into their pension and getting tax relief on this, and then immediately withdrawing 25% of it tax-free as a Pension Commencement Lump Sum. These measures will take the form of introducing a lower annual allowance limit of £10,000 (as opposed to the £40,000 that normally applies) to an individual once they have taken cash in excess of their tax free entitlement from a DC scheme in relation to any further pensions savings they make.

Miscellaneous

  • The current minimum age of 55 from which individuals can access their benefits will be increased in 2028 to 57. After then, the minimum age will stay at 10 years below the State Pension Age. This increase will not apply to public sector schemes that do not align their normal pension age to the State Pension Age, such as the Fire Fighters, Police and the Armed Forces schemes.
  • The age at which individuals can take trivial and small pots as cash will fall from 60 to 55.
  • The tax charge levied on pension savings on a drawdown product held at death (currently 55%) is, the Government recognises, too high. Options for changes will be announced in this year’s Autumn Statement.

The Guidance Guarantee

The consultation response confirms that the provision of the free guidance guarantee for members will not be made available to providers or schemes. Instead the Treasury, who will have overall responsibility for its design and implementation until the guidance service reaches maturity, will work with the Pensions Advisory Service and the Money Advice Service to deliver the guidance service.

  • The guidance will be face-to-face, electronic or by telephone but will not stray into specific product or provider recommendation.
  • Pension providers and schemes will have a statutory obligation to alert their members to the guidance service as members approach retirement.
  • The FCA will set and maintain standards for the guidance. The FCA has consulted on these standards - the consultation may be found here. The consultation closes on 22 September 2014.

Timetable and legislation

The majority of the above changes will be in a pensions tax bill - draft tax legislation will be issued for technical consultation in August 2014 and introduced into Parliament in the Autumn. Legislation regarding the guidance guarantee will be included in the current Pension Schemes Bill. A progress update on the guidance guarantee will be published in the autumn.

Comment

The key element of surprise in the Government's response to the consultation is that it will not be introducing restrictions on members of private defined benefit schemes to transfer to DC arrangements in order to take advantage of the flexibility measures. Moreover, the Treasury will consult on measures so that DB members will not need to transfer first to a DC scheme in order to access their savings flexibly (although no further details about these proposals have been provided at this stage). Schemes with a DC section may already allow members to transfer the DB benefits to their DC section; those with an AVC facility may be able to create a DC 'section' into which members may transfer their DB benefits relatively easily (subject to the rules of the scheme). It would be interesting to see what measures are floated in the consultation in this regard and what supporting legislation is proposed. The measures have the potential of enabling DB schemes to offer greater flexibility to their members around accessing their benefits and also to discharge some of  their DB liabilities.  They are therefore likely to be attractive to companies providing defined benefit schemes.

Cases

4. High Court overturns Pensions Ombudsman’s determination restricting the NHS administering authority’s ability to recover overpaid lump sum death benefits paid by mistake

The High Court has overturned a ruling of the Deputy Pensions Ombudsman in relation to an attempt by the Administering Authority of the NHS Pension Scheme to recover an overpayment of benefits from the estate of a deceased member of the NHS Pension Scheme. The Deputy Ombudsman had limited the amount the NHS Administering Authority could claim to the net assets of the Estate. The Court ruled that there was no legal principle to enable limiting the claim in such a way, and that the full amount of overpayment (subject to deductions) could be pursued by the Administering Authority. The Court did however, uphold the Ombudsman’s decision allowing the administrators’ legal expenses to be recovered and required the authority to reimburse the executors their legal expenses. For our e-briefing on the case, click here.

5. Seven categories of evidence in rectification claims

In MNOPF Trustees Limited v Watkins [2014], the High Court has allowed a claim for rectification of a pension scheme that was mistakenly amended to make the revaluation of benefits of deferred members for pensionable service before 1978 compulsory.

Facts

The claimant was the trustee of the Merchant Navy Officers’ Pension Scheme, which is split into an “old section” and a “new section”. The old section provided benefits in respect of contributions paid for service up until 1978, the new section provided benefits in respect of contributions made from 1978 onwards. The scheme was administered on the basis that there was no compulsory revaluation of deferred pensions accrued under the old section; it was at the trustee’s discretion whether to revalue old section benefits.

In 1999, the Scheme was amended, primarily as a tidying up exercise to take account of older deeds of variation and changes to statutory references - the amending deed and rules drafted by the trustees’ solicitors, mistakenly imposed an obligation on the trustees to compulsorily revalue deferred members’ benefits under the old section. When the error was realised in 2012, the trustee brought an application for rectification without seeking the true construction of the amendment on the basis there was sufficient uncertainty to justify rectification.

Judgment

The fact that the defendant (a representative beneficiary) did not oppose the rectification did not mean that it would automatically succeed. Evidence that the deed and rules did not or might not have accurately represented the true intention of the trustee was required for rectification to be granted. The Court granted the application for rectification as there was a compelling case that a mistake had been paid.  In granting the application, the judge set out seven categories of evidence that should be considered in a rectification claim:

Contemporary expressed statements of intent – the Court considered the minutes of trustee meetings from the time of the amendment, and the correspondence between the trustee and their solicitors. Of particular importance was that the solicitors had sent the trustee a letter explaining the purpose of the amending deed and rules; the letter made no reference to the position regarding the revaluation of deferred pensions. Additionally, the letter contained a recommendation that the trustee should agree to the amendments. The minutes of the trustee meeting at which the amendments were approved make it clear that the trustee had relied on the changes in the letter as being the only material amendments to the deed that they were agreeing to. At no point had the trustee expressed any intent to bring in compulsory revaluation of deferred members' benefits under the old section.

Was any thought was given to introducing the offending provision?– given the impact that introducing compulsory revaluation of benefits would have, it would be reasonable to assume that the trustee would have considered its position before introducing it (e.g. by instructing an actuary to determine the likely effect on the Scheme’s funding position) . No such consideration was given by the trustee in this case.

Context in which the amendment was made – at the time of the amendment, the trustee was conscious of the Scheme’s funding position, to the extent that it chose not to implement a discretionary increase to deferred members’ benefits that it had earlier planned to give. It would seem unlikely that at the same time as declining to implement a discretionary increase due to funding concerns the trustee would impose an obligation on itself to compulsorily revalue deferred members’ pre-1978 benefits. As the judge said, it “would indeed have been strange on the one hand to make compulsory something which there was insufficient money to do voluntarily.”

Purpose behind the amendment – the wording which required the compulsory revaluation of pre-1978 benefits was aimed at remedying an unrelated defect in the trust deed. The judge held that in this case insufficient thought had been given as to how this particular amendment might affect the revaluation provisions in the deed.

Capriciousness of the amendment – due to the way the offending amendment was worded, only a few deferred members would have had their pre-1978 benefits compulsorily revalued. The amendment only covered deferred members who were still in service in 1997; for other deferred members the position remained unchanged in that revaluation of their pre-1978 benefits was at the trustee’s discretion. The judge agreed with the trustee that making such a distinction between deferred members was arbitrary; this again reinforced the argument that the trustee must not have intended to implement the amendment.

Behaviour following the amendment – the trustee had continued to revalue pre-1978 benefits on a discretionary basis after the amendment.

Subjective intentions of the individuals – the judge did not rely on the subjective intention of individual directors of the trustee (as evidenced in letters), commenting that there is some controversy as to whether such evidence is permissible in rectification applications. However the judge did use the subjective intent of individual directors to cross check the conclusion he had reached in reliance on the other forms of evidence listed above.

Comment

The seven categories draw largely from existing case law but were also inspired by the facts of the case. There is some overlap between them and the relevance of each category will obviously be dependent on the facts of a particular case. In this case, the judge was only concerned with the intention of the trustee as the trustee could unilaterally amend the scheme; employer-consent was not required. For schemes where employer-consent is required for a rule amendment, the intention of the employer is also relevant.

The case is also notable as it confirms that rectification can be used even if it may be possible to interpret a provision as having the meaning sought by rectification, providing that there is sufficient uncertainty as to its meaning.

Pensions Ombudsman

6. Ombudsman holds trustee should honour the normal pension age which it had told the member applied to him

In McClean (PO-2382), the Pensions Ombudsman has upheld a complaint by a member of an occupational pension scheme that the scheme trustee could not increase his normal pension age (NPA) to 65 years after the trustee had mistakenly notified him that his NPA was 62 years.

Background

Following notification from the scheme trustee that he was approaching his normal pension age (NPA) of 62, and therefore could start drawing his pension in its entirety, Mr Mclean retired from the scheme at the age of 62 ,while continuing to work. He received a lump sum of £37,058 together with an annual pension of £5,558.

As it turned out, Mr Mclean’s true NPA was 65 years. Taken at age 62, under the Scheme’s early retirement provisions, his pension had to be reduced to reflect early payment. The trustee informed him of the mistake and that his pension would be reduced to £4,726 to reflect early payment. An explanation was given that the situation had arisen because certain changes to the Scheme to reflect the equalisation requirements arising from the decision in the Barber case (which required men and women to be treated equally) had not been correctly implemented.

Mr Mclean offered to pay back the lump sum and take the higher pension from his true NPA. In its response, the trustee acknowledged its mistake (and did not claim the overpayment for the previous 12 months) but stated it was not in a position to allow Mr McClean to be put back in the position he would have been had he not taken his pension until his actual NPA.

Mr Mclean complained to the Ombudsman’s office that the trustee should be prevented or ‘estopped’ from going back on the representation that it had made to him that his NPA was 62 and that the pension he had been receiving should be reinstated.

Estoppel

The requirements for estoppel by representation were outlined by Neuberger LJ in Steria v Hutchinson (2006) EWCA Civ 1551 as follows:

  • there must be a clear representation or promise made by the defendant upon which it is reasonably foreseeable that the claimant will act;
  • there must be an act on the part of the claimant which was reasonably taken in reliance upon the representation or promise; and
  • the claimant must be able to show that he will suffer detriment if the defendant is not held to the representation or promise.

Applying this test, the Ombudsman found that Mr McClean was able to rely on the defence of estoppel by representation. The information given by the trustee was an unequivocal representation on which it was reasonably foreseeable that Mr McClean would rely. Mr McClean had acted in reliance on the representation and even though he derived some benefit from receiving his pension and lump sum early, viewed against the annual pension of £7,938 he would have received had he delayed taking his pension for three years, he had acted to his detriment.

It was held to be unconscionable to allow the trustee to go back on the representations made to Mr McClean that his NPA was 62. Mr McClean was consequently entitled, going forward, to his unreduced pension on the basis of an NPA of 62 from that date, together with appropriate increases.

He was also entitled to a lump sum representing the shortfall between the pension he received from 1st December 2011 and the date of the re-instatement of his pension as directed above and the pension he should have received during this period together with interest.

An award of £150 for inconvenience was also granted.

Comment

In addition to estoppel, the Ombudsman also considered the remedy of negligent misstatement.  Negligent misstatement does not appear to have been specifically raised by Mr McLean but nevertheless considered by the Ombudsman.  The Ombudsman has in the past held that members do not need to raise specific legal arguments expressly in their claims; providing the substance for the argument is there in the claim, the Ombudsman will consider it especially where members are not legally represented.

The test for negligent misstatement was satisfied in this case, the Ombudsman held, but the remedy would have required the member to be put back in the position he would have been had he not taken his pension. This would have meant requiring Mr McClean to pay back the amounts he had already received, which he stated he was unable to do in full. A remedy arising out of the defence of estoppel was considered to be more practical and proportionate.