Pensions Bulletin 2014/42

Taxation of Pensions Bill published

The Government this week introduced the Taxation of Pensions Bill to the House of Commons, a key piece of the jigsaw to give effect to the DC flexibility announced in the March Budget. The intention is for the Bill to pass speedily through Parliament and to be given Royal Assent before the end of 2014 – ready to apply for members drawing benefits from 6 April 2015.

The Bill was accompanied with Explanatory Notes. HM Revenue & Customs has also published an updated tax information and impact note entitled “Pension Flexibility 2015”.

Publication of the Bill was heralded by huge press coverage. But most of the commentary related to a flexibility which was already announced in August when draft clauses/guidance were published for consultation (see Pensions Bulletin 2014/32). A case of old news re-spun.

However, the Bill does contain several new points of detail and clarification since the consultation draft.

Comment

Although there is little “news” in this Bill, its importance is such that it is worthwhile taking stock of the main provisions. A Pensions Bulletin Taxation of Pensions Bill special is being released shortly after this Bulletin with this aim in mind.

EIOPA consults on solvency rules for pension schemes

The unelected and, to all intents and purposes, unaccountable European Insurance and Occupational Pensions Authority (EIOPA) has published a 167 page consultation paper entitled “Further Work on Solvency of IORPs”. This further work is that which EIOPA has carried out on its own initiative following the launch of the IORP 2 directive earlier this year.

The paper develops EIOPA’s big idea of a “holistic balance sheet” (HBS) for defined benefit pension schemes and tries to address some of the many severe defects and gaps in this approach identified by the quantitative impact study last year (see for example Pensions Bulletin 2013/29). It covers in detail highly technical aspects of the HBS, including how to value sponsor covenant, benefit reduction mechanisms and discretionary decision making processes. A range of proposals for approaching these elements of the HBS are put forward.

The question of valuing the level of sponsor support that a pension scheme can rely on has proved to be an intractable one. EIOPA now seem to be leaning towards a principles based approach because the “…standard methods developed by EIOPA are unlikely to be suitable for all types of sponsor support arrangements, particularly those with complex interactions between security and benefit adjustment mechanisms or embedded options”.

However, the really important thing about this paper is that the question of “supervisory responses” is addressed. In other words, how are pension liabilities to be valued and how much in the way of assets, and what type of assets, will be required to cover the liabilities? A range of proposals are put forward, setting “trigger points” and associated regulatory actions incorporating various mixes of such HBS items as:

• A risk-free rate of return
• An assumed rate of return based on the expected return on assets
• A risk margin
• A “solvency capital requirement”
• Expected benefit reductions; and
• The market value of the scheme’s financial assets, sponsor support and pension protection fund

Some of these “supervisory responses” look very much like the Solvency II regime for insurance company capital adequacy. Some of them look less stringent. What they all do is point to a pan-European solvency requirement for UK defined benefit pension schemes which is likely to require more capital than under the current funding regime.

The use of the HBS in “pillar 2” governance requirements is also discussed.

Consultation closes on 13 January 2015.

Comment

When we reported widespread relief in Pensions Bulletin 2013/23 at the European Commission’s announcement that they were backing down on solvency we also counselled against premature chicken counting. Eighteen months later and “Solvency II for pensions” is right back on the agenda.

The IORP 2 directive is unlikely to be the vehicle for this. We understand that the Commission’s game plan is for this to come later in an IORP 3, possibly from 2019. However, it is not impossible that the European Parliament will attempt to introduce a solvency requirement into IORP 2. We also note the possibility that some version of the HBS will eventually be required by EIOPA, perhaps under subsidiary legislation, when conducting the risk evaluation for pensions required by IORP 2.

We have said before that the costs of imposing insurance style regulation on to UK pensions will be “crippling” for the UK economy and nothing has happened to change our view. It looks as though the UK government will have to be vigilant in keeping a blocking minority at the political level together to fend off either an amended IORP 2 or an IORP3.

September to September inflation down by 1.5%

The announcement this week that the Retail Prices Index (RPI) rose by just 2.3% over the twelve months to September 2014 and the Consumer Prices Index (CPI) by only 1.2% has re-ignited deflation fears. But the immediate impact for pensions is that it sets the scene for similar increases to various pensions benefits and limits to this time last year when the RPI rose by 3.2% and the CPI by 2.7%.

Amongst the benefits and limits affected by this inflation rise will be the Basic State Pension which is now likely to increase by 2.5% as this is the highest component of the so-called “triple lock guarantee” of the rise in the CPI, average earnings and 2.5%. Pensions in payment in defined benefit schemes may increase next year by 1.2% for those benefits whose statutory inflation-linking is capped at 5.0% and 2.5% and deferred pensions in such schemes may increase by the same amount.

On the tax legislation front, the earnings cap ceased to exist formally on 5 April 2006, and the transitional provision that saw HM Revenue and Customs announce “notional” earnings caps each year since then expired on 5 April 2011. However, if it were to continue to be calculated in the same manner as before, it would be either £149,400 in 2015/16 (if always using the declared annual growth) or £150,000 (if always using the unrounded indexes to derive the annual growth). There is some ambiguity, all to do with rounding, so some schemes may have advice to use one or other of these, or indeed another approach. For those accruing defined benefits the increase in the CPI of 1.2% is effectively the inflation allowance made before accrual of defined benefit pension counts as using up the Annual Allowance for pension input periods ending in the 2015/16 tax year.

Auto-enrolment – Government consults on 2015/16 earnings parameters

After a fallow year in which the Government chose not to consult, the Department for Work and Pensions has reverted to consulting before fixing the lower and upper limits of the qualifying earnings band and the earnings trigger for auto-enrolment for the next tax year.

With the continuing significant increase in the income tax threshold driven by political considerations, the paper asks whether it remains right to maintain the alignment of the earnings trigger with this measure – which would mean that it would be expected to rise to £10,500 pa in 2015/16. The concern is that less of the target population for auto-enrolment will remain eligible, and that women in particular will be disadvantaged. However, its continuation has the advantage of simplicity for payroll systems, ease of communication as well as ensuring that every £1 paid into a pension scheme by an individual benefits from tax relief.

The paper puts forward three other options, but it would seem that the Government is likely to continue with the income tax threshold alignment – at least for another year.

When it comes to the lower and upper limits of the qualifying earnings band, the paper is much more certain. The Government’s “opinion” is that the lower limit of the qualifying earnings band should remain linked to the lower earnings limit for national insurance contributions, whilst its “provisional view” is that the upper limit should remain linked to the upper earnings limit for NICs. If this is the final decision the qualifying earnings band can be expected to range between £5,824 and £42,285 in 2015/16.

Consultation runs until 25 November 2014, with the DWP expected to respond in December, around the time of this year’s Autumn Statement in order to give a reasonable amount of advance notice of the Government’s intentions to payroll administrators, software providers and other interested parties who will need time to update their processes.

Comment

Although the Government seems to be fairly firm on what the parameters for 2015/16 are likely to be, the results of the consultation should still give an interesting read with insights into the experience of employers who have already started auto-enrolling their employees, and maybe lessons to be learnt by smaller employers who have not yet started the staging process.

The long term viability of the current alignment of the earnings trigger with the income tax threshold has to be in doubt as the Coalition parties seek to further increase the latter, but any movement may well depend on a reformulation of the manner in which tax relief is given on employees’ pension contributions. There is also a danger that at its current level a significant number of employees within smaller firms (where wages tend to be lower) will be excluded as the first round of auto-enrolment draws to a close.

Should NICs be abolished? And what would that mean for pensions?

Unequivocally yes, says Michael Johnson in his latest policy paper from the right-leaning Centre for Policy Studies, with some significant implications for pensions should it come about.

His starting point is the possibility of the National Insurance Fund being exhausted. By 2035-36 says the Government Actuary’s Department (see Pensions Bulletin 2014/31); “imminently” prophesies the author, on the basis that wage growth has been and is likely to be far less than the 2.4% over CPI modelled by GAD. And what happens if the Fund does go bust? Rather than increase NICs to ensure that monies out are broadly matched by monies in, the author suggests that the Fund’s exhaustion should lead to the abolition of National Insurance Contributions and its replacement by an Earnings Tax.

Such a tax would combine income tax and NICs – the suggestion being that it is set at 32%, 42% and 47%. And to make it possible, the single tier state pension, being introduced in 2016, should be remodelled so that it is residency, rather than contribution based. It would also be necessary to revisit how non-earned income, such as that derived from state and private pensions, capital gains, property, savings and dividends, all of which are currently NIC free, should be taxed.

But what about the windfall for employers that their no longer having to pay NICs would bring? The author says that they would likely come under “huge pressure” to raise wages resulting in more Earnings Tax being raised and then more VAT as higher net wages leads inexorably to higher consumption. There would likely also be higher corporation tax since profits would be boosted. Dividends would also increase as would the tax on them. The effect of all of this would need to be modelled by HM Revenue & Customs, with the suggestion being that “any projected shortfall should be made up by additional consumer taxes”.

From a pensions perspective, the merging of income tax with NICs could herald a significant redrawing of tax relief on member contributions – basic rate taxpayers would find they get much greater relief (at 32%), whilst higher rate taxpayers could find that their relief also increases. But having one tax rather than two makes it possible for pension contribution tax relief to be reset – at say a single flat rate, as advanced by the Pensions Policy Institute amongst others (see Pensions Bulletin 2013/30) and thus take from those currently enjoying relief at 40% and 45% (not to mention a few at 60% at earnings levels where the personal allowance is being withdrawn).

This is because abolishing NICs would bring to an end those salary sacrifice arrangements whose motivation is to achieve an NIC saving. From a tax point of view employers would be indifferent between making a pension contribution directly and passing it over to the employee as greater earnings, for the employee to make the contribution.

Comment

The author is using the present troubles of the National Insurance Fund as a convenient jumping off point to run old arguments about merging NICs with income tax. Successive governments have looked at the case for merger and settled instead for harmonising the two systems. The final step might simply be too disruptive.

The time for merger may come, but, as the author acknowledges, the Chancellor can do no more than signal an intention, with no timescales, at his Autumn Statement due in a few weeks’ time. But that in itself would be huge.

Draft regulations remove NEST restrictions

A short consultation has been launched on two sets of draft regulations whose purpose is to remove the annual contribution limit and transfer restrictions on NEST from 1 April 2017. This follows the announcement by the Government on 8 September that it intended to take action in this area (see Pension Bulletin 2014/37).

Policy having been determined, the purpose of the consultation is to test whether the decisions taken have been properly reflected within the proposed changes to legislation. The consultation paper usefully references the confirmation from the European Commission that these changes (which could be as early as 1 October 2015 in respect of individual transfers) are compatible with the State Aid received by NEST as a consequence of its public service obligation (the European Commission approved the State Aid under the original set up in July 2010).

The consultation paper re-iterates the Government’s intention to lift the restrictions on individual transfers when the automatic transfer system is introduced.

Consultation closes on 29 October. It is not clear when the regulations will be laid before Parliament.

Comment

Unsurprisingly, the amendments give the NEST Trustee the discretion to administer transfers for individuals or groups in the same way as other trustees of occupational pension schemes. So NEST will not be obliged to accept transfers in, but it will be required to process requests to transfer out in line with the normal cash equivalent rules.

Quite when this new transfer freedom will be operational is not clear – the second of the draft regulations says 1 April 2017, but the Government must be hoping that the automatic transfer system will be in place well before then.

Government fills in the detail on Class 3A NICs

Draft regulations have been laid before Parliament making amendments to legislation consequential upon the introduction of Class 3A national insurance contributions (NICs) which people can pay to buy additional state pension rights if their State Pension Age is reached before 6 April 2016 (see Pensions Bulletin 2013/53).

The Pensions Act 2014 (Consequential Amendments) (Units of Additional Pension) Order 2014 makes technical adjustments to existing social security legislation in order to properly distinguish the additional State Pension secured by such voluntary NICs from that accrued through earnings and credits.

Separate regulations have also been laid that provide a cut-off date, after which a person will no longer be able to pay a Class 3A contribution, and details of the circumstances in which a Class 3A contribution will be refunded.

The Social Security Class 3A Contributions (Amendment) Regulations 2014 (SI 2014/2746) set the cut-off date as the later of 5 April 2017 and a 30-day period beginning with the day that the individual is sent information about Class 3A NICs by HM Revenue & Customs in response to a request made before 6 April 2017.

And a final set of regulations have been laid in draft form that set out the amount of Class 3A NICs payable to obtain a £1 unit of additional pension and which confirm that up to 25 units can be purchased. The Social Security Class 3A Contributions (Units of Additional Pension) Regulations 2014 are expected to come into force on 12 October 2015.

Comment

One interesting aspect of the first set of regulations is that the survivor pension bought through Class 3A NICs is to precisely mirror that which would have been inherited under the normal additional State Pension rules. So those who reached State Pension Age before 6 April 2002 will purchase a 100% survivor pension, whilst those who reached State Pension Age after 5 October 2010 will purchase a 50% survivor pension.

PPI analyses Class 3A NICs

The Pensions Policy Institute (PPI) has produced a Briefing Note on the operation of the new Class 3A voluntary national insurance contributions (NICs). It provides an overview of these contributions and assesses the implications for individuals who have accrued small amounts of additional State Pension. It concludes that these NICs may deliver better value for money than a private annuity purchase for many individuals.

NAPF and PMI to merge?

So it seems, according to a document jointly published by both bodies on 10 October 2014. The reason given is the need to meet “the challenges of a changing pensions industry”, with benefits including a stronger lobbying voice, shared educational events and administrative savings. But quite how the needs of a professional body and that of a lobbying organisation can be welded together is not clear; nor is the proposed name.

Comment

For most, this will have come as a bolt out of the blue. It is now important for the leadership of both organisations to give a more detailed account of the case for merger, looking at the cons as well as the pros, since on the face of it, this proposed tie up does not seem right unless the PMI is to no longer regard itself as a professional body, but rather a provider of pensions qualifications.

This Pensions Bulletin does not constitute advice, nor should it be taken as an authoritative statement of the law. For further help, please contact David Everett at our London office or the partner who normally advises you.