Breaking with tradition

first_img Previous Article Next Article Breaking with traditionOn 10 Jun 2003 in Personnel Today Comments are closed. Related posts:No related photos. Forthcomingpensions legislation will make some radical changes, including allowing workersto continue in a part-time capacity and limiting the amounts built up by topexecutives. HR needs to prepare the ground now for some truly groundbreakingchanges to the system. Sarah Ball reportsMostpensions commentators have branded the recent Department of Work and Pensions(DWP) Green Paper Simplicity, Security and Choice a damp squib, which won’tactually change anything. And HR folk may be tempted to put their feet up whilethe pensions pack get on with another few years of worthy, yet incomprehensibledebate over areas of the private and state pension system that the Governmenthas failed to reform. But,as every HR director who has been around the New Labour legislative block a fewtimes knows, it is the employers who are usually expected to deliver throughgood practice to avoid overly-prescriptive measures. The pensions path whichlies ahead is no exception. Whenthe new proposals were launched in December last year, Andrew Smith MP,Secretary of State for Work and Pensions said: “We believe that thepartnership between the Government, individuals, employers and the financialservices industry has long been a strength of the pensions system in the UK,and that the proposals we are setting out today will renew this partnership andreaffirm the responsibilities of each member.”Whetherthere are enough incentives for employers to go the extra mile is an unresolveddebate beyond the scope of this article. But there is still enough food forthought for HR to get its teeth into – especially as some of the legislationcould be in place as soon as this time next year. Forthe pensions purists, the platter promising the juiciest morsels is the accompanyingTreasury and Inland Revenue’s Green Paper – Simplifying the taxation ofpensions: increasing choice and flexibility for all. Chris Jackson, a solicitorat Hammonds, says: “The tax proposals, due to be introduced as early as2004, could be the radical reforms that actually do reshape UK pensions.”ColinSinger, a senior consultant at Watson Wyatt, highlights how some of theproposals are great news for HR directors currently reviewing their pensionscheme designs. All existing tax regimes for pensions will be replaced by asingle system.Hesays that under the current Inland Revenue (IR) rules, there is only so muchsurplus a defined benefit scheme can accumulate. Since 1987, schemes have notbeen allowed more than 105 per cent in their fund without being taxed. This isreally out of date – no scheme these days has anywhere near this much surplus.Singeroutlines the possibilities: “An exciting avenue that may be opened by thenew regime is greater flexibility of design,” he says. “This isperhaps particularly so for ‘risk-sharing’ designs that lie between pure finalsalary and pure defined contributions (DC).”Thekey to unlocking such designs will be the funding flexibility envisaged in theregime which, if twinned with an appropriate mixture of guaranteed anddiscretionary benefits, may result in a better balance between members’guaranteed benefits and employers’ guaranteed costs than either of the polarextremes of final salary or defined contributions.” TomMcPhail, of corporate independent financial advisers Hargreaves Landsdown, saysan area of priority for HR directors in the tax proposals will be the changesaffecting your most senior and/or long-serving staff. “It is worthapplying some due diligence in this area now, just in case the proposals docome in next April.” Contributionsby employers and staff would continue to attract tax relief, but the changecomes where the limits for this will extend to 100 per cent of earnings subjectto a £200k per annum ceiling. “This means that an employee can build up apension in very short space of time if they wish,” says McPhail.Butthe really big news is that total pension fund accumulations will be capped ata lifetime limit of £1.4m. Twenty-five per cent of the fund’s cash will beavailable tax-free, and pension will be taxed as earned income.  “Sometransitional arrangements will protect people with pensions already over £1.4m,but the new limits will otherwise operate retrospectively,” McPhail adds.”Funds that breach this will be subject to a 35 per cent recovery chargeon the amount over the limit and all benefits taken from the excess funds willbe fully taxable – an effective tax rate of 60 per cent.” Thisis pretty steep, so senior staff will want up-to-date information on theirpensions to make informed choices.  SimonMartin, head of research at Aon Consulting, warns the proposals will have adivisive effect by giving senior staff a minimal stake in the company pensionscheme. “Pensions schemes work best when they include all employees,”he says. “However, these new tax proposals are particularly penal onsenior executives.  It should bepossible to have a fair tax treatment for all employees, but in this case theGovernment has taken its objective of simplify the tax regime too far.”Gettingyour administrative ducks into line is another area to review before nextApril. Geraldine Brassett, a consultant at Hewitt Bacon & Woodrow, assessesthe costs employers need to be prepared for when it comes to implementing thenew IR and DWP proposals. “Oneof the aims of the proposals is, in the longer term, to drive downadministration costs. The simplification of the tax regimes should help toachieve this, but this needs to be balanced against the flexibility aroundpayment of benefits and the fact that there will almost certainly besubstantial set up costs when the changes are introduced.”Shesays the extent of these initial costs will obviously vary depending on theexisting scheme design, the age and capability of the current administrationplatform and changes in communication around processes.”Assumingno changes to existing individual scheme designs – although we know this willbe likely for a large number of schemes – we estimate that the costs could bein the region of £5,000 to £25,000 per scheme, although this could be more ifimplementing these changes necessitates a significant one-off expenditure, suchas purchasing a new administration system.”Changesrequired will not only be to software, but also to processes and procedures andpossibly member communications, and Brassett advises HR directors not tooverlook these areas. Althoughthe tax proposals potentially contain more substance, the DWP’s Green Paperdoes merit another glance from HR directors. In brief, it outlines the suite ofvoluntary mechanisms the Government wants to employ, to help avoid theso-called ‘pensions crisis’.Itreiterates that our increased longevity means we cannot sustain the state‘pay-as-you-go’ pension system unless we work longer or save harder, or both.Of particular note is chapter 6, Extending Opportunities for Older Workers,which looks at how to encourage and facilitate a larger proportion of people inthe 50-plus age group to remain economically active.Thisdovetails with the consultation paper that the Department of Trade and Industryis due to launch this summer, regarding a new EU directive which will outlawage discrimination by 2006. Organisations can currently set their own normalretirement ages, beyond which staff are unable to sue for unfair dismissal.This is set to change. JamesDavies, a partner at Lewis Silkin Solicitors, thinks the Government will imposea default normal retirement age of 70, and that it will be up to organisationsto justify anything below this. “Pre-established succession planning, or agenerous occupational pension scheme might be grounds for exemption, but theseare obviously matters for the consultation.” Otherwise, staff who want tocarry on working will have the right to do so.Accordingto research by Penna Sanders and Sidney, 93 per cent of employees would extendtheir working lives if offered flexible working arrangements. TheGreen Paper on tax contains proposals to encourage flexibility, but for somethey have not been implemented soon enough.AonConsulting’s Martin says: “At the moment, a full-time employee close toretirement cannot switch to part-time work and start drawing a pension, butthey can do so if they leave to join a direct competitor. This is a ridiculousimposition by the Inland Revenue, and is a major disincentive to companieswanting to retain valued older employees.”Typesof pension scheme designDefinedbenefit (DB) or final salary schemesTraditionallythe main type of scheme provided by large UK employers, typically related tothe employee’s final salary at retirement. The employer promises the employee acertain proportion of salary at retirement and takes on the risk and cost ofproviding it. Contributions from employer and employees are put into a fundmanaged by trustees. Careeraverage revalued earnings (CARE) Anotherform of DB scheme, but is based on average salary (adjusted for inflation) overthe whole career, rather than on final salary at retirement. The employer stilltakes on risk and cost in the same way as for final salary schemes. Definedcontribution (DC) or money purchase schemesThefastest growing type of company scheme in the UK (and elsewhere). The amount ofpension the employee eventually gets depends on various factors, includingmoney contributed by and employee and employer and annunity rate at date ofretirement.Thecompany can set up its DC scheme under a separate trust, managed by trustees(as for DB schemes), or can pay into a contract with an insurance company (seePersonal and Stakeholder Pensions below). StakeholderThesespecial DC schemes came in during 2001, and in broad terms, employers who didnot then have an occupational scheme had to designate a stakeholder providerfor their employees. It aims is to increase private pension provision forbelow-average earners. Contributionsfrom both employers and employees are entirely voluntary, despite unionpressure for employer ones to be compulsory. The insurance provider’scharges  for administration is capped at1 per cent.Personalpensions Theseare individual insurance contracts, usually taken out by employees outside ofwork pensions and rarely used by employers. Broadly the same as stakeholderschemes, but without the capped insurer’s charges. Hybridschemes Thesecombine DB and DC in a variety of ways – a DB scheme might guarantee some modest level of final pay, but pays outthe value of an underlying DC pot if greater.Grouppersonal pensionsAversion of personal pensions used by some employers. The provider bundles theindividual personal pensions together (on enhanced terms normally), andpresents them as an employer scheme using payroll deduction and worksitemarketing. Stakeholder pensions run by employers are also normally grouped in asimilar way. Tosee the first part of this two-part article on forthcoming pensions legislationand for a fuller explanation of types of pension scheme, go to www.personneltoday.com/goto/19143LegislationchecklistYouwill need to get advice on how your pension scheme(s) may be affected by:Spring2003     Statutory Money PurchaseIllustrations introducedMid-2003        Publication of consultation paper onimplementation of the age discrimination aspects of the EC Framework DirectiveMid-2003        Next round of consultation on theprotection of pension rights on TUPE transfersDec2003         Extension of limit forback-dating pay in equal treatment claims from two to six yearsDec2003         Latest date for UK Governmentto ban discrimination in employment on grounds of religion or sexualorientation (EC Framework Directive)Early2004       TUPE regulations on futurepension rights expectedOct2004         UK Government to removeemployment exemptions from Disability Discrimination Act 1995 (EC FrameworkDirective)Apr2004         Earliest date forimplementation of new simplified pensions tax regimeJan2005          Full implementation of FRS17required in relation to accounting periods ending on or after 1 January 2005Dec2005         Estimated implementation datefor EC Pensions DirectiveDec2006         Latest date for UK Governmentto ban discrimination in employment on grounds of age (EC Framework Directive)2010                Minimumearly retirement age (other than for ill-health) increased from 50 to 55last_img