Developments in Employee Benefits law and practice

16 February 2016

Week ending 14 Feb 2016: Think tanks issue warnings over changes to pension tax reliefs | New guide on security of DC assets and more

Think tanks issue warnings over changes to pension tax reliefs

The Institute of Economic Affairs has described plans for a flat-rate of pension tax relief as misguided and arbitrary. An IEA press release contends that, although critics claim that pension tax relief is expensive and skewed towards those on high incomes, there are several key objections to such a change:

  • Higher-rate taxpayers could end up effectively paying a “fine” to make pension contributions. Under a so-called flat-rate relief, higher-rate taxpayers could end up obtaining tax relief of 30% on a contribution used to buy a pension that is taxed at 40%, in effect people ‘fining’ people when they make pension contributions.
  • It would be hugely detrimental to those with fluctuating incomes. The current system facilitates income smoothing so that the tax system comes closer to taxing individuals with the same lifetime income at the same rate. A flat-rate would eliminate one of the corrections that the current system of tax relief makes against the injustice of a progressive tax system – that those with highly fluctuating incomes tend to pay much more in tax across their lifetimes.
  • Those on high incomes receive more relief because they pay more tax. The UK’s system of tax relief is a system of tax deferral. A high amount of tax relief can be attributed to higher rate taxpayers because these groups pay the majority of taxes on income.
  • The potential abuses would necessitate further complex legislation. A single rate of tax relief would necessitate hundreds more pages in the tax code to counteract potential loophole exploitation and to correct for incentives the new regimes creates.
  • Estimates of the ‘cost’ of tax relief under the current system hugely over-estimate the real cost. Those arguing for reform to pension tax relief misleadingly refer to the gross cost of tax relief. This implies that the counterfactual is a world in which pension contributions are made out of net income, and that pensions are taxed when received so that income tax would be charged twice on pension contributions. This is clearly a colossal overestimation of cost.

Separately, the Institute for Fiscal Studies has warned that potential reforms to the tax relief on pensions could have a ‘significant effect’ on the future of UK finances. The IFS states that some of the options being considered would have a more significant effect on the timing of tax payments in future years than they do on the overall amount that is being raised. It will be very important for the OBR to publish estimates of the effect on revenues in all future years and full details of the underpinning assumptions. According to the IFS, the government should not rely on temporary revenues to achieve a budget surplus in 2019–20, since this would not be in keeping with the rationale underpinning the Chancellor’s stated fiscal objectives

New guide on security of DC assets

The Security of Assets Working Party has launched a guide for trustees entitled “How safe are your DC assets?”. The report aims to help trustees explore the levels of protection in place for DC assets, to improve levels of understanding of the protections members have, and to highlight key areas to explore when seeking to change platform provider or fund managers.

NAO finds that new administrator failed civil service pension schemes

The administration of the civil service pension payroll and certain other services moved from outsourcing company Capita to pension administrator MyCSP in September 2014. Following the changes, many scheme members and participating employers expressed dissatisfaction with the services provided by MyCSP.

The National Audit Office has published the findings from its investigation into members’ experience of civil service pension administration.

Key findings by the NAO are:

  • The NAO found that when MyCSP took over the administration of the civil service pensions payroll in September 2014 it did not cope with the workload, resulting in a large backlog of work building up.
  • Some people were paid late and reported hardship and distress, and members had difficulty in contacting MyCSP. The problems were made worse by longstanding limitations in membership data.
  • The NAO says that although MyCSP’s performance is now back to a ‘steady state’, the underlying data problems have still not been fixed and should now be a priority for the Cabinet Office, MyCSP and the employers.

The NAO recommends the Cabinet Office and Civil Service Pensions Board should:

  • Work with employers and MyCSP to produce a plan as to how data will be cleansed and properly maintained. This includes determining who pays for the data cleanse.
  • Continue to reform the governance of the civil service pension schemes to ensure employers are properly involved.
  • Performance-manage MyCSP and involve employers in that management.
  • Consider and disseminate the lessons from the migration and the subsequent problems for the wider programme of shared services across government, where the centre is responsible for managing outsourced services on behalf of other central government services, and the wider programme of mutual joint ventures.
  • Define clear roles, responsibilities and interfaces for the complex end-to-end process of civil service pension administration based on the outcome of the recommendations above.

Government response on pension transfers and early exit charges

Further to the July 2015 consultation, HMT has published a document summarising responses and setting out next steps that the Government will be taking.

The Government has tabled an amendment to the Bank of England and Financial Services Bill to require FCA to make rules prohibiting early charges for those seeking to exercise their rights under the pension freedoms.

DWP to introduce legislation for rule amendments in relation to GMP revaluation

Currently legislation provides, in relation to early leavers, that a scheme may provide that fixed rate revaluation of the GMP is triggered at the time the member leaves contracted-out service. In response to pension industry concern that when contracting out ends on 6 April 2016, fixed rate revaluation would be automatically triggered simply because members will have left contracted out service, DWP amended section 16 of the Pension Schemes Act 1993 (“PSA 1993”).

From 6 April 2016, section 16 PSA 1993 will provide that in deciding how to revalue GMP for early leavers from 6 April 2016 schemes would have to choose:

  1. to operate fixed rate revaluation (but calculated from the date when pensionable service ends, not from the date contracting-out ends), or
  2. to calculate earnings revaluation by reference to earnings in the final tax year of the earner's working life i.e. by reference to increase orders under Section 148 in force. 

So, essentially, to take account of contracting out ending, fixed rate revaluation would be triggered, after 6 April 2016, not by when contracted out service ends, but from when pensionable service ends.   Schemes will have to choose to amend their scheme rules to carry out fixed rate revaluation from the end of pensionable service even if they had chosen fixed rate previously as the preferred method. 

DWP have been told that many schemes will not be able to exercise this choice because their scheme amendment rules are limited and would not enable them to make the necessary changes.  As a result, the option to choose fixed rate for such schemes will fall away when contracting out ends.

DWP want schemes to be able to modify their scheme rules in order to take advantage of fixed rate revaluation from when pensionable service ends after 6 April 2016 which is why they intend to provide in legislation for a statutory modification power. The modification power would have retrospective effect to allow changes to take effect from 6 April 2016. DWP intend to make this legislation in the next few months.

 

PPF updates

The Pension Protection Fund has published a revised statement on how it will make funding determinations when deciding if it should assume responsibility for a pension scheme during an assessment period. The PPF is able to make a funding determination in place of a full section 143 valuation where it is clear that a scheme has either insufficient or excess assets at the time of the qualifying insolvency event. The statement also gives guidance to actuaries who are asked by the PPF to provide an estimate of the protected liabilities and assets of the scheme in place of a section 143 valuation.

The PPF has also published updated versions of sample certificates for the six types of contingent asset that schemes may use to reduce their risk-based levy.

Contact:

John W. Wilson LLB(Hons) FPMI ACII, Head of Research| Email: john_wilson@jltgroup.com

Julian Rowe, Head of Technical | Email: julian_rowe@jltgroup.com