Spotlight. Pensions. Contents. In this issue... Issue 5 - November For Financial Adviser Use Only

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1 For Financial Adviser Use Only Pensions Spotlight A regular update on all matters affecting pensions Issue 5 - November 2012 In this issue... of Pensions Spotlight I have included a number of pieces which I hope you will find interesting. The first piece is Frequently Asked Questions on Sovereign Annuities. There has been much comment on Soveriegn Annuities in recent months and hopefully you will find this short note on them as a useful starting point in learning a bit more about them. The second piece looks at some of the considerations of the Tax Strategy Group (TSG), an interdepartmental committee chaired by the Department of Finance, which prepares papers on various options for the Budget. The Department of Finance have just released the TSG s considerations of Pension Taxation Issues (2011), used as part of the Budget 2012 process. While it doesn t necessarily have any direct bearing on what might happen in Budget 2013, some of the comments and views expressed are interesting and might be a pointer to what might happen in Budget The third piece provides some comment on a recent Commercial Court case involving a Small Self Administered Pension Scheme which seems to strengthen the protection of retirement benefits in trust based schemes from creditors. And lastly, I have included some brief news items in relation to some pension initiatives and product launches that Aviva Life & Pensions has brought to market in recent weeks. Mark Reilly Mark Reilly Retirement Marketing Manager mark.reilly@aviva.ie Contents Sovereign Annuities Frequently Asked Questions (FAQs) Pensions and Budget 2013 Pension Protection from Creditors Pension News from Aviva Life & Pensions

2 Sovereign Annuities Frequently Asked Questions (FAQs) What is a sovereign annuity? A sovereign annuity is an annuity issued by a life assurance company, which undertakes to pay a specified level of income for the lifetime of the annuitant. Why is the annuity referred to as a sovereign annuity? It is called a sovereign annuity because the life company backs its obligations under the annuity by investing in bonds issued by one or more EU sovereign governments, referred to as Sovereign Bonds. In particular sovereign annuities are likely to be backed substantially by special Irish government bonds called amortised bonds. How is a sovereign annuity different from an ordinary annuity? The difference is that under a sovereign annuity the life company retains the right to reduce or suspend annuity payments if the government which issued the Sovereign Bond to the life company defaults on it s bond repayments. Under an ordinary annuity the life company could not reduce the annuity payment in such a circumstance; it carries the default risk. Therefore the holder of a sovereign annuity is subject to a counterparty default risk not present under an ordinary annuity, i.e. the risk that the issuer of the bond to the life company which is backing the annuity will default on its repayments to the life company leading to a reduction or complete suspension of annuity payments by the life company. What is the benefit of a sovereign annuity? Ordinary annuities are usually priced on the assumption that the life company will invest in low risk German and French government bonds. At the moment this means a life company setting its annuity rates may be assuming that it can invest at a rate of no more than 2% pa. This translates directly into low annuity rates; for example a level annuity for a male aged 65 might be currently quoted at just under 5.00%. Sovereign annuities will offer higher annuity rates because the life company will be investing mainly in Irish government bonds which currently yield about 6% pa. This means the life company can afford to offer a higher annuity rate, particularly as it can vary or suspend the annuity payment if the Irish government defaults on its bond obligations to the life company. For example a sovereign annuity rate for a level annuity for a male aged 65 might be quoted at around 7.00%. Who can buy sovereign annuities? Sovereign annuities are initially likely to be only sold to the trustees of defined benefit occupational pension schemes. It is not clear at this stage whether life companies will be prepared to issue sovereign annuities to individuals such as holders of personal pension plans and individual members of defined contribution occupational pension schemes. Page 2

3 How will sovereign annuities help defined benefit pension schemes? The trustees of defined benefit schemes could use sovereign annuities in one or both of the following ways: 1. To buy out existing pensioner liabilities. The trustees buy the annuity and then give it to the pensioner in lieu of the right to continue to receive a pension under the scheme. Of course this means that the pensioner now carries the counterparty risk, i.e. the risk that the Irish government might default on its bond obligations to the life company. 2. To buy and hold as an investment to match its liabilities to pensioners. In this case the pensioner still receives a pension from the scheme but the scheme holds a matching sovereign annuity. However, crucially for the pensioner, the counterparty risk resides with the scheme and not directly with the pensioner, so that if the Irish government defaulted on its obligations to the life company, the pensioner would still be entitled to receive their pension from the scheme assuming the scheme had sufficient assets. The big advantage for trustees buying sovereign annuities is that it may reduce the scheme liabilities for pensioners by approximately 20% ~ 25% thereby reducing the scheme deficit and leave more funds for active and deferred members. So, for example, let s say a defined benefit occupational pension scheme has 11m of assets but has the following liabilities: Pensioners : 5m Active and deferred members: 10m. The scheme currently has a deficit of 4m, and if the scheme wound up today, active and deferred members would only get about 6m out of the 10m, i.e. 60% of their current preserved benefit expectation, as the first 5m of assets would be used to secure ordinary annuities for pensioners. However, if the trustees were to buy sovereign annuities, they might reduce the pensioner scheme liability from 5m to say 4m, leaving an extra 1m for active and deferred members. This would then increase the asset coverage for active and deferred members from 60% to 70%. Are trustees of defined benefit occupational pension schemes likely to buy sovereign annuities? At the moment it is unclear how many trustees of defined benefit occupational pension schemes will buy sovereign annuities. Sovereign annuities are a high risk investment; higher investment returns are obtained in exchange for higher risk. Trustees have to be aware of their duty to act in all of the scheme members best interests by investing assets prudently, and this may complicate decision making with regard to investing Page 3

4 in sovereign annuities because the counterparty risk could then pass on to pensioners or the scheme would be exposed to the risk of default on the sovereign annuities. Trustees could alternatively invest directly in the amortised bonds issued by the Irish government rather than invest in sovereign annuities backed by such bonds. In this way the scheme would still benefit from the higher return by the Irish government bonds, and hence reduce their pensioner liabilities, but without exposing pensioners directly to the counterparty risk. However the scheme continues to hold the longevity risk in such circumstances. Sovereign annuities or amortised bonds do not magic away defined benefit occupational pension scheme liabilities; they can reduce scheme liabilities but only in return for higher risk which may, in some cases, be passed on to pensioners. Page 4

5 Pensions and Budget 2013 The Tax Strategy Group (TSG) is an interdepartmental committee chaired by the Department of Finance, which prepares papers on various options for the Budget. The Department of Finance have just released the TSG s considerations of Pension Taxation Issues (2011), used as part of the Budget 2012 process. While it doesn t necessarily have any direct bearing on what might happen in Budget 2013, some of the comments and views expressed are interesting and might be a pointer to what might happen in Budge Some of the comments in the TSG Budget 2012 Report are as follows: Curtailing Pension Tax Reliefs it...appears that the restrictions in (pension tax) reliefs, together with the prospect of future curtailments, have also had some impact on the public s confidence in pension investment. The debate on the cost of pension tax relief can be misleading and often creates a false impression of the potential for real cost savings or tax yields that may be delivered by way of significant adjustment to some of these reliefs. Among other impacts, of course, would be the significantly reduced level of investment in pensions that would likely take place in the absence of reliefs. Finance (No 2) Act 2011 introduced the pension fund levy which raised over 460 million. When taken with the Budget 2011 measures, it means a total policy adjustment of 750 million has been made in This is equivalent to 32% of the estimated net cost of pension reliefs in Standard Rating Tax Relief Given the imposition...of the temporary 0.6% stamp duty levy on pension fund assets...a move to standard rating of tax relief on contributions, in addition to the levy, could have a significant negative impact on the pensions industry...there are very significant IT developments, logistical and administrative problems to be overcome for the Revenue Commissioners and others in delivering the tax relief changes in this area (i.e. the move to standard rate tax relief) As the most important fiscal incentive to encouraging pension saving, a reduction on this scale would also represent a major setback to the objective of improving the adequacy and coverage of private pension provision. The Net Relevant Earnings Limit...a further reduction in the level of the cap (i.e. 115,000) would further improve the equity of the existing tax relief arrangements. A reduction from 115,000 to 100,000, for example, would yield about 30 million in a full year. Page 5

6 There is a case, in equity, for incorporating employer contributions to occupational pension schemes within the annual earnings cap and age-related % limits which apply to employee and individual contributions to pension saving, generally, or to apply separate limits to employer contributions. However, aside from the immediate logistical and implementation issues, there are a number of matters in this area which would need to be considered in more detail:..the Revenue Commissioners approval of retirement benefit schemes requires an employer contribution to the scheme which must be meaningful in terms of the benefits to be delivered under the scheme. Placing a limit on employer contributions could have implications for deficit reduction of schemes and could have implications for pension legislation in that schemes are required to reach a minimum level of funding. A limit could also affect proper funding of very ordinary employee schemes that rely heavily on employer contributions. Standard Fund Threshold (SFT) Limits About 1,200 applications for Personal Fund Thresholds (PFTs) (7 December 2010) have been received and over 660 of those have been approved representing total pension funds valued at about 2.1bn (an average PFT of about 3.2 m) The recent reduction (December 2010) in the SFT has exposed certain fault lines in the efficiency and effectiveness of the operation of the SFT/PFT limits as between the private sector and the public service. The limits appear to operate as intended in the private sector to deter the overfunding of retirement benefits through the tax system. Members of DC schemes... can stop contributing to their pension pots so as to avoid exceeding the relevant threshold and suffering a penal tax charge on the chargeable excess. Members of DB schemes in the private sector can arrange with the employer sponsor of the pension scheme to stop accruing benefits for the same reason, the use of the SFT as a means of capping or controlling the value of retirement benefits payable to individuals may only be effective up to a point, particularly in a public service context, after which further reductions in the limit might render the use of the SFT as unwieldy at best. The Programme for Government contains a commitment to cap taxpayer subsidies for all future pension schemes.that deliver income in retirement of more than 60,000. If the SFT were to be used as the mechanism to deliver this commitment then, depending on the approach taken to valuing retirement benefits, the limit may have to be reduced from 2.3m to about 1.4m. Apart from the significantly greater level of administrative complexity involved in dealing, for example, with many thousands more PFT applications... the difficulties created by the operation of the SFT in a public service context as outlined above will become significantly more pronounced. Page 6

7 Imputed Distributions on ARFs and Vested PRSAs For 2009, about 7m was paid...in respect of tax on notional distributions in relation to over 2,600 ARFs The value of assets in ARFs may currently (2011) be of the order of 6bn, which would also include AMRFs Increasing the percentage notional distribution for ARFs generally, and for those of modest value in particular, beyond the current 5% of the value of ARF assets would increase the risk that such ARF owners funds could be depleted before death. There is a case on the grounds of equity and consistency for extending the notional distribution arrangements to PRSAs on the same basis as applies to ARFs. Limits on Tax-Free Lump Sums Finance Act 2011 reduced the maximum lifetime limit of the tax-free retirement lump sum to 200,000. Amounts in excess of this tax-free amount are taxed in two stages. The taxation of retirement lump sums...applies in respect of pension arrangements in both the public and private sectors. One significant difference between public sector and private sector schemes is that private sector schemes invariably allow scheme members the option of commuting part of their pension fund for a tax-free lump sum. This option is not available to members of public sector schemes. Depending on the impact of the tax charge on retirement lump sums, the option to commute part of a pension fund may no longer be exercised by private sector pension scheme members or may be exercised in a manner that reduces the value of the lump sum taken to minimise or avoid any immediate tax charge. Pre-retirement access to pension funds There are a number of reasons why, under existing policies, early withdrawals of pension savings are not permitted, the principal one being that schemes (and the associated tax relief on contributions) are designed to encourage savings over the long term that will be locked away until retirement in order to help provide for an adequate income throughout old age. In the current economic environment, the idea of allowing individuals pre-retirement access to their pension savings if this would prevent them from having their home repossessed or to pay down other household debts is, on the face of it, very attractive....there is no evidence that those individuals likely to be most significantly affected by mortgage or other debts would have access to sufficient pension savings to make a meaningful difference to their immediate financial situation....there is no guarantee that the release of the AVC funds would make a positive economic contribution (the money could be spent on foreign holidays)....the withdrawn funds could be recycled to make further pension contributions relieved at the person s marginal rate of income tax. Page 7

8 Pension Protection from Creditors A recently reported Commercial Court case involving a Small Self Administered Pension Scheme (SSAPS) seems to strengthen the protection of retirement benefits in trust based schemes from creditors. The case involved two members of an SSAPS who had not yet taken benefits from the scheme. In March 2012, a bank successfully appointed a receiver to the member s interest in the SSAPS. The members successfully appealed this decision to the Commercial Court, who discharged the appointment of the receiver. While the full judgement is not yet available, it appears that the Judge relied on the fact that the benefits were held under an irrevocable trust and that: prior to retirement, the members had no legal or beneficial ownership of the SSAPS assets, and their right to retirement benefits under the SSAPS was subject to the agreement of the trustees. From this we can conclude that: neither member was personally a trustee of the SSAPS. it seems that the employer was also not a trustee of the SSAPS, and the terms of the SSAPS trust deed specifically required the trustees permission to consent to the provision of benefits to the members at retirement. Therefore in the SSAPS in point, the member and their benefit entitlement under the scheme appear to have been distanced significantly. While the judgement appears to clarify that benefits held within an occupational pension scheme are safe from creditors at least until drawn, the last two points above may qualify the full applicability of the judgement to other trust based occupational pension schemes where: the member and/or employer might also be a trustee of the scheme, and/or the scheme rules may not require trustee permission to take retirement benefits. The judgement appears to have no direct applicability to personally held arrangements, such as Approved Retirement Funds (ARFs), which are not held under trust. A receiver was appointed some time ago to an individual s ARF, presumably with a view to encashing the ARF to realise funds for the creditors. In the case of Buy Out Bonds (BOBs), Personal Retirement Savings Accounts (PRSAs) and Personal Pension Plans (PPPs), the products are also personally owned but they contain a statutory prohibition on assignment of the benefits under such products. In the case of PRSAs, s.98 of the Pensions Act specifically states that no legal or equitable charge may subsist over the PRSA assets. Page 8

9 However it s not clear whether this prohibition on assignment of benefits could stop a receiver being appointed to an individual s BOB, PPP or PRSA with a view to forcing maturity and payment of the proceeds in circumstances where the individual themselves could draw on those benefits at that time, e.g. over age 50 in the case of a BOB, or over age 60 in the case of a PPP or PRSA. What is clear is that the best protection against creditors applied to benefits held in occupational pension schemes where the member is not a trustee and their retirement benefit entitlement is subject to the trustee s permission. BOBs, PPPs and PRSAs come next with a prohibition on assignment of benefits, but potentially open to the appointment of a receiver who could trigger payment of the benefits in certain circumstances. The least protection of all seems to be with ARFs, to whom a receiver can be appointed who could trigger the encashment of the ARF at any time. Page 9

10 Pension News from Aviva Life & Pensions Special Offer for Pensions Business Our special offer for pensions business provides for a reduction in fund management charge of up to 0.15% (depending on premium size) OR increasing the allocation rate by up to 1.00% (depending on premium size). You can opt for a reduced fund management charge OR an increased allocation rate on Horizon Plan (single & regular premiums) and also on Horizon Plan Options (single premiums only). This offer is available from 1 October to 16 November (terms and conditions apply - please refer to Pensions Special Offer sales aid for further details). Launch of 3 new ARF / AMRF Products Aviva is delighted to announce the launch of our new Options range of ARFs/AMRFs products. The three new products give you flexibility on premium amounts, charges, allocation rates and commission. This, along with Aviva s wide investment choice, will give you and your customers the edge in post-retirement planning. New Fund Based Commission Structure To coincide with the launch of our new ARF / AMRF products we are now giving Financial Advisers the option of taking fund based commission in bands of 0.05% across our Horizon Plan range of pensions products, our Group Pension Plans and also on our Group Buy Out Bond. The option of taking fund based commission in bands of 0.05% is available to new business on the following range of products: Horizon Plan Horizon Plan Options Corporate Plan Corporate Plan Options Group Buy Out Bond ARFs / AMRFs New Revenue Maximum Contribution Calculator You will find a new Revenue Maximum Contribution Calculator which will serve as a useful tool in working out how much your customer can contribute personally to their chosen pension arrangement based on their net relevant earnings. Enhancements to our Mind the Gap Pension Calculator Enhancements have been made to the Mind the Gap Pension Calculator to allow customers to view both Present Day Values and Values at Retirement. This enhancement has been made to both the Customer Version and the Financial Adviser Version. Simply click on the Values at Retirement tab to switch from the default - Present Day Values. Present Day Values and Values at Retirement are also displayed on the PDF report which is generated from the Financial Adviser version of the calculator. For details on any of the above initiatives please logon to or feel free to contact me or talk to your broker consultant. Page 10

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12 Disclaimer: This newsletter has been produced by Aviva Life & Pensions Ireland Limited, a subsidiary of Aviva Life Holdings Ireland Limited, a joint venture company between Aviva Group Ireland plc and Allied Irish Banks, p.l.c. Great care has been taken to ensure the accuracy of the information it contains. However, the company cannot accept responsibility for its interpretation, nor does it provide legal or tax advice. This newsletter is based on Aviva s understanding of current law, tax and Revenue practice as at November Warning: The value of your investment may go down as well as up. Warning: If you invest in this product you may lose some or all of the money you invest. Warning: If you invest in this product you will not have any access to your money before you retire. Warning: These products may be affected by changes in currency exchange rates. Warning: Withdrawals and switches from funds investing directly or indirectly in property may be deferred for up to 6 months. Warning: Withdrawals and switches from all other funds may be deferred for up to 3 months. Warning: The income you get from this investment may go down as well as up. Aviva Life & Pensions Ireland Limited. A private company limited by shares. Registered in Ireland No Registered Office One Park Place, Hatch Street, Dublin 2. Member of the Irish Insurance Federation. Aviva Life & Pensions Ireland Limited is regulated by the Central Bank of Ireland. Aviva Life & Pensions Ireland Limited is a subsidiary of Aviva Life Holdings Ireland Limited, a joint venture company between Aviva Group Ireland plc and Allied Irish Banks, p.l.c. Life & Pensions One Park Place, Hatch Street, Dublin 2. Phone (01) Fax (01) Telephone calls may be recorded for quality assurance purposes