In Sight. This quarter s round-up. Regular features. 02 Countdown to auto-enrolment. 04 Budget Asset-backed pension contributions

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1 In Sight May 2012 a quarterly pensions publication This quarter s round-up 02 Countdown to auto-enrolment Automatic enrolment will become a reality for employers within a matter of months. Most of the framework is now in place, allowing employers to take action to ensure compliance with their new duties. 04 Budget 2012 A summary of the announcements relating to pensions. 05 Asset-backed pension contributions The Government has announced further changes to the previously published draft legislation and structured finance rules on asset-backed employer pension contributions. 06 The Pensions Regulator The Pensions Regulator has published its fourth financial support direction. 06 Statutory Money Purchase Illustrations The Board for Actuarial Standards has published Version 2.0 of TM1 that applies for illustration dates on or after 6 April Pension Protection Fund The US Court of Appeals upholds an earlier ruling in the Nortel case. The sixth edition of the Purple Book published with the Pensions Regulator is now available. 07 Guaranteed Minimum Pensions We consider the DWP s consultation on equalising pensions for the effect of GMPs and note that the fixed rate of GMP revaluation has increased. 07 EU pensions The European Commission has published a White Paper on adequate, safe and sustainable pensions in the European Union. It includes plans to update the Pensions Directive, which the EU pensions authority is consulting on separately. 08 Implementing FATCA It is still not clear whether UK pension schemes are exempt from the provisions of the US Foreign Account Tax Compliance Act. Regular features 05 On the horizon 08 Seminar and teleconference dates

2 Counting down Automatic enrolment will become a reality for employers within a matter of months. The largest employers will be required to automatically enrol employees into a pension scheme from October. While employers prepare, the Government and the Pensions Regulator have issued regulations, consultations and guidance intended to complete the framework of the new regime. Timetable delayed for smaller employers In the February edition of In Sight, we reported that the Department for Work and Pensions (DWP) had confirmed that it was delaying auto-enrolment for smaller employers. The DWP has provided further details of the proposed timetable for employers with less than 250 employees and issued a consultation on the draft regulations to effect the revised staging dates. Revised staging dates for employers with fewer than 250 employees are as follows: Employer size (by PAYE scheme size) Revised staging date between 50 to April April to 49 1 August October 2015 Fewer than 30 1 January April 2017 New employers setting up between April 2012 and September 2017 will have staging dates between 1 May 2017 and 1 February Transitional periods extended The transitional periods for employers qualifying schemes will be extended, in line with extensions being applied to smaller employers staging dates. For employers providing defined contribution (DC) qualifying scheme membership, the minimum contribution requirements will be phased in over the period to 1 October 2018, as shown in the following table: Phasing-in of contribution requirements Transitional period Staging date to 30 September October 2017 to 30 September October 2018 onwards Minimum employer contribution Minimum total contribution 1% 2% 2% 5% 3% 8% Employers providing defined benefit or hybrid qualifying scheme membership will be able to defer automatic enrolment for certain existing workers. The transitional period will end on 30 September 2017, one year later than under the current legislation. Thresholds for 2012/13 Following consultation, the DWP has announced that the following thresholds will apply for the 2012/13 tax year: The automatic enrolment earnings trigger is 8,105. This is equal to the 2012/13 threshold for payment of income tax (the basic personal allowance). The lower limit of the qualifying earnings band is 5,564. This is equal to the 2012/13 lower earnings limit for National Insurance contributions (NICs). The upper limit of the qualifying earnings band is 42,475. This is equal to the 2012/13 upper earnings limit for NICs. While the thresholds are aligned with tax and NICs thresholds, this need not be the case in future. We do not know whether the increase in the income tax personal allowance to 9,205 for 2013/14 (announced in the Budget) will be reflected in an increase in the automatic enrolment earnings trigger next year. If the trigger is set to tie in with this allowance, more workers will fall outside of the auto-enrolment requirements. Automatic enrolment regulations finalised In July 2011, the DWP consulted on draft legislation for completing the legislative framework for automatic enrolment. In February, it issued its response to the consultation and finalised regulations. In response to feedback received during the consultation, the DWP made a number of changes to the framework. This included clarification of the pensionable pay definitions for the alternative certification requirements for DC schemes, extending the period that employers have to notify employees if they postpone automatic enrolment, and simplifying and aligning the requirements for providing information. 2 In Sight Aon Hewitt Quarterly Pensions Publication May 2012

3 Alternative certification requirements for DC schemes A DC scheme that bases contributions on its own definition of pensionable pay may be able to meet an alternative quality requirement set out in the regulations. The arrangements in respect of the employees considered for certification need to meet one of three tests. The three tiers allow for pensionable pay as follows: Tier 1 Pensionable pay is subject to a minimum of basic pay Tier 2 Pensionable pay is subject to a minimum of basic pay, and total pensionable pay is at least 85% of total pay across all relevant employees Tier 3 Pensionable pay is equal to all earnings For tiers 1 and 2, basic pay is pay that does not vary. It excludes commission, bonuses, overtime, shift premiums, allowances paid in respect of fire wardens or other ancillary duties, relocation allowances, car and certain other allowances. Reasonable allowances for clothes, meals, attendance and first aid duties are also excluded. However, geographical allowances, such as London weighting, are included in basic pay. The various components of pay are illustrated below. Different minimum contribution requirements apply to each tier. The regulations have also been amended to extend the period of validity of a scheme certificate from 12 to 18 months. Postponing automatic enrolment for employees While employers can opt to postpone automatic enrolment for up to three months (for example, to stagger enrolment of a large workforce or to align the date with an existing internal process), the consultation proposed that they would only have one week from what would have been the automatic enrolment date to notify employees of their decision. The DWP has decided to extend this period, which means that employers will have one month to notify employees, beginning with the day after what would have been the automatic enrolment date. Simplifying and aligning the requirements for providing information The DWP confirmed that the regulations do not bar an employer from providing a worker with additional information if it wants to as long as it does not encourage an individual to opt out. It also states that information can be provided at any time and, where appropriate, employers may use this flexibility to provide information in advance of the periods set out in legislation. Pensions Regulator s guidance Following the release of the finalised regulations, the Regulator updated its detailed guidance. The revised guidance, which is available on its website, includes new content on the following areas: How employers can postpone the assessment and automatic enrolment of workers The certification of DC schemes Areas to consider to help determine whether an employee is ordinarily working in the UK, including further examples for employers Contractual enrolment, which is where an employer can enrol members into a scheme (for example, under a contract of employment) using its own process but will still need to comply with ongoing obligations under the automatic enrolment requirements Salary sacrifice and flexible benefits arrangements The Regulator has also set out its regulatory strategy for maximising employer compliance with the auto-enrolment duties and supporting the pensions industry to deliver DC schemes with the characteristics necessary for good member outcomes. Components of pay Earnings 42,475 Qualifying Earnings 5,564 Pensionable Earnings Fluctuating Pay Certain allowances Shift premium pay Basic Pay Bonus Commission Overtime Salary & wages Holiday pay Statutory sick pay Maternity/paternity Adoption Pay Can exclude from basic pay any reasonable allowance for: Car allowances Clothing allowances Meal allowances Attendance allowances Shift allowances Allowances for ancillary/health and safety duties such as fire warden, first aid, key holder Relocation allowance Delivery of a service to the jobholder Shift premium pay means: Where the employer applies different rates of pay to different periods of time for which the job holder works within a certification period, the difference between: The earnings that result from applying the different rates of pay to the periods to which each of them respectively apply, and The earnings that would result from applying the lowest of the different rates of pay to the total time worked during the certification period 3

4 Budget 2012 Despite the many rumours that the Government would make further cuts to pensions tax relief, there were no significant changes announced in the March Budget. However, there were a number of pensions-related announcements, while changes announced elsewhere in the Budget will impact on the attractiveness of pensions. State pensions Following its Green Paper last year, the Government plans to change the State Pension into a single-tier system for future pensioners, providing a weekly payment of about 140 a week. The new system will be introduced early in the next Parliament. Further details are due to appear in a White Paper in the spring, with the Government making its final decisions at the next spending review. This appears to signal the end of contracting out. The Government intends to ensure that the State Pension age continues to rise in future to take into account increases in longevity. Other pensions-related proposals Further regulations are expected to make minor changes to the rules surrounding fixed protection and the annual allowance, to ensure that they work as intended. The Government also announced plans to limit some existing practices: Ensuring that flexible remuneration arrangements, where an employer pays a pension contribution for an employee s spouse or family member, cannot be used to obtain tax and National Insurance Contributions (NICs) advantages for the employee or the employer Strengthening reporting requirements and powers of exclusion relating to Qualifying Recognised Overseas Pension Schemes The Government also repeated that it would take action if it appears necessary to prevent any new and extensive use of unfunded pension arrangements from creating a significant fiscal risk. The Debt Management Office is to consult on the issuance of gilts of over 50 years and perpetual gilts. A new Pension Infrastructure Platform, owned and run by UK pension funds, will make the first wave of its initial 2 billion investment in UK infrastructure by early A separate group of pension fund investors has also presented proposals to the Treasury for increasing pension plan investment in infrastructure. Income tax and allowances From April 2013 the top rate of income tax will go down from 50% to 45%. At the same time, the income tax personal allowance will be increased to 9,205. However, age-related additional allowances will be frozen and eventually withdrawn to give a single allowance that applies regardless of age. New proposals to taper the withdrawal of child benefit could increase the attractiveness of pension contributions or salary sacrifice for those with incomes between 50,000 and 60,000. The indications are that making pension contributions could effectively boost the child benefit that individuals in this group receive. The Government will also launch a detailed consultation on integrating the operation of income tax and NICs. It will set out a broad range of options for the operation of employee, employer and self-employed NICs. Corporation tax The main rate of Corporation Tax is to be reduced from 26% to 24% from April 2012 (compared with the reduction to 25% already planned). It will then go down by a further 1% as planned for the next two years. This means that the rate will be 22% from April Capping non-pensions tax relief The Government announced that it would introduce a limit on all uncapped income tax relief. The announcement stated that for anyone seeking to claim more than 50,000 of reliefs, a cap will be set at 25% of income. This limit will not be extended to reliefs that are already capped, such as pension contributions. It has subsequently been suggested that the proposal might be revisited due to the adverse impact on charitable giving. 4 In Sight Aon Hewitt Quarterly Pensions Publication May 2012

5 Clamping down on asset-backed pension contributions The Government continues to clamp down on perceived abuses around asset-backed contributions. Its concern is that scheme sponsors sometimes obtain tax relief which is excessive in relation to the contributions that are actually paid. There are two problem areas: Sponsors using a special purpose vehicle (SPV) to obtain double tax relief. (The sponsor obtains upfront tax relief on a contribution paid to the pension scheme which is used to buy an interest in the SPV, and also claims relief on the ongoing income payments that the SPV makes to the pension scheme.) Sponsors claiming tax relief up front in relation to an arrangement that includes a final bullet payment to the pension scheme, the size of which is contingent upon the pension scheme s funding level at the time the payment is due (and which might therefore never actually be paid). In the February 2012 edition of In Sight, we reported that the Government had released draft legislation in the Finance Bill 2012 in order to address these issues. The new provisions would affect certain payments or accounting write-downs made from 29 November Other payments relating to arrangements that qualified as structured finance arrangements would be protected under transitional arrangements. In certain circumstances, where the arrangement ends (or is deemed to end) and the amount of tax relief already received exceeds that justified by the contributions actually paid, the excess would be clawed back. However, it subsequently transpired that the draft legislation was not going to work as intended, and a revised draft was published on 22 February, restricting beneficial tax treatment to acceptable structured finance arrangements. The 22 February rules will apply to certain payments and write-downs made after that date. However, they do not completely replace the provisions in the earlier draft legislation, which will still apply in some circumstances. The Chancellor announced further amendments in the March Budget. These ensure that the claw-back provisions can still be applied where, before the finance arrangement ends, a company ceases to be a taxable entity (for example on wind up) and make further changes to the definition of a structured finance arrangement. The upshot is that while SPVs and other asset-backed contributions continue to be useful for many reasons, the rules relating to tax relief have become considerably more complex. Key dates for expected legislative developments impacting occupational pension schemes are highlighted in the chart below. 1 October 2012 Auto-enrolment starts for large employers 21 December 2012 Certain gender-based premiums or benefits become unlawful 1 January 2013 New IAS19 to apply Spring 2012 White Paper on State Pensions December 2012 Deadline for schemes to meet Pensions Regulator s member data targets 31 December 2013 First deadline for member requests for scheme pays 5

6 Round-up Pensions Regulator Determination notice published in Box Clever case The Pensions Regulator s Determinations Panel has published a determination notice and its reasons for issuing financial support directions against five companies in the ITV group. This notice relates to the insolvency of Box Clever Technology Ltd (BCT), which was established in 1999 by the Granada and Thorn groups in a joint venture. As part of this arrangement, a pension scheme was set up for employees transferring from Granada and Thorn. The Granada and Thorn schemes retained liability for service before the transfer, but the Box Clever Pension Scheme topped up those benefits by paying for final salary linkage. The ITV group received cash proceeds of approximately 500 million as a result of the transaction, which was paid from debt of 860 million raised by BCT. This debt was a major factor in the insolvency of BCT. The proceeds from the sale of the BCT businesses were not sufficient to meet the claims of the unsecured creditors, including the Box Clever Pension Scheme, which in December 2009 had a buy-out deficit of approximately 62 million. The Determinations Panel did not find any misconduct on the part of the five companies but found that it was reasonable for them to provide financial support for the Box Clever Pension Scheme because they had received valuable financial benefits from the creation of the venture, and its structure left the sponsoring employers in a weak position. The target companies have referred the decision to the Upper Tribunal. The Regulator cannot issue financial support directions while appeal proceedings are pending. Statutory Money Purchase Illustrations The Board for Actuarial Standards has released a new version (2.0) of Technical Memorandum 1(TM1) on Statutory Money Purchase Illustrations. Following extensive consultation, the Board has made a number of amendments that are designed to simplify the text. Key changes also include alterations to the assumptions for mortality and potential investment returns. Version 2.0 applies to illustrations with an effective date on or after 6 April However, the implementation timetable is more flexible than originally envisaged, with the option of complying with the current version (1.4) for statements issued between 6 April 2012 and 20 December Pension Protection Fund PPF loses US appeal The US Court of Appeals has upheld an earlier ruling that the Pension Protection Fund (PPF) and the trustees of the UK Nortel pension scheme cannot pursue a financial support direction against various US-based Nortel subsidiaries. The PPF and the trustees had hoped to make use of a police power exception US law that allows a governmental unit to bring or continue actions against a debtor to prevent or stop violations of law affecting matters of public health, safety, or welfare. The Court ruled that neither party is a governmental unit: under UK law the trustee is a private party responsible for administering the plan and ensuring that members receive their benefits, and the PPF is a Government-created but privately funded entity that acts as a safety net where employers cannot fully fund their pension obligations. It noted that the Pensions Regulator may be a governmental unit, but it is not a party to Nortel s bankruptcy proceedings. The Court further noted that, in any case, the financial support direction fails the tests that are required for the police power exception to apply because the primary goal is to determine whom to hold liable for the deficiency in a private pension scheme. This does not protect public safety and health, and it is too far removed from the broader goal of protecting pension plans in the UK. The effect of the judgment is that the PPF and the trustees will have to negotiate with other creditors for their share of Nortel s assets from its US, Canadian and European entities. Purple Book 2011 The Pension Protection Fund and the Pensions Regulator have published the latest Purple Book, an annual publication that focuses on the risks faced by the UK s defined benefit schemes. The new edition sets out changes to scheme funding over the 12 months to March 2011 based on a dataset of over 6,400 schemes. The results show that the aggregate funding position of all schemes on a section 179 basis fell over the year to March 2011, from 104.3% to 99.9%. It is noted that the position is likely to have deteriorated markedly since then. The book can be found on the Regulator s website. 6 In Sight Aon Hewitt Quarterly Pensions Publication May 2012

7 Guaranteed Minimum Pensions Addressing the equalisation issue The Department for Work and Pensions (DWP) has finished consulting on proposed changes to legislation which would, for the first time, introduce an explicit requirement to equalise scheme benefits for the effect of unequal Guaranteed Minimum Pensions (GMPs) and remove the need for there to be a comparator of the opposite sex before such equalisation is required. The Government recognises that a degree of uncertainty has existed for some time over GMP equalisation and wishes to offer schemes as much help as possible in providing equalised benefits. However, it has rejected the suggestion that it should bring forward a Governmentsponsored test case on the grounds that this would only prolong the uncertainty and not address the issue of how equality is to be achieved. The consultation included details of a possible method for equalising benefits, which the Government is considering publishing. However, there would be no obligation on schemes to use this method and it would not constitute legal advice to schemes, or be a definitive statement on how to equalise. It remains to be seen whether DWP backing would encourage trustees to use the proposed approach. Developments in Europe White Paper on pensions The European Commission s delayed White Paper on pensions, An Agenda for Adequate, Safe and Sustainable Pensions, was published in February. Against the backdrop of an ageing population and the current economic crisis, both of which are putting pressure on public finances, the paper discusses the current challenges, which are seen to be: Securing the financial sustainability of pension systems Maintaining the adequacy of pension benefits Raising the labour market participation of women and older workers. Successful reforms should balance the time spent in work and retirement, and develop complementary private retirement savings. Proposed measures include: Encouraging Member States to provide better information to individuals on retirement planning Presenting a legislative proposal to review the Pensions Directive, taking account of Solvency II (see right) Resuming work on a portability Directive (originally drafted in 2005) to set minimum standards for the acquisition and preservation of pension rights. The White Paper promises a large number of initiatives starting in For the UK, many of these echo action already taken or proposed, but some may lead to further legislation. The suggested approach For members with GMP earned between 17 May 1990 and 5 April 1997 (the date of the Barber judgment and the date on which GMPs ceased to accrue respectively) two calculations would be carried out for the relevant period: The existing calculation, and A calculation using the GMP of the opposite sex At each date a payment becomes due the higher of these two calculations would need to be paid. In many schemes, this would lead to members receiving more in total than either a male or female would have received, over the period of their retirement. The approach suggested would lead to a significantly increased administrative burden (apart from the additional liability cost of the increased benefits). In addition, many of the complexities are not addressed, such as dealing with historic payments over the last 20 years. Increase in fixed rate of GMP revaluation Quite separately, fixed rate revaluation of GMPs for early leavers has increased from 4% to 4.75% where a member s contracted-out employment ceases on or after 6 April EU pensions authority advises on pensions harmonisation Also in February, the EU pensions authority (EIOPA) published its final advice to the European Commission on the review of the Pensions Directive. As part of this review, EIOPA was asked to advise on what changes would need to be made to the Solvency II requirements that apply to insurance companies if they were to be applied to pension schemes. EIOPA notes in its response that it was not asked whether Solvency II was the correct starting point and that many respondents to its consultation stated that it was the wrong initial framework. EIOPA s proposal is for a holistic balance sheet based on a market-consistent valuation of all enforceable pension promises. Much of the detail remains uncertain and there are a wide range of possible outcomes; the worst case scenario would see defined benefit schemes forced to fund to a buy-out level (or higher). EIOPA emphasises that its advice is conditional on the results of a Quantitative Impact Study, to show whether a common level of security would be effective in terms of costs and benefits. Work on this has already started and EIOPA aims to publish the results in the second half of the year. The European Commission is due to publish a draft of the revised Pensions Directive before the end of EIOPA s advice also covers cross-border activity (and its definition), governance and risk management, and - for defined contribution schemes in particular a possible reserve against operational risks. 7

8 Implementing FATCA From 2014, the US Foreign Account Tax Compliance Act of 2010 (FATCA) may start to have a significant effect on UK pension schemes that either have US sponsors or invest in the US. The extent of the impact is currently uncertain, but could result in contributions or investment proceeds originating in the US becoming subject to a withholding tax. Draft US regulations issued on 8 February would expand the category of foreign retirement plans that are exempted from the requirements. However, at the moment it is unclear whether UK registered pension schemes would qualify for this exemption. Also on 8 February, governments of the US and five EU countries (including the UK) issued a Joint Statement proposing an alternative approach to implementing FATCA. The intention is that affected institutions in these five countries will comply by reporting directly to their own tax authorities, who will then exchange information with the US. For any UK pension schemes that do not qualify for an exemption, it may be that a practical way for them to comply will be found under this approach. Seminar dates Unless it says otherwise, all courses take place in central London Full day course Defined Benefit part 1 (one day) Defined Benefit part 2 (one day) Defined Contribution (one day) PMI Award in Pensions Trusteeship (two days) Pensions Management Committee Training (half day) Support with the Pensions Regulator s Toolkit Pre-retirement Seminars (half day) Other events Current Issues for Trustees Seminars 5.30 pm Trustee Teleconference 9.00 am 2012 dates 9 May, 20 June, 11 July, 5 September, 21 November 29 May, 18 July, 26 September, 4 December 3 July, 7 November 10/11 October Dorking, Surrey 2 October Courses organised on request Courses organised on request 2012 dates 26 June 25 September 20 November 19 June 20 September 27 November If you have any questions, please speak to your usual Aon Hewitt consultant or contact Helen-Mary Finney on: t: +44 (0) e: helen-mary.finney@aonhewitt.com Aon Hewitt, Parkside House, Ashley Road, Epsom, Surrey KT18 5BS About Aon Hewitt Aon Hewitt is the global leader in human resource consulting and outsourcing solutions. The company partners with organisations to solve their most complex benefits, talent and related financial challenges, and improve business performance. Aon Hewitt designs, implements, communicates and administers a wide range of human capital, retirement, investment management, health care, compensation and talent management strategies. With more than 29,000 professionals in 90 countries, Aon Hewitt makes the world a better place to work for clients and their employees. Nothing in this document should be treated as an authoritative statement of the law on any particular aspect or in any specific case. It should not be taken as financial advice and action should not be taken as a result of this document alone. Individuals are recommended to seek independent financial advice in respect of their own personal circumstances Aon Hewitt Limited Aon Hewitt Limited is authorised and regulated by the Financial Services Authority. Registered in England & Wales. Registered No: Registered Office: 8 Devonshire Square, London EC2M 4PL. This document has been produced using a minimum of 50% recycled material from a sustainable forest. SB3313