Global Defined Contribution Update Fourth Quarter 2010 This quarterly Update summarizes recent legislative developments and trends related to defined contribution retirement (DC) plans and highlights recently passed and pending legislation that may require employers to take action to comply with new rules or review existing plans. Action May Be Required Norway Employers are reminded that new National Insurance (NI) rules creating a flexible retirement system will be implemented effective January 1, 2011. Under the new NI, the fixed retirement age will be abolished, and employees will be permitted to draw their pension between age 62 and age 75 while continuing to work and accruing pension rights. Occupational pension plans will be required to follow the same rules. With regard to occupational DC plans, this means an employee will remain a member of a plan as long as he or she is working and the company is contributing to the account, regardless of whether the employee begins to draw a pension. In order to draw a graded pension at age 62, the minimum account balance must exceed 0.2 times the NI Basic amount (B.a.) throughout the pension payment period. The employee also may draw a full pension and receive benefits until the account has been depleted. The pension must be paid until the employee reaches age 75 and for a minimum of 10 years. The employee can opt for a time-limited payment or a lifelong payment until age 75. If an employee continues to work and receive a pension, the cost of managing the pension account is split evenly between the employee and the employer. 2010: An Overview 2010 can best be characterized as a year of starts-and-stops with regard to legislative activity addressing employer-provided and statutory defined contribution plans. In Japan, Diet debate stalled on the expansion of the DC system to allow employee contributions. In the Philippines, the implementation of Personal Equity Retirement Accounts (PERAs), a 401(k)-like system, still awaits additional tax regulations. In Hong Kong, employee choice of Mandatory Provident Funds (MPF), expected in 2010 and postponed to 2011, may be further delayed as the government considers a complete review of the MPF system. In China, on the other hand, new tax treatment of employer contributions to Enterprise Annuities appears to be facilitating the growth of these plans. In Korea, employer interest in DC plans has been reignited by the change in tax benefits for the external funding of severance pay plans. Copyright 2010 Aon Hewitt Inc 1
The debate in Europe has focused primarily on statutory and mandatory DC plans. In the United Kingdom, regulations for the implementation of mandatory autoenrollment of jobholders into qualified workplace pension arrangements or the National Employment Savings Trust (NEST) in 2011 is being finalized. The Hungarian government stopped short of a full nationalization of second-pillar pension funds by suspending contributions to the pillar and giving individuals the ability to opt out. In Poland, the government looked like it might follow a similar path before it pulled back and decided to allow open pension funds (OFEs) to develop greater investment options, differentiated by risk. The Czech Republic and Ukraine are likely to implement three-pillar systems in 2011. In North America, the United States has passed various notices and regulations designed to strengthen the DC system, and the federal and several provincial legislatures in Canada are reviewing bills that affect DC plans. In Latin America, the Bolivian government continues to pursue plans to nationalize private pension funds. Legislative Developments Americas On November 30, 2010, the U.S. Internal Revenue Service (IRS) released Notice 2010-80, which provides additional relief for nonqualified deferred compensation plans covered under Code Section 409A. Notice 2010-80 expands the types of plans eligible for relief under Notice 2010-6, which was released by the IRS on January 5, 2010. Notice 2010-80 provides an additional method of correction and transition relief under Notice 2010-6 for certain plan document failures relating to payments at separation from service, and modifies the correction reporting requirements in Notice 2010-6 and Notice 2008-113. The U.S. IRS also issued Notice 2010-84, which provides guidance relating to rollovers from Section 401(k) plans to designated Roth accounts in the same plan (i.e., in-plan Roth rollovers ). The guidance in Notice 2010-84 also generally applies to rollovers from Section 403(b) plans to designated Roth accounts in the same plan. Section 2112 of the Small Business Jobs Act of 2010 added Section 402A(c)(4) to the Code, effective for distributions made after September 27, 2010, to permit plans that include a qualified Roth contribution program to allow individuals to roll over amounts from their accounts other than designated Roth accounts to their designated Roth accounts in the plan. This Notice includes guidance related to: 1) the timing of plan amendments; 2) participant disclosures; 3) plan treatment of converted amounts; and 4) taxation and withholding of the in-plan rollovers and subsequent distributions. To improve Canada s retirement income system, the Standing Senate Committee on Banking, Trade, and Commerce recommends that the federal government: 1) encourage multiemployer pension plans, including Registered Retirement Savings Plan (RRSP) arrangements, to facilitate employer contributions that would be locked in for retirement purposes until the employee retires; 2) amend the Income Tax Act (ITA) to increase over an eight-year phase-in period the maximum age for contributing to an RRSP from age 71 to age 75; 3) annually review the current schedule of minimum Registered Retirement Income Funds withdrawal rates to ensure it remains appropriate; 4) amend the ITA to establish an amount for lifetime contributions to a tax-free savings account, initially set at CAD 100,000, which would be indexed to inflation; 5) make necessary legislative amendments to ensure that, while remaining taxable, RRSP withdrawals have no impact on eligibility for or the amount of federal income-tested benefits and tax credits; 6) develop in association with the provinces, territories, and relevant stakeholder groups, financial education materials appropriate for a range of ages and situations and Copyright 2010 Aon Hewitt Inc 2
available in various formats; and 7) work with the provinces and territories to establish a Canada-wide DC pension plan featuring automatic enrollment with an opt-out feature, lower fees, and shared risk. Asia Australians and New Zealanders will soon be able to voluntarily transfer their retirement savings between approved Australian superannuation funds and New Zealand KiwiSaver funds in order to consolidate their retirement savings in their country of residence. Access to transferred funds will be governed by the rules of the country from which the funds were transferred; access to earnings will be governed by the rules of the country of residence. Partial transfers will not be permitted. New Zealand has passed legislation establishing a trans-tasman retirement savings portability scheme. Australia s parliament is expected to consider legislation implementing the scheme in its upcoming session. In Hong Kong, the Legislative Council is debating a motion to comprehensively review the MPF system, which turned 10 years old on December 1, 2010. The review is likely to include: 1) implementation of universal retirement protection; 2) elimination of provisions that allow employers to use their contributions to the MPF to offset severance and long-service payments; 3) implement a system of one lifelong account through the portability of MPF accounts and require trustees to facilitate account inspection; 4) reduce MPF management and administration fees; 5) give employees totally unrestricted choices under the MPF system, allowing them to select trustees for their contributions and employers contributions; 6) strengthen the regulation of MPF products; and 7) determine the appropriateness of existing minimum and maximum levels of income and if the minimum level of income should be higher than the minimum wage. The Malaysian government has announced plans to establish a Private Pension Scheme (PPS) to give employees more choice in retirement savings funds and, presumably, to compete with the Employees Provident Fund (EPF). Reportedly, existing tax relief for contributions to the EPF (MYR 6,000) would be extended to funds in the PPS. It is not clear how funds approved for the PPS would relate to the Members Investment Savings Scheme (MISS). The MISS is an alternative EPF investment program which allows EPF members who are younger than age 55 and have at least MYR 55,000 in their retirement account (Account I) to invest part of this amount in a unit trust through external fund managers appointed by the Ministry of Finance. Members must invest at least MYR 1,000 but no more than 20% of the amount exceeding MYR 50,000 in Account I. All investments in MISS must be made through fund managers appointed by the Ministry of Finance. Europe The U.K. government has indicated that it will permit pension transfers from defined benefit (DB) contracted-out schemes to DC schemes. It will introduce safeguards so that members fully understand the transfer process, as the requirement to provide survivors benefits after the transfer will be eliminated. In October 2010, the Hungarian Parliament passed legislation that suspends contributions to second-pillar pension funds for 14 months. As of November 2010, these contributions are being diverted to the first-pillar. Opposition parties requested a review of this move by the Constitutional Court; however, the government blocked the review. The European Union is expected to review the government s actions. In related news, the Parliament passed and President Schmitt signed the Law on the Free Choice of Pension Funds at the end of October 2010. Membership in second-pillar funds is optional for individuals just joining the workforce, and second-pillar members Copyright 2010 Aon Hewitt Inc 3
are permitted to return to the first-pillar pay-as-you-go system until the end of 2011. Government officials have indicated that they see a future for the pay-as-you-go system and voluntarily funded private pension funds. In Poland, work on the reform of second-pillar open pension funds (OFEs) continues. The government reports that an expert commission is drafting amendments to OFE legislation that would restructure the system in order to allow OFEs to offer multiple funds differentiated by risk. The OFEs would be permitted to offer three funds. The first fund, which would target young investors, would be permitted to invest up to 85% of assets in stocks; the second fund, 40%; and the third fund, 15%. Fees charged by the funds would fall 20% to 25%. The Ukrainian government announced plans to introduce the second- and third-pillar pension systems by 2012. The 2003 Compulsory State Pension Insurance Act established a new three-pillar pension model consisting of a mandatory solidarity system financed on a pay-as-you-go basis by contributions from employees and employers (first pillar), a mandatory state pension insurance fund which would invest contributions in the Ukrainian economy (second pillar), and voluntary nonstate pension insurance (third pillar). Implementing legislation for the second and third pillars has been under development since the legislation s passage. Under the proposal, contributions to the second pillar would be initially set at 2% in 2012 and increase to 7% by 2017. The plans are part of the government s 2010 2014 Program of Economic Reforms. United Kingdom: Update on NEST The government announced that it intends to proceed with the implementation of autoenrollment on the basis of recommendations made by an independent commission, specifically proposals for an increase in the earnings threshold for automatic enrolment; elimination of the NEST exemption for micro-employers; and consultation around schemes certifying that they meet the qualifying requirements. The earnings threshold at which an individual is automatically enrolled into a workplace pension is to be aligned with the income tax personal allowance (GBP 6,475 in 2010/11, but going up to GBP 7,475 the following year). However, the threshold at which pension contributions become payable will be aligned with the National Insurance primary threshold (GBP 5,720 in 2010/11). This reduces the likelihood of low earners who might not ultimately benefit from autoenrollment from being included, while ensuring that those who are included have a reasonable sized pension pot when they retire. Workers with earnings between these two thresholds can opt in, in which case they will be eligible to receive the employer contribution. The report recommends that there should be no exemption for micro-employers from the autoenrollment obligation. In the opinion of the review team, NEST is uniquely suitable for the smallest employers and without it, autoenrollment would not be feasible for companies employing fewer than 20 employees. The report also recommends that the government should legislate to remove, in 2017, the limit on contributions payable to NEST and to remove the restrictions on transfers in and out of NEST. One other long-standing issue has been how pension plans that use a pensionable salary definition which differs from the qualifying earnings definition can certify that their plan meets the quality test (the self-certification issue). The review team has addressed this issue and has recommended that the following contribution structures in a DC plan should be certifiable: Copyright 2010 Aon Hewitt Inc 4
Nine percent of pensionable pay, including at least 4% from the employer; Eight percent of pensionable pay, including at least 3% from the employer provided pensionable pay constitutes at least 85% of the total pay bill ; and Seven percent of pensionable pay, including at least 3% from the employer provided the total pay bill is pensionable. These compare with the quality requirement for DC schemes set out in the Pensions Act of 8% of band earnings, including at least 3% from the employer. A consultation on this proposal will be held. The largest employers, scheduled to be brought into the reforms in October and November 2012, will be allowed to automatically enroll as early as July 2012. Employers will be allowed to operate a waiting period of up to three months before an employee needs to be automatically enrolled into a workplace pension. Workers can, however, opt in during the waiting period. There will be no minimum employer contribution rate required in order to operate this waiting period. With the exception of some detail around self certification, the final pieces of the puzzle are now in place, assuming the recommendations are implemented. Therefore, companies can start to finalize their plans for complying with their autoenrollment obligations. Trends in Defined Contribution Plans Australia: A Review of Superannuation The Superannuation Guarantee Law mandates a minimum level of contributions that an employer must pay to a qualified retirement (superannuation) fund for all employees with earnings of at least AUD 450 per month. It is managed by the private sector. Employers must make Superannuation Guarantee contributions at least quarterly (by October 28, January 28, April 28, and July 28) each year. Employers that do not meet the quarterly deadlines must pay the superannuation guarantee charge to the Australian Tax Office, which includes the outstanding Superannuation Guarantee plus administrative costs and interest. The age limit up to which superannuation contributions are required is age 70. However, employed individuals who work at least ten hours per week can make personal superannuation contributions up to age 75 (employers are not required to do so beyond age 70). Concerns relating to Australia s aging population have triggered government initiatives to encourage people to contribute to superannuation at increased levels, with the intent to reduce future reliance on the Social Security Age Pension. Copyright 2010 Aon Hewitt Inc 5
Characteristics of Superannuation Plans in Australia Plan Feature Design Comments Approach Employer Contributions Defined contribution accumulation fund Statutory: 9% of Ordinary Time Earnings (OTE) to AUD 160,680 1 Companies may have multiple funds due to past actions, choice of fund legislation, and/or collective labor agreements ( awards ). Approximately 30% of companies contribute more than the statutory maximum, typically up to an additional 2%. Employee Contributions Voluntary Typically on a pretax basis. Normal Retirement Age 65 Access to benefits possible at preservation age (age 55 to age 60, depending on the date of birth), retirement, or age 65 (if not retired from the workforce). Vesting Immediate Employee contributions + interest + amount funded by employer contributions meeting at least minimum requirement. Benefit Form Lump sum Payable on retirement, disability, or death. Investment Options Multi- and single-asset class options Employee choice of products, of with range of managers. Default arrangement is usually a balanced fund. No mandatory interest rate guarantees. Financing Master trust Industry-wide fund Shift from corporate funds to master trusts (usually operated by financial institutions or actuarial consulting firms). Industry-wide DC plans typically required for award and union staff. 1 OTE is defined as 1) total earnings with respect to ordinary hours of work other than lump-sum payments for unused sick leave, annual leave, or long-service leave made to the employee on the termination of his or her employment; and 2) earnings consisting of over-award payments, shift-loading, or commission. Spain: Employer-Sponsored DC Plans In recent years, there has been a clear trend toward DC plans in Spain, and given the recent economic crisis and debate over the social security system, interest continues to grow. Based on Aon Hewitt data, 54% of companies offer DC plans. Most of these companies offer their plans to all employees; 59% have contributory plans. Few defined benefit (DB) plans are being established. Based on Aon Hewitt data, only 14% of companies have a DB plan in place. The plans that have been established are typically for managers or executives. Replacement rations are being lowered to approximately 60% to 75% of final salary for medium- to high-paid employees and between 80% and 95% of low-paid employees. Replacement ratios include the social security old age pension. Copyright 2010 Aon Hewitt Inc 6
Characteristics of DC Plans in Spain Plan Feature Comments Participation requirements Common to specify minimum service requirement, usually 1 to 2 years. Participation is generally voluntary. Trend to include part-time employees. Pensionable salary Both fixed pay only and fixed + variable pay. Employer contribution Contribution = 0.5% 3% to MIN (salary offset) + 4 16% x MAX (salary - offset, 0). (Offset equals maximum social security pension, employee s social security contribution ceiling, or fixed amount). Employee contribution In a two-step formula, employees typically contribution 1/3 of total contribution. In QPP and PPSE (refer to Funding below), maximum total contribution (for tax purposes) is lower of EUR 10,000 or 30% of earnings through age 50; EUR 12,500 or 50% of earnings thereafter. Investment options Determined by Control Committee under QPPs and PPSEs and by insurance company under insured plans. Normal retirement age Age 65. Benefit formula Account balance. Indexation According to benefit form selected by employee. Vesting QPPs and PPSEs: 100% immediate, required by law. Benefit form Funding Employees may choose between: Lump -sum payment; Monthly pension, defined by the beneficiary; or Mix of both. Qualified Pension Plan (QPP)l Group life insurance policy; QPP with group life insurance (PPSE); or Mutual welfare society. In a Qualified Pension Plan (QPP), the plan s assets must be managed by a pension fund. A pension fund can manage the assets of one plan (for one company or group of related companies) or of two or more plans (for two or more unrelated companies). The assets under an insurance contract are managed by the insurance company. The mutual welfare society is a special vehicle used only for specific types of organizations. Copyright 2010 Aon Hewitt Inc 7
The following summarizes the main differences between funding vehicles: Retirement Plan Funding Vehicles in Spain Plan Feature QPP Group Life Insurance PPSE Eligibility Implementation Control Committee Nondiscriminatory definition required Negotiation with representatives of plan participants required Required. Majority of employee representatives. Responsible for plan management. Discrimination allowed. Negotiation with representatives of plan participants not required. No requirements. Sponsoring employer and insurance company responsible for plan management. Nondiscriminatory definition required. Negotiation with representatives of plan participants not required. No requirements. Sponsoring employer and insurance company responsible for plan management. Employer contribution rate Contribution limit for tax purposes In the Control Committee, employees and the company must have an equal number of representatives. May vary based on objective criteria age, salary, past service, employee contribution. The Control Committee must approve any difference in contribution level. Lower of EUR 10,000 or 30% of earnings through age 50; EUR 12,500 or 50% of earnings thereafter No requirements except those imposed by general labor legislation. No limit. Vesting Full and immediate No requirements if premiums not considered salary in kind for employee. No requirements except those imposed by general labor legislation. Lower of EUR 10,000 or 30% of earnings through age 50; EUR 12,500 or 50% of earnings thereafter. Full and immediate. Full and immediate vesting if premiums considered salary in kind for employee. Copyright 2010 Aon Hewitt Inc 8
Plan Feature QPP Group Life Insurance PPSE Financing of past service at date of plan amendment Amortized over maximum 15 years. Minimum annual contribution equals 5% of initial liability; 50% of total liability to be financed by middle of amortization period. Subject to a financing plan. Maximum amortization period is 10 years. Amortized over maximum 15 years. Minimum annual contribution equals 5% of initial liability; 50% of total liability to be financed by middle of amortization period. Funding Tax treatment of contributions Tax treatment of benefits Liability for each participant should be financed when a contingency occurs but no later than 1 year after date of contingency. Pension fund managed by fund manager. Pension plans in same pension fund determine investment policy. Employer and employee contributions full tax deductible up to limit Taxed in full as income Insurance company assets. Portfolio policies under management or unit linked contracts (DC plans). Policyholder may agree with insurer on general orientation of investment policy. Employer contributions: Deferred deduction if not imputed income; Immediate deduction if imputed income. Employee contributions: Tax neutral if not imputed income; Taxed as salary in kind if imputed income. Fully taxable if contributions were not imputed income; Taxed on portion of pension in excess of contributions paid if contributions were imputed income. Liability for each participant should be financed when a contingency occurs but no later than 1 year after date of contingency. Insurance company assets. Portfolio policies under management or unit linked contracts (DC plans). Policyholder may agree with insurer on general orientation of investment policy. Employer and employee contributions full tax deductible up to limit. Taxed in full as income. Copyright 2010 Aon Hewitt Inc 9
Plan Feature QPP Group Life Insurance PPSE Tax treatment of lump sums Attributable to: Pre-2006 contributions 60% taxed as income; Post-2006 contributions taxed in full Attributable to pre-2006 contributions: 60% taxed as income if contributions were not imputed; 25% to 60% if contributions were imputed. Taxed in full as income. Attributable to post-2006 contributions: taxed in full. * * * * * For more information on Aon Hewitt s Defined Contribution Plan offer, please contact your local retirement consultant. For more information on the countries covered in this report, please refer to the Aon Hewitt Country Profiles eguide. You can learn more about the Country Profiles eguide here. Copyright 2010 Aon Hewitt Inc 10
About Aon Hewitt Aon Hewitt is the global leader in human capital consulting and outsourcing solutions. The company partners with organizations 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. For more information on Aon Hewitt, please visit www.aonhewitt.com. Copyright 2010 Aon Hewitt Inc. This document is intended for general information purposes only and should not be construed as advice or opinions on any specific facts or circumstances. The comments in this summary are based upon Aon Hewitt's preliminary analysis of publicly available information. The content of this document is made available on an as is basis, without warranty of any kind. Aon Hewitt disclaims any legal liability to any person or organization for loss or damage caused by or resulting from any reliance placed on that content. Aon Hewitt reserves all rights to the content of this document. Copyright 2010 Aon Hewitt Inc 11