May 2014 Trustee Quarterly Review Quarterly update for pension scheme trustees
Introduction Welcome to the May 2014 edition of our Trustee Quarterly Review. The Review is published by the Mayer Brown Pensions Group each quarter, and looks at selected legal developments in the pensions industry over the previous quarter that we believe are of particular interest to trustees of occupational pension schemes. Each article summarises the relevant development and provides a short commentary on its likely implications for trustees. The Review also includes details of upcoming Pensions Group events at Mayer Brown, and a timeline of important dates and expected future developments. Please speak to your usual contact in the Pensions Group if you have any questions on any of the issues in this edition of the Review. Jonathan Moody Ian Wright Partner, London Partner, London E: jmoody@mayerbrown.com E: iwright@mayerbrown.com 2 x Trustee Quarterly Review
Contents Page Budget 2014: removal of annuitisation requirement and new guidance guarantee 1 Budget 2014: changes to commutation and drawdown limits 2 Budget 2014: new powers to combat pensions liberation 3 New definition of money purchase benefits : implementing regulations finalised 4 DWP proposals on charges cap and DC quality standards 6 IORP Directive: changes announced 7 Case law round-up 8 Upcoming Pensions Group events at Mayer Brown 9 Dates and deadlines 10
Budget 2014: removal of annuitisation requirement and new guidance guarantee The Government announced wide-ranging changes to defined contribution ( DC ) pension schemes in its 2014 Budget, including: removing the requirement to annuitise (i.e. to use part of a member s DC pot to provide a pension); and requiring schemes to offer free and impartial guidance at retirement to help members make a decision. The Government is currently consulting on the above changes, which it plans to introduce from April 2015. Increased DC flexibility The current restrictions on taking DC benefits directly as income ( drawdown ) will be removed from April 2015, so as to let members of DC schemes draw down some or all of their benefits as cash from age 55. This effectively removes the requirement to annuitise. The current tax-free cash will continue to be available, and members will pay tax on amounts drawn down above the tax-free cash limit at their marginal rate, even where they withdraw all their benefits. Currently, a 55% tax charge applies if a member does this. In addition, all members of DC schemes whether contractbased or trust-based must be offered free and impartial face-to-face guidance at the point of retirement (referred to as the guidance guarantee ) to help make retirement decisions. The Government will make up to 20m available over the next two years to develop this initiative. Consultation transfers from private sector defined benefit ( DB ) schemes to DC schemes should be banned (transfers from public sector schemes to DC schemes will be banned); differing approaches to the guidance guarantee should be taken for contract-based and trust-based schemes, and whether the guidance should be provided by an independent third party; and whether the earliest age at which individuals can take their pension benefits (i.e. normal minimum pension age) should increase in line with state pension age so that it is always 10 years below state pension age. Comment The guidance guarantee is designed to deal with concerns about ensuring that members make the right decisions about their income for retirement. It remains to be seen whether it will achieve its aim in practice. There will also be concerns about the level of obligation that the guidance guarantee will place on trustees and other providers, and how much it will cost. In practice, in trust-based schemes the employer will probably have to meet the cost, but this may lead to some employers questioning whether they can afford more generous DC contribution levels in the light of increasing financial obligations towards DC members that were not anticipated when they set up the scheme. Depending on the results of the consultation, trustees of DC schemes will need to think about what options they offer members at retirement, whether any rule amendments are necessary, and how they will comply with the requirements of the guidance guarantee. Trustees of DB schemes should also follow the consultation s progress as any ban on transfers to DC schemes will clearly have implications for their schemes. The consultation closes on 11 June 2014. The Government is consulting on a number of questions relating to these changes, including whether: a statutory override should be put in place to ensure that scheme rules do not prevent individuals from taking advantage of the new flexibilities (for example, where scheme rules require annuitisation of funds above the tax-free cash limit); Helen Parrott mayer brown x 1
Budget 2014: changes to commutation and drawdown limits In addition to the increased flexibility for members of defined contribution ( DC ) schemes from 2015, the 2014 Budget included an almost immediate relaxation of the drawdown limits for DC schemes, and of the limits below which small DC and defined benefit ( DB ) pensions can be exchanged for cash lump sums. These changes came into force on 27 March 2014. Commuting small pensions Trivial commutation lump sums: if a scheme member is over 60 and the total value of their benefits under all registered pension schemes is 30,000 or less, tax rules may now let the member exchange all their benefits under a scheme for a taxable cash lump sum. (Until 27 March a limit of 18,000 applied.) This new limit applies to both DB and DC schemes; DB pensions are valued for this purpose on HM Revenue & Customs normal 20:1 basis. When a member takes a trivial commutation lump sum, all of his or her benefits and all his or her survivors benefits under the scheme must be extinguished. Trustees should remember that the old 18,000 limit still applies where a member has died and instead a dependant s benefits are being exchanged for a dependant s lump sum death benefit. Small pot (or de minimis ) commutation: additionally, a scheme may now allow individuals aged over 60 to take small pensions in the form of a (taxable) one-off lump sum, regardless of their total pension wealth, provided that the value of the pension in that particular scheme does not exceed to 10,000. (Previously a 2,000 limit applied.) This new limit also applies to both DB and DC schemes. Here, it is for the scheme to decide how DB pensions should be valued. Flexible drawdown: previously, if DC members could show that they had guaranteed income of 20,000 a year from other sources, in principle tax rules allowed them to draw taxable cash from any DC pot that they had not already converted into an annuity. The income threshold for accessing flexible drawdown has now been reduced to 12,000 per year. Capped drawdown: whether or not they had other guaranteed other income, members who had not reached age 75 could designate a part of their uncrystallised DC pot as available for capped drawdown. Previously, under capped drawdown members were allowed to draw an annual taxable cash sum from the designated pot equal to 120% of an equivalent annuity (with the value of an equivalent annuity being determined using tables produced by the Government Actuary s Department). The annual limit has now been increased to 150% of an equivalent annuity. Comment Depending on the detail of how their scheme rules are worded, some schemes may find that their rules reflect the new limits automatically. Other schemes that wish to take advantage of the new tax limits would need to amend their rules first. Trustees and administrators should also ensure that, where relevant, their administration processes are updated to reflect the new limits. Drawdown Tax legislation already allows schemes to let members draw down their DC pots to a limited extent. The thresholds for both existing forms of drawdown flexible drawdown and capped drawdown have been relaxed with effect from 27 March 2014. Sally MacCormick 2 x Trustee Quarterly Review
Budget 2014: new powers to combat pensions liberation In the 2014 Budget, the Government announced new HM Revenue & Customs ( HMRC ) powers to refuse to register new pension schemes, or to de-register existing pension schemes, which it suspects of being pensions liberation schemes, and new anti-avoidance provisions. Background Pensions liberation continues to be a big concern for the pensions industry, with an estimated 600 million having been liberated up to late 2013. Liberation schemes typically involve high fees and, where payments are made to individuals before age 55, an unauthorised payment tax charge of up to 55% will be payable. From 20 March 2014... HMRC can use new powers to: refuse registration of new schemes, or de-register existing schemes, if it considers that their main purpose is to provide benefits other than authorised benefits. HMRC will assume an existing scheme s main purpose is to provide authorised benefits unless there is evidence to suggest otherwise; issue formal notices for information and enter business premises to inspect documents. HMRC guidance says such information could include marketing documents and information provided to potential members. Provision of inaccurate information could result in a 3,000 fine. From 1 September 2014... HMRC will be able to refuse registration of new schemes, or de-register existing schemes if the scheme administrator is not a fit and proper person. There is no statutory definition of fit and proper person. HMRC s guidance says this standard is likely to be met if the scheme administrator is familiar with, and capable of competently performing, the scheme administrator s responsibilities and there is nothing in their past behaviour to suggest that they should not be responsible for the financial management of the pension scheme. Examples of past behaviour that may give cause to question the assumption of a fit and proper person include criminal convictions or civil proceedings relating to finance, corporate bodies or dishonesty and prior involvement in fraudulent behaviour. If an investigation takes place, the registration of a new scheme will be put on hold and no confirmation of registration will be provided for an existing scheme. Comment The new powers are welcome additions in the ongoing battle against pensions liberation fraud, following on from the recent establishment of a Pensions Liberation Industry Group and changes in October 2013 to HMRC s registration and confirmation of registration processes. Additionally, a surrender of pension rights in favour of an employer is now an unauthorised payment if its purpose is to fund an authorised surplus payment. Olivia Mylles mayer brown x 3
New definition of money purchase benefits : implementing regulations finalised The Department for Work and Pensions ( DWP ) has published the long-awaited final version of the regulations implementing the new statutory definition of money purchase benefits. The finalised regulations will require trustees to revisit past decisions in fewer areas than draft regulations published last year suggested, so that very few schemes will need to revisit past decisions. The new definition nonetheless will have a significant impact going forwards for schemes with benefits that are recategorised under the new definition. The new definition is expected to come into force this July. Background In July 2011, the Supreme Court gave its decision in the case of Houldsworth v Bridge Trustees. The case considered, among other things, whether: defined contribution ( DC ) benefits where the scheme had promised a guaranteed interest rate; and money purchase benefits which had been converted into a pension paid from the scheme, counted as defined benefits or money purchase benefits. Although the case was concerned with a winding-up, in principle the decision was relevant for other statutory purposes too: tax aside, the same definition of money purchase is used throughout pensions legislation. The DWP had argued in the case that benefits should count as money purchase only if the scheme s benefits liability is automatically matched by corresponding assets. However, the Supreme Court decided that in both cases the benefits were money purchase benefits because their amount was calculated by reference to contributions previously paid, even though there was no necessary exact match between the size of the benefit and the assets the scheme held to secure them. On the same day as the Supreme Court decision, the DWP announced its intention to change the statutory definition of money purchase benefits retrospectively, with effect from 1997, to say that, until it comes into payment, a benefit can be money purchase only if it is not possible for a deficit to arise in respect of it. Moreover, if a scheme provides pensions internally, when money purchase benefits come into payment, those pensions will count as money purchase only if they are secured through policies bought from an insurer. In other words, under the new definition, liabilities count as money purchase only if they are necessarily matched by the assets held to meet them. The statutory definition was subsequently enacted in s29 Pensions Act 2011 ( s29 ). To date, s29 has not been brought into force. The DWP carried out a lengthy period of stakeholder engagement to help it decide how to implement the new definition in light of its retrospective application. In late 2013, it consulted on draft regulations which, while providing for a number of easements, would still have required schemes to revisit some past decisions, in particular in relation to employer debt. The regulations Section 29 will come into force once the regulations receive Parliamentary approval (expected to be in July 2014 the implementation date ), and will have effect from 1 January 1997. As a result, some schemes with benefits previously thought to be money purchase benefits will be considered to have held non-money purchase benefits since that date. In contrast to the consultation draft, the finalised regulations provide easements which will prevent such schemes from having to revisit the great majority of decisions made about those benefits in the period between 1 January 1997 and the implementation date. Generally speaking, where the period prior to the implementation date is concerned, the only issues that schemes will need to revisit are employer debt calculations in two very limited circumstances which are unlikely to affect most schemes. From the implementation date, schemes will need to be administered on the basis that any benefits which are currently considered to be money purchase benefits, but which fall outside the new definition are defined benefits. While in the 4 x Trustee Quarterly Review
main this should not create significant problems for schemes, the regulations may have some unwelcome implications for the indexation of money purchase pots that are converted into pensions without the scheme buying a matching annuity as it would appear that the scheme will be required to provide increases on such pensions. We are exploring the issue with the DWP. Schemes which are currently considered to be wholly money purchase, but which hold benefits that fall outside the new definition, will become subject to a range of new requirements going forwards. Among other things, they will need to: However, the new definition will apply in full from the implementation date, and benefits under many schemes will be recategorised as a result. Those schemes with benefits which they currently treat as money purchase, but which will become non-money purchase under the new definition, will need to start preparing for July 2014. Given that there are only a couple of months until then, schemes would be advised to consider as a matter of urgency whether they hold any benefits which will be recategorised in light of the new definition and, if so, what action they to need to take in respect of those benefits. appoint a scheme actuary by 6 October 2014; carry out an actuarial valuation and agree a schedule of contributions and, if necessary, a recovery plan within 15 months of the valuation s effective date. The effective date must be within 12 months of the implementation date; and submit a Pension Protection Fund ( PPF ) valuation by 31 March 2015 and start paying the PPF levy with effect from the 2015/16 levy year (they will be eligible for PPF entry with effect from 1 April 2015). Jonathan Moody However, we understand that the DWP does not intend to change some existing easements which, for example, allow schemes to count as money purchase for the purposes of the scheme funding legislation if the only defined benefit they promise is a lump sum on death in service which is matched by an insurance policy. Comment Since the DWP announced its intention to change the definition of money purchase benefits with effect from 1997, the pensions industry has been united in its attempts to persuade the DWP of the need to mitigate the impact of a retrospective application of the definition. The consultation draft of the regulations, which envisaged a certain level of retrospection, indicated that this battle had been lost. The fact that the scope of the easements in the regulations has been extended so that few schemes will need to revisit past events is therefore to be welcomed. mayer brown x 5
DWP proposals on charges cap and DC quality standards The Department for Work and Pensions ( DWP ) has published a Command Paper in response to its 2013 consultations on quality standards and charges in defined contribution ( DC ) workplace schemes as well as the OFT market report on workplace DC schemes. In the paper, the DWP has proposed three key measures designed to ensure that DC schemes are of high quality, offer value for money and... capable of delivering good outcomes. Minimum quality standards New minimum quality standards for DC workplace pension schemes will be introduced so those running schemes are mindful of scheme quality and prioritise members interests. This complements the recent Code of Practice on DC governance issued by the Pension Regulator (the Regulator ) which sets out 31 quality standards for DC schemes, as well as the Regulator s standard template to help trustees assess whether they meet those quality standards. From April 2015, trustees will have to report against the statutory quality standards. Contract-based schemes will have to establish an Independent Governance Committee ( IGC ) to perform this assessment. Restrictions on charges The DWP is concerned that the level of fees charged to members could hinder the success of automatic enrolment. Therefore, from April 2015, the DWP proposes to introduce a charges cap on any default funds that members are automatically enrolled into. This cap will apply to default funds in all qualifying schemes. (For more information on the definition of qualifying schemes for the purposes of automatic enrolment, see the Timeline for Personal Accounts Compliance article by-lined by our Pensions partner Martin Scott.) At present, this cap is intended to be 0.75% of funds under management, and will include all member-borne charges, such as the default fund charges and commission payments. Although it will initially exclude transaction costs, in 2017 the DWP will consider whether transaction costs should be included, as well as the level of the cap. In addition, in qualifying schemes: consultancy charges will be banned from April 2015; and active member discounts and the deduction of advisers commission payments from members accounts will be prohibited from April 2016. Increased transparency From 2015, to improve transparency and ensure members get value for money, new duties will be imposed on trustees and IGCs to report on costs and charges. These disclosure requirements will be standardised in time, but the DWP is encouraging action to be taken now. Next steps Consultation on the DWP s proposals closed on 15 May 2014. Any changes adopted will be implemented in phases. The first step, for the primary legislation (the Pensions Act 2014) which requires compliance with the measures to be given Royal Assent, has been completed. The DWP will now draft regulations providing the details for compliance and has said it will work with all stakeholders on achieving transparency of costs and charges. Comment Although the first raft of changes will not be implemented until 2015, trustees of DC schemes, and in particular of qualifying schemes, should start considering now how the reforms will affect them, and start planning accordingly. Beth Brown 6 x Trustee Quarterly Review
IORP Directive: changes announced The European Commission has proposed a new version of the IORP Directive ( IORP II ), which will require member states to put in place minimum governance standards for pension schemes in their territories. Once the new version is in force, member states will have to incorporate it into national law by 31 December 2016. The proposals The original IORP Directive was first introduced in June 2003 and aims to standardise pensions regulation across the EU. IORP II proposes that member states should be required to comply with further obligations including: To allow cross-border transfers of all or part of any pension scheme registered in their territories (after prior authorisation by the supervisory authority in the receiving scheme s home state). Not to impose any additional investment restrictions on a cross-border scheme (cross-border schemes should be able to invest in line with the rules of their home state). To require schemes to have an effective system of governance including internal controls and contingency plans. They must also require those responsible for running a scheme to meet fit and proper requirements, including having professional qualifications, knowledge and experience that are adequate to enable them to manage the scheme soundly and prudently and to perform their key functions. To provide specified information to current and prospective members, including an easy-to-read annual benefit statement. Comment Most of the new requirements are probably already covered by UK pensions legislation. The area of possible concern is the fit and proper requirements which, as currently drafted, could require all trustees to have a professional qualification, meaning that lay trustees would not be able to act. (This seems to go further than the fit and proper test that HM Revenue & Customs will be policing from September 2014 as part of its drive to stop pensions liberation.) Benefit statements provided by UK schemes would also need to meet the requirements of IORP II these statements must be printed in large type on, at most, two A4 pages (though the draft Directive itself takes five pages explaining the information and warnings they must include). An EU directive designed to encourage the free movement of workers by setting minimum preservation standards for benefits held by an individual who moves from one member state to another (known as the Portability Directive ) has also recently been adopted. We understand that the UK Government does not believe that any changes to UK legislation will be required in order to comply with the new directive even if changes are required, the directive does not need to be implemented in national law until May 2018. Beverly Cox mayer brown x 7
Case law round-up Pension benefits for civil partners The Employment Appeal Tribunal (the EAT ) has decided that the statutory provision that allows contracted-in occupational pension schemes to restrict the equal treatment of civil partners as regards survivors benefits to post-5 December 2005 service (the statutory exception ) is compatible with the EU Equal Treatment Directive (the Directive ). The decision overturns a December 2012 Employment Tribunal ( ET ) decision to the contrary. The case concerned a scheme which provided only the statutory minimum level of survivors benefits for civil partners. The ET had held in 2012 that the difference in treatment between spouses and civil partners under the scheme amounted to unlawful direct and indirect discrimination on the grounds of sexual orientation, and that the statutory exception was in breach of the Directive (which prohibits discrimination on the grounds of, among other things, sexual orientation). However, the EAT disagreed. It decided that, although the difference in treatment under the scheme between spouses and civil partners did amount to indirect and direct discrimination, it was not unlawful because the statutory exception was compatible with the Directive. This was because the Directive did not have retrospective effect in relation to unequal treatment that arose prior to its implementation date. The Directive also did not require past unequal treatment to be remedied. Innospec Ltd and another v Walker Employer duty of good faith when making benefit changes The High Court has decided that an employer had breached its duty of good faith in the relevant circumstances by making a package of changes which included closing its two defined benefit pension schemes to future accrual. Among other things, the judge decided that: member communications and statements to the trustees in connection with two previous benefit change projects had created reasonable expectations among the members that, among other things, the schemes would remain open to accrual in the long term unless there was a significant change in economic and financial circumstances; and the employer s business case for the proposed changes was not sufficient to justify going against those expectations. The judge was clear that employers are entitled to take account of their own financial interests when exercising a power or discretion in respect of a pension scheme. However, an employer could only place its own financial interests above the reasonable expectations of members if it was not irrational or perverse to do so. The obligation to reduce pensions-related costs had been imposed on the employer by its US parent, and the judge considered that acting on a parent company s instructions did not in itself justify the employer acting against members reasonable expectations. It was necessary to look at the parent company s reasons for imposing the obligation, and the judge found that the reason given in this case (the need to reduce costs to meet the parent company s earnings per share targets) was not sufficient justification since this did not in itself mean that the required savings had to come from the UK pension schemes. The judge also considered that the other grounds given for making the changes, namely the employer s desire to make the UK business more competitive and profitable, did not justify the changes, as less far-reaching changes could have been proposed. In addition, the judge found that the employer had breached its duty of good faith in conducting the consultation process in a way that was not open and transparent, and by providing misleading information. We understand that the employer intends to appeal the decision. IBM UK Holdings Ltd and another v Dalgleish and others Katherine Dixon 8 x Trustee Quarterly Review
Upcoming Pensions Group events at Mayer Brown If you are interested in attending any of our events, please contact Katherine Dixon (kdixon@mayerbrown.com) or your usual Mayer Brown contact. All events take place at our offices at 201 Bishopsgate, London EC2M 3AF. Trustee Foundation Course 16 September 2014 9 December 2014 Our Foundation Course aims to take trustees through the pensions landscape and the key legal principles relating to DB funding and investment matters, as well as some of the specific issues relating to DC schemes, in a practical and interactive way. Trustee Building Blocks Classes 17 June 2014 - internal controls 18 November 2014 - topic to be confirmed Our Building Blocks Classes look in more detail at some of the key areas of pension scheme management. mayer brown x 9
Dates and deadlines 10 June 2014 PPF levy deadline for certification of full block transfers 30 June 2014 New Regulator code of practice and policy on DB scheme funding expected to be published 1 July 2014 Deadline for completion of Government review of differences in survivors benefits provided by occupational pension schemes for opposite sex and same sex couples in legal relationships New definition of money purchase benefits expected to come into force July 2014 1 Sept 2014 New fit and proper person test for scheme registration/ deregistration comes into force Restrictions on drawdown of DC pots (i.e. requirement to annuitise) removed Requirement for all DC schemes to offer at retirement guidance to members Quality standards for all workplace DC schemes come into force Cap on charges in default funds in DC qualifying schemes comes into force Ban on consultancy charging in all DC qualifying schemes comes into force Duty on trustees of all workplace DC schemes to report on charges comes into force 6 April 2015 5 April 2016 Revised deadline for making resolution under s251, Pensions Act 2004 to retain scheme rules allowing surplus payments to employer Expected date of introduction of single-tier state pension and abolition of DB contracting-out Ban on active member discounts and member-borne adviser commissions in DC qualifying schemes comes into force 6 April 2016 31 Dec 2016 Expected deadline for implementation of IORP II Directive into UK law Proposed lifetime allowance deadline for members to apply for individual protection 5 April 2017 Deadline for making resolution under s68, Pensions Act 1995 to remove protected rights provisions from scheme rules 5 April 2018 October 2017 Automatic enrolment - 2% employer contributions required for DC schemes Automatic enrolment - end of transitional period for DB schemes 21 May 2018 Deadline for implementation of Portability Directive into UK law Automatic enrolment - 3% employer contributions required for DC schemes October 2018 Key: 5 April 2021 Deadline for employers to exercise statutory power to amend their schemes to reflect increase in employer NICs resulting from abolition of contracting-out Important dates to note For information 10 x Trustee Quarterly Review
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