We’re now well in to the new regulatory environment somewhat ironically called pension “simplification” (clearly somebody needs to buy HMRC a dictionary or at least a quick and easy guide on how to use one) and the supposedly level playing field imposed between trust and contract based pension arrangements and some interesting issues have begun to emerge.
Trust based arrangements now appear much less attractive for most scheme sponsors than the contract based alternatives given that not only have many of the trust based advantages, such as early leaver refunds, greater tax free lump sums and higher funding rates, now been lost, but also as a result of the increased direct and indirect costs associated with the additional trustee involvement required via the trust based route – MNTs, trustee knowledge and understanding et al. It is therefore becoming increasingly difficult to identify reasons why any employer would opt for a trust based solution. I know we can all come up with reasons for a report but the only real one I can think of is that it’s a less complex regulatory regime from an FSA perspective, in theory anyway, but that doesn’t really seem like a valid reason to recommend it to a client, given the other disadvantages.
Given this, the new legislation seems to hasten the inexorable move towards contract based arrangements, a move which will be ‘simple’ for those establishing schemes for the first time. However, as with many other areas in pensions, it is the practical issues associated with resolving the legacy scheme problems which will undoubtedly slow the pace of change.
Whilst the employer may embrace the need for change it is sometimes difficult to see why scheme trustees may be quite so enthusiastic. A move from a self administered trust based arrangement where, for example, the employer picks up the cost for a significant proportion of the administrative costs to a contract based arrangement with a single AMC charge may see members subject to charges in excess of what they were paying previously under the old arrangement. In these circumstances trustees need to consider if it is in members best interests to consider a move and need to carefully weigh up any additional options available.
A switch to a contract based solution may be expensive for some schemes, not only in terms of the above issue but also the professional costs involved in establishing the new scheme. Furthermore penalties may apply to the removal of funds from their current home. Some schemes retain historic charging structures with penalties for moving money away and whilst lower than over the past few years many providers still impose market value adjustments (MVA’s) on with profit funds.
Also from April 2006 there has been a requirement to consult with affected members and their representatives where a company is proposing to amend its pension arrangements. The requirement to consult is avoided if such change has no lasting effect on a person’s rights to be admitted to a scheme or on the benefits that may be provided. It is likely that a replacement arrangement with Company contributions remaining unchanged will have an effect on benefits to be provided on the basis that employees pick up a higher proportion of the charges through a higher annual management charge than would be the case under the existing scheme. Therefore the Company would be required to consult prior to making any changes unless some form of compensation payment was made or company contributions were increased to mitigate the effect of the higher annual management charges. Presumably, someone will need to certify for the trustees that any compensation offered actually protects members’ positions.
In addition senior staff from within the company may also be doubling up as scheme trustees and the benefits they can see from a scheme sponsor perspective may well cloud their judgement from a trustee position and they need to guard against this. Trustee obligations for money purchase schemes are no less onerous than those for final salary schemes in the area of conflicts of interest.
We must also then consider any change in investment options going forward. This can be particularly difficult for the trustee where underlying investment guarantees apply such as with-profits or deferred annuity type investments or where guaranteed annuities exist. The situation becomes even more complicated where these apply only to a small number of the overall membership as the trustees need to consider how these members will be dealt with if it appears that any bulk move would be to the benefit of the membership as a whole.
The move to a contract based scheme also transfers the investment selection from the trustees to the members. Often the move significantly increases the number of investment funds available. It would appear reasonable for trustees to want to ensure that members are in a position to make an informed decision about the investment selected. The company needs to consider how this process will be handled, the level of financial advice likely to be required and the commensurate associated cost.
Even if all these issues are addressed how do you then deal with the values held in the legacy scheme? Bulk Section 32 or transfer in to the new contract based arrangement? This equally could be complex as the benefits could need to be compared to ensure that no-one was losing out on a benefit entitlement held prior to the change, such as an entitlement to a tax free cash amount of above 25% of the fund value.
It will also be necessary to very closely examine the scheme documentation to establish who holds the important scheme powers, such as the power to wind-up the scheme or the power to amend scheme benefits. Employers may find they do not have a carte blanche for change and trustees will need to ensure any changes they agree to can be demonstrated to be in the members’ interests.
Whilst for many the objective may seem clear the practical steps to get there are fraught with difficulties and advisers need to take great care over the advice given. Scheme sponsors need to carefully consider their options and to arrive at the most suitable solution for their individual circumstances.