Posted on Saturday 22 January 2011 byUlster Business
Stuart Faloon, principal of global company Mercer's life and pensions operation in Belfast, outlines why pensions are set to make the headlines again in the next 12 months
Since coming to power, the Coalition Government has been busy implementing reforms to pension provision in the UK. Firstly, it is looking to ensure that individuals who do not currently save for their retirement start to do so. Secondly, it is looking to review the cost of public sector pensions (and potentially increase the level of contributions to be paid by public servants). Thirdly, it is seeking to place restrictions on the tax relief received by those people currently earning the most generous level of pension provision.
In the private sector, partly in reaction to the banking crisis, many companies have been deleveraging (i.e. reducing the level of debt in) their balance sheets. During 2009 and 2010, many company's primary objective has been to reduce bank debt. As we move into 2011, expect to see an increasing number of companies seeking to reduce or remove pension risk. Subject to having the necessary cash available to do so, some companies that operate defined benefit (final salary) pension schemes are now seeking to transfer their pension obligations to insurance companies. This may create opportunities for individuals who would prefer to establish their own arrangements.
Private sector companies will also be gearing up in preparation for the introduction of the requirement to automatically enrol employees into a pension arrangement, and the cost of having to pay contributions towards the cost of providing pension benefits will, undoubtedly, form part of 2011 pay negotiation strategies.
As a consequence, 2011 could turn out to be a transformational year for pensions, and individuals will have to engage in decisions on how they will provide for their future retirement needs. Public servants will need to plan for entering an era where they may receive less generous benefits in retirement and many private sector employees will be offered pension choices never before made available to them. All individuals will need to start planning their pension saving earlier in life, since some of the announced changes could make funding for an adequate pension unattractive if they don't.
So what are the main legislative changes that are being introduced?
Pension taxation changes
On 14 October 2010, the Government published draft legislation and guidance on how it will amend annual and lifetime allowances. Further details were published on 9 December. Whilst these changes were not expected to come into force until the 2011/12 tax year, technical features of the legislation mean that this regime is already in force for some people.
The annual allowance will reduce from £255,000 to £50,000. This will be fixed until at least 2015/16.
Any unused annual allowance from the previous three years can be carried forward to offset the current year's accrual.
The value of £1 annual defined benefit pension accrued (over and above inflation) in a year will be valued as £16 (previously £10).
Tax relief will be granted at the full marginal tax rate up to the annual allowance.
The lifetime allowance will reduce to £1.5 million with effect from 6 April 2012 (from £1.8 million currently).
Changes to statutory pension increases
The rate at which public sector and some private sector pension benefits increase will, in future, be based on the Consumer Price Index rather than the Retail Prices Index. As CPI has historically been around 0.5% per year lower than RPI, future pension increases will be lower than in the past.
To the extent that this change in legislation affects private sector schemes, it is more likely to affect the rate at which deferred pensions increase before retirement rather than after retirement. An employee who leaves a defined benefit pension scheme is typically entitled to a deferred pension that increases between their date of leaving and retirement date in line with the increase in inflation. To the extent that pensions are increased by reference to CPI rather than RPI, the initial amount of pension at retirement will also be lower than was previously the case. Trustees and sponsors of private sector pension schemes need to check their Scheme rules to assess the extent to which this change might impact on them.
Change to State Pension age
The Department for Work and Pensions has confirmed that the State Pension age will rise to 66 by 2020 for both men and women – six years earlier than under the previous Government's plans. The change will be phased in from 2018.