Pensions simplification supplement 2005: Feature – A complete guide to A-day

With A-Day less than eight months away Jenny Keefe runs the rule over do’s and don’ts, and gives employers a jargon-busting directive looking ahead to April 2006

Case Studies: AWG, GUS

Article in full

April 6 2006 heralds the end of the pensions world as we know it. On A-day, so called because the letter A marks the beginning, the government will roll eight sets of tax rules into one new regime.

The Inland Revenue has dubbed the process simplification and says it is combing through Britain’s unwieldy pensions law, leaving us with one clean and clear rulebook.

But is anything ever that simple? Ros Altmann, pensions adviser to the Treasury, says: "We really do have the most unbelievably complicated pensions system. Nobody who really understood it could possibly believe it could exist, but it does. "

"At the moment there are all sorts of complicated rules which govern how you can contribute, also what you can invest in and how you take the pension out."

But she says that the jury is still out on whether the legislation will untangle all the knots. "I call it ‘complifaction’. It will make things simpler for some, but more complicated for others." One thing’s for sure: the new rules affect everyone so employers need to get into gear.

From April 2006, new rules will govern how much employees can put into their pot each year. At the moment, members of occupational schemes who joined after 1 June 1989 can contribute a maximum of 15% of their salary into their pension, excluding employer contributions. The government is scrapping this earnings cap and, in future, employees will be subject only to an annual allowance and lifetime contribution limit.

Staff will be able to put up to 100% of earnings in to a scheme, as long as the figure does not exceed the annual allowance: initially set at £215,000 and pencilled to rise by £10,000 each year, reaching £255,000 in the 2010-11 tax year.

In the year before retirement, there is no annual limit, so workers who have not saved enough could whack in a huge lump sum at the 11th hour. "You will have a much more flexible way of contributing so people will be able to delay saving until later.

"And for some people just starting out in their twenties or thirties, on basic rate tax, they might be better off putting their money into something like an individual savings account (Isa) now. Then when they are on higher rate tax they can put all of it into their pension in one lump sum and get the whole lot at a higher rate of tax relief," says the Treasury’s Altmann.

She adds employers will have to decide whether they want to put their pension contributions into an Isa for staff.

For high flyers, the sting in simplification’s tail is the new £1.5m lifetime limit on pension saving. This is set to rise each year until it reaches £1.8m by 2010. Members that exceed this lifetime allowance will be subject to 55% tax on the excess if they take it as cash or 25% tax if they take it as income.

There are ways, however, of safeguarding large pension pots. Employees whose funds are worth more than £1.5m on 5 April 2006 need to register for primary protection. They will then get an allowance of a percentage above the current cap and could continue to contribute. For example, if a worker had saved £1.8m by A-Day, they would get an allowance 20% higher than the standard cap. So, if the allowance rose to £2m they would have an allowance of £2.4m.

By signing up for enhanced protection, employees can escape the allowance completely. Any amount accrued before this date will be protected, provided the worker stops paying into the scheme after A-day. Anyone can register for this protection, whether they have exceeded the limit or not.

Helena Davies, a professional support lawyer at law firm Lovells, says: "You should be looking at how many people have to register." Fund details need to be gathered up to check how much staff have saved in total, especially if they have different funds or have changed employers.

But should you really be babysitting executives? "There is an argument about the extent to which employers are obliged to tell their employees about this. In general terms, employers should flag it up but they can’t be expected to provide detailed advice," says Davies.

With some of the sheen taken off pensions, bosses need to look at alternative benefits for high earners. "For employees who have got way above £1.5m then you might need to negotiate some other remuneration with them," adds Lovell’s Davies. A study by recruitment firm InterExec has found that nearly nine-out-of-10 organisations plan to give senior executives more share options to compensate for the lifetime allowance.

The new rules not only govern how much employees can put into their funds, but also where they can put them. Under current pension rules, members of occupational schemes who earn over £30,000 a year are not allowed to pay into any other scheme. But from April, workers can pay into as many funds as they want.

This opens up self-invested personal pensions (Sipps), wrappers, which allow staff to pay into a wide range of investments. Tom McPhail, head of pensions research at stockbrokers Hargreaves Lansdown, says: "Whereas a personal pension or stakeholder will offer an investor a choice of investment funds, a Sipp will offer you an almost unlimited range of investments. These include direct equity investments and direct Gilt investments and literally thousands of unit trusts, [including] things like property and so on."

With all sorts of weird and wonderful investment opportunities out there, the new concurrency rules offer the potential injection of fun that pensions are crying out for. "The removal of the investment restriction will, for the first time, allow people to buy residential property and all the esoteric investments such as fine wine, race horses, herds of goats, brothels in Amsterdam [and] all this sort of thing," adds McPhail.

Provided they gain Inland Revenue approval, all these investments will benefit from the same tax advantages as traditional pension schemes.

After A-day, employers will no longer have to offer additional voluntary contributions (AVCs) for employees. "What you are going to increasingly see is that those employees that would have put money into an AVC in the past are going to turn round and put the money into a Sipp," says McPhail.

Andy Bell, managing director of Sipp provider AJ Bell, says: "Employers have a decision to make as to whether they will redirect their contributions into a Sipp. I think the bigger the employer the less likely they are to offer a flexible solution.

"I don’t see a massive relationship between employers and Sipps. Some employers may want to do a collection of Sipps for their senior executives. But when it comes to pension provision for the [employee] mass market, I think most employers are just going to carry on as they are at the moment, accepting that some individuals may also choose to take advantage of a Sipp offering alongside."

Nevertheless, these additional funds will need to be tracked, to ensure staff don’t exceed the lifetime allowance.

Simplification will also change the way employees take their pensions out. Workers will be able to take 25% of their pension as a tax-free lump sum on retirement. They will also be able to use AVCs for this lump sum.

Raj Mody, pensions strategy consultant at consultancy firm Hewitt Associates, explains: "You may want to change your scheme rules to make sure that that flexibility is bought in. Possibly people will want to delay retiring until after that, so actually the communication programme around that needs to have started already."

Employers also need to make sure that their administration systems are up to scratch. Under the new rules, schemes will have to provide members with regular updates on the value of their pension, to help them avoid unnecessary tax charges.

Penny Green, chief executive of Saul Trustee Company, trustee for the non-academic staff pension scheme of the University of London, predicts these new benefits statements could goad staff into action. "When I joined Saul in 1998 we did not provide benefits statements and when we put them in in 1999, there were a lot of people thinking ‘I haven’t saved that much and I need to put some more in’."

Aside from creating data systems to hold all this new information about staff’s pensions, employers should purge old records and check that information is reliable.

After A-day, scheme administrators will also have to send forms and payments to the Inland Revenue electronically. Regular reports, self assessment forms and quarterly tax payments will all be done online.

And organisations that have outsourced their administration needn’t think that they can rest on their laurels. "We all like to think that our administrators are just sitting there, waiting for our call, but the truth is probably different. Ask what your third party administrators are doing. If you don’t, how will you know that they are doing the right thing and it is suitable for your organisation?" says Green.

She advises employers to draw up a budget. "The sheer cost of making these changes will be significant. You need to make sure you have an idea how much this will be." A 2004 report Are you ready for simplification? by Hewitt found that a third of UK organisations predict that costs will exceed £50,000. "The impacts are going to be profound, they are going to be expensive and they are going to change the way we do business," says Green.

A-Day: dos and don’ts

  • DO go back to basics: Schedule training sessions to make sure HR, pensions managers and trustees are all aware of the new rules.
  • DO dig out the data: Gather up details of different funds and identify which employees have already hit, or are about to hit, the lifetime allowance limit.
  • DO talk about it: Decide how you will communicate the new rules to staff, whether through one-to-one sessions, newsletters or the intranet.
  • DO spring clean your records: Make sure all your data systems are in order and ready to provide members with up-to-date statements.
  • DON’T forget protection: Make sure that high earners register for primary or enhanced protection well in advance of A-day.
  • DON’T go overdrawn: Draw up a budget for the changes – a Hewitt survey found that a third of UK organisations expect costs to exceed £50,000.
  • DON’T let third party administrators run wild and free: Check that they are on track for the new regime because the buck stops with you.
  • DON’T leave it till the 11th hour: There are just eight months left to put your plans into action – and this includes Christmas and bank holidays

Jargon buster

  • A-Day: 6 April 2006, the date when all the changes introduced by the Finance Act 2004 come into force.
  • Annual allowance: The new cap, set at £215,000 for the tax year 2006-2007, which limits how much can be contributed into a pension each year.
  • Lifetime Tax Allowance (LTA): The maximum that someone can save in to a pension and avoid tax. This cap has been set initially at £1.5m.
  • Primary Protection: Staff whose benefits exceed the LTA on 5 April 2006 can apply to have their allowance extended by a percentage. They can continue to pay into their pension and their allowance will rise in line with any increases to the LTA.
  • Enhanced protection: A way of safeguarding pension funds from the lifetime limit. All members can apply for this, regardless of how much they already have in their pension pot, but they will have to stop contributing to the scheme.

Case Study: AWG

Water services group AWG is sending trustees back to school to make sure they are prepared for the new pensions regime. Anthony Speller, secretary to the trustees, says: "The trustees need to be fully aware of what’s going on. Our trustees are embarking on a structured training process. As well as in-house sessions, we have outsourced training from the National Association of Pension Funds and the Pensions Management Institute."

The company will be keeping firm tabs on its third party administrators. "What we do have to manage is what our advisers are doing and whether they are up to speed. I’m sure they are, but as good trustees you would have to expect them to see how [advisers] are coping with the changes because we are only one client out of quite a few," he explains.

"Ultimately, the trustees are responsible for their own scheme. Essentially if the service provider is not up to speed they won’t get fined, the trustees will. They are responsible for the scheme and the buck stops with them."

Case Study: GUS

Retailing and financial firm Gus is making sure top earners are up to speed with the new rules and don’t get caught out by the new lifetime tax allowance (LTA). Lesley Sutherland is pensions manager at the firm, which owns Burberry Group, Argos Retail Group and credit report company Experian.

"We’ve already identified people who are affected by the lifetime allowance. They will receive individual advice. There is another group who won’t actually be affected by the allowance but there are some UURBS (unfunded unapproved retirement benefit scheme) issues to be taken into account, so they will be dealt with by a separate communications exercise," she says. "And then in terms of the overall membership, for those that aren’t affected by UURBS or the LTA, we will be issuing general communications and newsletters."

The firm has a final salary scheme with 880 members and a money purchase scheme with 3,000 active members. Sutherland adds that the scheme is on track to cope with the changes. "Its something we’ve been looking at for some time. I think it will, to a large extent, depend on your consultants and to which extent they have driven you – maybe the smaller schemes will be behind."