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The government gave advance notice in the budget that from 6^th April 2006 there will be a simplified pensions regime. So what are the consequences and what must employers do?

Gone are all the old Inland Revenue limits (see box "Familiar Limits that will go") all to be replaced by 3 simple limits:

The new regulations form wrap-up limits that include the benefits under existing regimes. There has been much press about the options for senior executives who have pension funds bigger than the new limits already, as there are special protections available in such cases.

We do not want to go into these here, as the subject has been adequately covered by the technical pensions press.

What we do want to do, is to analyse what this new regime means for those companies with pension schemes already, and what the implications are for new schemes in future.

It has been much heralded that for 95% of pension scheme members, and most pension schemes themselves, there will be little that changes. Unfortunately, this is far from the truth.

Now that the Inland Revenue limits that we were so used to have gone (see box), reference to them must be eradicated from scheme rules. Some of these are simple changes, others may require more thought. For example; the contributions limits have, in the past, been capped at 15% and 17.5% and this is usually communicated regarding AVC’s. This will now be 100% of earnings (possibly also avoiding the need for bonus sacrifices to fund pensions at higher rates). So if nothing else, all members (and probably all employees) will need to be advised that these rules have changed.

Of course, as an employer, you will want to choose whether there should be any limit in your scheme? You may, for instance, feel that it is unwise for any member to save more than 50% of their income, or indeed anything at all, if it might impact on company contributions later in their career.

Then there is Life Cover. Typically this is provided at 4 times salary, the old IR limit, but now the life cover can be the whole pensions fund or the lifetime limit. This requires more thought. What level of cover is relevant? Does it change as members get older? How does it interact with a spouse’s pension? Does fair value become an issue? So, though leaving cover at 4 times salary is possible, is this what you now want given that the old rationale for it has ceased?

The position on disability pensions is especially murky, as the only cap might now be the lifetime limit! And what will you do with benefit statements? Will you now show these as cash sums against the limit?

This said, existing schemes don’t have to change their benefit structures. Either DB or DC, they can continue unchanged as long as no member exceeds the 3 limits above.

?Max ⅔rds pension

►Fastest accrual 20 years.

?Employee contributions limited to 15% (Defined Benefit) or 17.5% (Defined Contribution)

?Averaging variable earnings over 3 years (for pensionable earnings calculations).

►The Earnings cap (though replaced by the new higher one)

►4 times earnings for life cover.

►Disability pension based on prospective service.

►Max tax-free lump sum 1½ times pensionable salary in DB schemes (replaced by 25% of fund)

►Earliest NRD 50

Suggesting no change, means sticking with benefit structures restrained by a regime that no longer exists. What will now be the justification for accruing 1/60^th of Final Pay over 40 years based just on basic salary and excluding overtime, commissions and bonuses? What is the organisation’s attitude to some staff accruing benefits equivalent to 100% of salary? (see box overleaf "What £1.5m might buy"). Why will 4 times salary life cover be the "right" level?

In the past the limits have been a convenient excuse. "We can’t do any more as these are the Inland Revenue limits".

Thankfully these will no longer exist, but we now have to determine just what benefit levels are appropriate. And we don’t have a lot of guidance.

Certainly the style of the new limits reinforces the concept that pensions are just deferred pay (remember those old debates about this issue). Certainly by defining contribution limits they seem to favour the defined contribution approach. And using a fixed 20:1 valuation of defined benefits certainly means that cash is going to be the common way of comparing benefits.

But some major issues now arise. If we want to be "employer of choice" is a conventional DB scheme the most beneficial and cost effective. If not what alternatives might there be? And at the same time, if we have a DC scheme do we want it to provide a low or high level of contribution, and why?

For example; those over the new annual earnings limit of £215,000pa can accrue the max. tax relieved pension pot in just 7 years! We also understand that the annual contribution limit can we waived in the year of retirement. Does this mean that senior executive pensions will, in future, take the form of an un-funded golden handshake straight into a pension fund?

Another question is, "If pensions are now deferred pay what is the rationale for making employees contribute?"

The new regime will certainly make us question the ways we do things.

For example, with flexibility over contribution rates, will companies choose to provide contributions only for those say over 40 and with a minimum of 10 year’s service? This avoids the need for all those messy transfer values for the younger, more mobile employees, though it would probably breach the proposed Age Discrimination laws.

And now that residential property can be incorporated into the lifetime limit, will employers make contributions to mortgages or outright purchase of a home, as long as the deeds are held as personal pension assets. In this way companies can help with a real need for the younger employees which is the purchase of a home not the accrual of a pension.

On the subject of life cover, will we move to the Australian style of life cover, where the amount provided is greater in the early years than later? This has always seemed a sensible idea, that is, a big life fund when everything is at risk, gradually diminishing as the pensions fund itself becomes substantial. Again, this may fall foul of the proposed Age Discrimination laws.

It certainly seems as if it may now be best to Contract-In to the state scheme? These benefits do not then count against the contribution or lifetime limits.

Additionally, employees can take a pension after age 55 but continue working and accruing further pension at the same time. This will obviously have major benefits for decisions about the "work/life balance". Employees may now wish to cease full-time employment, draw a pension, but continue part-time. Will this change the way people think about retirement? What is more, the proposed Age Discrimination laws may make it impossible to compulsorily retire employees at any age. Will this mean that some employees will want to continue to accrue extra years of pension in their older age, to make up for lack of contributions in their younger lives? What are the HR implications of this?

In summmary, pension simplification is to be welcomed, but now organisations have many more choices to make.

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