Stakeholder, or bloodsucker?

Stakeholder pensions will affect the legal profession in a number of ways. The life assurance and pensions industry already has preparations under way for their planned introduction in April 2001.  The legal profession will be affected too and will have to start planning.  Stakeholder will affect all solicitors.  It will affect principals and partners as employers because they will have to have something in place for their employees; it will affect employed and self employed solicitors who will have to make personal financial planning decisions about their own pensions and how those are affected by stakeholder; and it will affect solicitors and their firms involved in financial planning for clients.

Buzzword comes in to land

One of the buzzwords or sound bites employed by the Labour Party in the 1997 election campaign was the “stakeholder society”.  On finding themselves elected, a meaning had to be found for this platitude and it turns out to be a cheap (although whether it will be cheerful remains to be seen) personal pension scheme.  Legislation is now in place but as usual the details will be contained in regulations.  A consultation process has been gone through although the outcome of that has not yet been finalised and announced.  At present, for employed earners the state pension scheme contains two elements, a basic pension and the State Earnings Related Pension Scheme (“SERPS”).  The combined effect of the fall off in the birth rate and, in Scotland, net emigration, with older people living longer means that a pay as you go scheme, such as the present state scheme including SERPS, is seen as rapidly becoming unaffordable.  Something had to be done, both to reduce the direct burden of the state scheme, particularly SERPS, and to encourage people to make alternative provisions for themselves.  SERPS is to be converted into the state second pension for which there is a Bill, the Child Support, Social Security and Pensions Bill, presently before Parliament.  Stakeholder pensions were seen as the way of facilitating people making alternative provision for themselves.

Whether it will achieve this end or not remains to be seen.  Many doubt  it.  The original architect of the stakeholder pensions reform, Frank Field, Labour MP for Birkenhead, and former Welfare Reform Minister, has said that in his view stakeholder pensions will not encourage the lower paid to save for retirement because more is on offer from the state.  He has said the reforms will work only if paying into the stakeholder pension is made compulsory for anyone who does not already save into a pension.

Stakeholder pensions - what are they and how will they work?

The Welfare Reform and Pensions Act 1999 contains the framework for construction of the new proposed system of stakeholder pensions.  The details are to be contained in regulations which are coming out in draft.  Over the last year or so, the Government has been undergoing a process of consultation on what is to be contained in the regulations.  

The proposals are specifically aimed at capturing the £ 9,000 to £18,000 annual earnings range of employees who have no existing non-state pension provision, estimated at some 5 million people.  The proposals in fact cover also the self employed and non-earners.

The main features are:-

• The stakeholder pension must offer money purchase benefits.
• An annuity must be  provided in the age range 50 to 75.  Income drawdown may be available but this would be risky for the type of people it is designed to cater for.
• Life Assurance (up to 10% of contributions) and premium waiver are not essential but can be provided (no tax relief on premium waiver).
• Tax free cash can be allowed (unlike a free standing additional voluntary contribution scheme).
• Inland Revenue limits will be, as with personal pension schemes, percentage limits on contributions rather than benefits.  There will always be a window to pay up to £ 3,600 as a “minimum” maximum.  More details are given below.
• The taking of annuity may be phased.
• The big thing has been to limit charges to a maximum of 1% per annum, including transfer charges, but special services like advice, annuity purchase, and sale and purchase dealing charges may be additional.  Some providers are saying they will allow conversion from an existing arrangements at no extra cost.  This is so that sales of their existing arrangements are not sterilised.
• All schemes will require to have a default option on investment for members who do not wish to choose.  Because of charges limitation it is thought many schemes may use the Government’s propose new pooled pension investment wrapper.
• There must be a transparent annual statement of entitlement.
• There will be an employer access requirement. The main proposals are:-
• All employees earning above the national insurance lower earnings limit will have access to a stakeholder pension scheme if no occupational scheme is offered;
• Group personal pensions which meet certain standards could exempt the employer from the employer access requirements;
• Changes in contributions will be restricted to a three month basis to keep down costs to employers;
• Allowing a year from the introduction of stakeholder pension schemes (April 2001) for employers to make arrangements before the employer access requirement comes into force.

It has been suggested employers will receive incentives (payroll systems, staff training etc) from life offices and other providers seeking nomination.  Whether they will run to that on 1% expenses remains to be seen.

On 10th January 2000 the Government announced the following exemptions: -    

• minimum contribution to stakeholder to be £20 per month.
• employers with fewer than 5 employees or no employees earning over the National Insurance Lower Earnings Limit (currently £ 3,484 p.a.) are to be exempt.
• a group personal pension scheme to which a minimum contribution of 3% paid, but will not be considered a suitable alternative if it imposes exit charges.
• for an occupational pension scheme to provide exemption admission must be within 12 months (extended from previous 6 months) from joining service.
• however employers have to have this in place by October 2001.
• A stakeholder can be used for contracting-out, if a spouse’s pension is provided.
• A stakeholder scheme must be run by a board of trustees (at least one-third of whom must be independent from the manager) or a FSA-approved manager.
• Certain “minimum standards” are to apply but remain to be thought up.

Other, even existing, arrangements which meet these criteria can be badged as stakeholder.

When used for contracting-out of the State Earnings-Related Pension Scheme (SERPS) the existing national insurance rebates will apply, depending on whether the stakeholder is set up as a personal pension scheme or an occupational pension scheme.

The direct impact of the proposals relating to the stakeholder pension arrangement should be relatively limited on occupational pension schemes.  Stakeholder is primarily targeted at individuals who do not have additional pension benefits either from an occupational pension scheme or personal pension.  Nevertheless, if the stakeholder format proves to be attractive, there may be a trend for employers to discontinue occupational pension schemes in favour of a less burdensome alternative.  In addition, there is a number of specific issues which employers will need to address, including the requirement to nominate a stakeholder arrangement for any employees who are not eligible to participate in any occupational scheme of the employers.

It is expected that there will be schemes which are run by unions or employers’ organisations, and industry-wide schemes.

The critical factor is that the costs are to be kept down.  It seems that there are not going to be armies of financial services providers direct sales staff or financial intermediaries roaming the country for people to sell or indeed mis-sell stakeholder pensions to because there is just simply not enough reward.  They are going to have to be hard strapped for other things before they will turn their minds to this and if they do it is likely to be people operating in the smaller or at any rate independent sector of the market.

Tax regime

A consultation exercise has taken place on draft Finance Bill clauses and draft Tax Regulations were published in April 2000 to be effective from 6th April 2001.  It is intended that this regime will apply also to other forms of money purchase arrangement including personal pension schemes and defined contribution occupational pension schemes (employer sponsored schemes - in which limits currently operate on the benefits coming out rather than contributions going in).  This is intended to be a “simplified” tax regime, which seems to be the expression which the Inland Revenue use in relation to removal of reliefs and allowances.  The simple integrated tax regime for all defined contribution (DC) pensions, including stakeholder schemes will contain the following main features:

• contributions permitted of up to £ 3,600 each tax year irrespective of earnings;
• higher level contributions under the existing personal pension age and earnings related limits. These can continue for up to 5 years after earnings have ceased;
• all contributions from individuals will be paid net of basic rate tax with the pension provider reclaiming that tax from the Inland Revenue;
• employers’ money purchase schemes may opt into this new tax regime;
• new and simpler rules will replace the existing personal pension “carry forward” rules, but “carry back” rules will be retained but only to allow payments made before 31st January to be carried back for one tax year.;
• 10% of the pension contribution can be used for life assurance;
• tax relief for waiver of pension contributions insurance will be simplified, and broadened to circumstances other than ill-health, such as unemployment;
• shares from an approved employee share scheme can, within the contribution limits, be put into the pension and attract tax relief;
• contributors must be resident in UK unless serving, or the spouse of someone serving, abroad and undertaking “Crown duties”;
• contributions cannot be made by an individual who is also contributing to a defined benefit occupational scheme;
• simplification will also be carried through into the administrative arrangements for defined contribution pensions - for example, electronic and telephone applications will be permitted and information requirements relaxed;
• the rules regarding benefits are being altered to allow phased vesting from within a single arrangement.  This technical change will ease administration for new and existing personal pension providers.

Concurrent membership of any number of defined contributions schemes will be allowed.  The Government is still considering allowing members of schemes outside the new defined contribution tax regime on “modest” earnings also to contribute to a stakeholder.  It would, in many cases, be used by those who already have good pension provision rather than the lower and middle earners who are the target of the stakeholder initiative.  Ministers have, however, said that they will be prepared to examine ideas for partial concurrency aimed at helping those on modest earnings.  Such approaches would have to be  both cost effective and workable.  The Inland Revenue will be contacting employers’ and pension industry representatives to see whether they wish to be involved in this process.

Carry forward/carry back

In line with its earlier proposals, the Government has decided to simplify these complicated rules from April 2001 i.e. - remove this useful relief.  A new arrangement will be introduced under which a payment made before 31 January (the filing date for a self assessment return) can, on election on or before it is paid, be treated as a payment for the previous tax year.  There will be no carry forward of unused reliefs since this is no longer needed for the majority of people.  The new facility to make payments of up to £3,600 a year without reference to earnings will allow the vast majority of people to catch up on their pension contributions. The minority of people wishing to make higher contributions (less than 5% of existing defined contribution contributors) will find in future that they have to plan their affairs on the “use it or lose it” basis that exists with other tax favoured savings schemes such as Investment Savings Accounts.  Use of the “earnings holiday” arrangements described in the next paragraph will however provide some additional flexibility for them.

Contributions above £3,600: The Government has decided to extend the concept of the earnings holiday - where someone whose earnings cease can continue contributing for five years - to contributions above £3,600. Under these proposals contributions over £3,600 will be based on the highest level of earnings in the previous five years. Put another way, earnings in a particular year can allow higher contributions for that year and the next five.

What now? - employers

An employer with five or more employees will have, after consultation, to make available a nominated stakeholder arrangement, even although there is no requirement for the employer to contribute to it.  This will involve providing clear information about the options, and a payroll deduction facility, subject to the contribution payment requirements and timescales within the Pensions Act 1995 and regulated by the Occupational Pensions Regulatory Authority.  To avoid these requirements there will have to be some acceptable alternative, either an occupational pension scheme with a waiting period of less than one year or a group personal pension scheme to which a minimum 3% contribution is paid and there are no exit charges.   The Minister of State at the Department of Trade and Industry has said that regulatory requirements will be scrutinised by the Chief Executive of the Small Business Service.

What the employer does now will depend, to some extent, on what is already in place.  Options are:-

1. To avoid involvement in the stakeholder requirements by making available membership of a suitable occupational pension scheme or group personal pension.

2. Take the stakeholder route, which may involve decisions about existing pension arrangements and will involve a decision about which one to choose.  It may also involve provision of a concurrent top up money purchase arrangement , such as a group personal pension scheme or occupational pension scheme.

3. Maintain existing arrangements and make them eligible for stakeholder exemption. Employers will have to consider how switching to the stakeholder regime will affect the Inland Revenue limits regime applying to the scheme.

What now? - solicitors as earners and savers

The position is not yet fully developed.  There has been some criticism in the pensions press that the continued delay in finalising stakeholder arrangements and having them introduced is causing a blight on planning arrangements.  Many pension provider companies are revising their products to endeavour to make them “stakeholder friendly” so that people know that they can readily convert or fit into the new arrangement when they come into play.  Any solicitor, self employed or employed, thinking of taking out a pension arrangement should ensure that it is going to be stakeholder friendly.  Employed solicitors should also enquire of their employers as to what their intentions are.

At present it is difficult to predict how this will be viewed but the pressure on charges in stakeholder pensions may filter through to other pension vehicles.

What now? - solicitors providing financial services

As mentioned above, the uncertainty has caused something of a blight on pension planning and it has been thought that some people have been putting off making arrangements.

When a solicitor is helping a client with retirement planning, he will certainly have to explain to him this area of uncertainty and the possible options.  A client who is an employee should be told to make enquiries of his employer about intentions and should certainly not be got into something which will have high exit charges in the short term.  The solicitor should enquire as to whether the arrangement which he is recommending is or will be “stakeholder friendly”.

What the future of pensions financial planning will be remains to be seen in the new stakeholder low charges environment.  It is difficult to see a lucrative market developing for giving advice in a very complex area which has already been driven by mis-selling scandals and no doubt will be subject to further consumer driven complaint and scrutiny.  The demise of the independent financial advice sector has been predicted.  This may indeed happen and the big providers will simply sell stakeholder pensions and perhaps other products over the Internet.  The Government has called for the production of “decision trees” to take people cheaply through the decisions to be made. Because of the complexity of the decisions and past scandals it is difficult to see how these will work satisfactorily.

Conclusion

Solicitors who are employers are shortly going to have to examine their plans.  Solicitors who want to save through a pension arrangement should continue with that intention but ensure they are taking into account the forthcoming new regime.  Solicitors who are providers of financial services are going to have to ensure that they are giving “best advice” which takes into account the forthcoming stakeholder regime and are going to have to put into place processes which are lean in consumption of time and money but fat in output of full and technical advice.