Pensions Essentials - February 2024

Once the relevant provisions are in force (anticipated to be 6 April 2024), the Pension Schemes Act 2021 will amend the funding regime to require trustees to have a FIS which specifies the funding level a scheme should have achieved at a particular date and the investments it should have. This should be set out in a statement along with some additional information. The new regulations require the FIS to set out a journey plan showing how the scheme will be fully funded when it reaches the “relevant date” (chosen by the trustees and not later than the end of the scheme year in which the scheme will reach “significant maturity”). The strategy for reaching full funding should generally assume that assets are invested in a “low dependency investment allocation” by the relevant date.

The regulations provide that a scheme reaches “significant maturity” when the duration of its liabilities is the number of years specified by the Pensions Regulator in the Funding Code (yet to be finalised) and determined in accordance with a formula. The economic assumptions used in the formula must be based on conditions on 31 March 2023 (to avoid the relevant date changing because of changes in economic conditions). Trustees can also take into account whether the scheme is open to new members or future accrual, providing that their assumptions are “reasonable” and consider the covenant strength of the employer.

The definition of “low dependency investment allocation” no longer requires assets to be broadly cashflow matched to liabilities as the 2022 draft regulations did. It is now defined as meaning that the assets of the scheme are invested in a way that is highly resilient to short term adverse changes in market conditions and further employer contributions are not expected to be required. The low dependency investment allocation does not apply to any surplus at the relevant date and schemes are intended to be allowed more flexibility in relation to the way surplus assets are invested. 

The final regulations contain revised provisions in relation to employer covenant.  Trustees need to assess covenant strength to determine the level of risk that can be factored into actuarial assumptions. Employer covenant is “the financial ability of the employer, in relation to its legal obligations to the scheme, to support the scheme” and can take into account the expected support from contingent assets.  Trustees will need to consider “how long [they]… can be reasonably certain that the employer will be able to continue to support the scheme” and that the other matters that they have taken into account in assessing the covenant will remain accurate. Unlike the draft regulations, there is no formalised role for the Pensions Regulator in the covenant assessment process. 

The first time trustees will need to have a FIS and a statement in place is 15 months from the effective date of the first valuation obtained on or after 22 September 2024. The timing is intended to align the new requirements with the valuation tranches that TPR uses in its annual funding statements. 

Finally, regulations will require trustees to follow the principle that funding deficits have to be recovered as soon as the employer can reasonably afford when setting recovery plans. However, in the response to consultation the Government recognises “the importance of investment in UK business to drive innovation and growth and want[s] to enable such investment wherever possible” and has therefore included an additional (but secondary) consideration for trustees to take into account “the impact of the recovery plan on sustainable growth of the employer”.

For more details on the new funding regime, see our Client Briefing.

In Newell Trustees Limited v Newell Rubbermaid UK Services, the scheme rules prevented amendments which “would prejudice or impair the benefits accrued in respect of membership up to that time”. In 1992, members under 40 were automatically transferred to a new DC section of the Scheme. Those aged 40-44 had the option of staying in the DB section or transferring to the DC section and those over 45 were left in the DB section with no option to transfer.  The trustee sought confirmation as to whether the amendments providing for this were valid.

Amongst other things, the judge held that the amendment power did not prevent the conversion of DB benefits to DC benefits. For the restriction to bite, it was necessary to show that the DC benefits “would” have been worse than DB benefits at the time of conversion. This could not be said as it depended on investment returns and salary increases over time and in fact, a percentage of members were better off in the DC section. 

However, the amendment power did prevent the final salary link from being broken as the protection given to salary links by such provisions was well-established in case-law.  A continuing salary link could be provided in a DC context by applying an underpin to the benefits of the relevant members equal to the value of their benefits at the date of transfer to the DC section, revalued by reference to actual salary increases. If this was higher than the amount transferred, the DC accounts would be increased by the shortfall plus the investment returns it would have earned had it been invested in the default strategy.

The judge also considered whether it could be said that the members who had elected to transfer had created a binding contract which effectively overrode the Scheme rules. The answer to this was yes as the basic elements of a contract were all present, particularly as the members had a genuine choice whether to agree to transfer and were offered an enhancement by the employer for doing so. 

Finally, the issue of age discrimination was raised as older members were allowed to remain in the DB section. The judge concluded:

• The employer and trustee made a one-off decision in the 1990s to create a DC section with transitional age-related eligibility provisions which was lawful at the time. The fact that benefits might be lower in the DC section did not result from action taken later by the trustee after age discrimination became unlawful. 
• The treatment of younger members was justified as the arrangements had the legitimate aim of ensuring inter-generational fairness and cushioning older employees from any adverse outcome as a result of making changes close to their retirement. There was also no basis to say that the means of achieving this aim were not proportionate as this came down to whether the age chosen struck the right balance between achieving the aim and the impact on the younger members and the parties had acted on advice and a line had to be drawn somewhere. 
• UK law says that age discrimination only applies in relation to pensionable service after 1 December 2006. Although it has previously been held that this limit is incompatible with European law, this only applies where claims were brought before the completion of Brexit (31 December 2020).

In Avon Cosmetics v Dalriada Trustees the amendment power prevented any amendment that prejudicially affected “benefits accrued or secured up to the date on which the amendment takes effect”. In 2003, the DB section was closed to accrual and a new CARE section (based on career average earnings) was set up. Accrued DB benefits were to be calculated by reference to salary at the date of the change and revalued up to retirement. Some members were better off as a result of the change as their salary increases over the period were lower than the rate of revaluation applied to their benefits but others were worse off.  The question before the court was whether the amendment was wholly invalid or only invalid in relation to those members who were worse off as a result. 

The court held that the amendment was valid in relation to those members who were better off and invalid in respect of those who had lost out. Where an amendment can be conceptually separated into a valid and invalid exercise of a power and the two are in substance conceptually different, it is possible to save the valid part. In this case, the concepts of better and worse off members were sufficiently different and identifiable, even if there were timing issues in relation to categorising individuals. 

The court also had to be satisfied that if the person exercising the power had properly appreciated the true limits on it, they would still have done the same thing. This test is an objective one and does not involve a consideration of state of mind or actual intention.  Here, the substantial purpose of the amendments was to remove the salary link by closing the DB section to future accrual and providing revaluation. If the amendment power prevented severing the salary link for members who were worse off, preserving it for other members was precisely within the scope of the objective intention. 

The practical result was that an underpin needed to be applied so where a member was worse off as a result of the salary link being severed, they would get a higher level of benefits calculated by reference to their actual final salary.

Both cases show non-pensions judges taking a highly pragmatic view of the efficacy of amendments. They also demonstrate the need to consider the wording in amendment powers very carefully. However, they do leave open a number of questions. In particular, the Avon case did not consider the fact that the amendment power was a joint trustee/employer power and the employer’s objective intention in making the amendment was unlikely to be an outcome which resulted in more costly benefits.

Some of the key confirmations provided by HMRC in its recent Newsletter 155 and the February LTA newsletter are:

• Pension commencement excess lump sum (PCELS): In a helpful move for high value retirements, there will be no “permitted maximum” for a PCELS, which will replace the lifetime allowance excess lump sum (LTAELS) in the new regime.  The current, problematic, formula will be removed from the legislation by way of regulations which HMRC intend to introduce ahead of 6 April 2006. This should mean that the same options around pension commutation can be offered to members before and after 6 April 2024. A requirement for the PCELS to link to a pension, which wasn’t present for LTAELS, remains, but this requirement is typically met. 
• LTA statements in 2024/25: There is a requirement in the new legislation for one off LTA statements to be provided in 2024/25 where individuals/personal representatives would not otherwise receive one. There has been concern about the scope of this requirement. HMRC has confirmed the statements are only required where a member has had a previous benefit crystallisation event and is not a pensioner but has remaining uncrystallised rights in the scheme (so is a “member”). This scenario is likely to be rare in DB schemes, but might occur in a DC scheme where, for example, uncrystallised funds pension lump sums have been paid but there has been no drawdown. The newsletter (wrongly) states the percentage of lifetime allowance “available” (rather than expended) must be included on these statements.
• Transitional tax free certificates: These certificates may be relevant where an individual has crystallised benefits before 6 April 2024. An individual/personal representative can ask a registered pension scheme to certify the actual tax free amounts used by them across all registered pension schemes, before their first “relevant benefit crystallisation event” under the new regime, but must first provide “complete evidence”. The certificate should be presented to schemes subsequently paying benefits, who would otherwise operate the standard default calculation, which makes various assumptions, including that full tax free cash has been taken on retirement.
  
  HMRC has committed to providing early guidance on the certification process for both members and schemes, including examples of what might be considered due diligence by schemes and accepted as complete evidence. As this is a completely novel process, this guidance will be essential when designing robust processes. HMRC’s view is that the standard calculation will work for the majority of affected members, but industry expectation is that there will be a wide range of scenarios in which certificates might be requested.

• Reporting: HMRC had already announced in the December LTA Newsletter that the legislation will be amended so that schemes will only have to report under Event 24 any taxable lump sums/lump sum death benefits above the available new allowances, and such lump sums where the member’s allowance is not exceeded due to reliance on a protection or enhancement factor. Also, that personal representatives will continue to provide information on death benefit lump sum payments to HMRC, and HMRC will continue to calculate and assess the tax due from beneficiaries.
  
  Newsletter 155 confirms further amendments to scheme’s reporting requirements. Whilst the summary in the newsletter is not altogether clear, it appears that HMRC’s intention is that schemes will not have to report on the availability of allowances where lump sums are paid on death, but will only have a reporting obligation where lump sums paid on a death exceed the standard lump sum and death benefit allowance.