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Pensions Update and Recent Developments
PRACTICE AREA GROUP: Employment, Pensions and Benefits
Finance Act, 2011 – Impact on the regulation of pension arrangements in Ireland
Budget 2011 together with the National Recovery Plan set out a wide range of fiscal measures, including significant reductions in tax reliefs on pensions. Finance Act 2011, was signed into law by the President on 6 February 2011 and for the most part confirms the tax changes already announced in the Budget last December. While the exact impact of these changes remains to be seen, it is anticipated that such measures will discourage retirement savings. On a more positive note, the introduction of more flexible retirement options for retirees of defined contribution pension schemes is to be welcomed. In summary, the measures affecting employee benefit provision are as follows:
Employee Tax Relief on Pension Contributions
With effect from 1 January 2011, employee contributions will no longer be exempt from PRSI (4%) and the new universal social charge (7% on earnings in excess of €16,016). In addition, tax relief on member contributions is restricted in any year of assessment to a percentage of the member’s remuneration from the employment being pensioned. The annual earnings limit has been reduced from €150,000 to €115,000. The annual earnings limit for the year of assessment of 2010 will also be deemed to be €115,000 for the purpose of determining how much of a pension contribution paid by an individual in the year of assessment 2011 will be treated as paid in 2010, where the individual elects under existing rules to have it so treated.
The percentage relief limits are age related and currently are:
|50 or over||30%|
|55 or over||35%|
|60 or over||40%|
The result of the changes is that the net cost to an individual to contribute to a pension arrangement has increased significantly.
Employer Tax Relief on Pension Contributions
With effect from 1 January 2011, the employer PRSI exemption has been reduced by 50%. Employers will see an increase in their PRSI payment where they operate a contributory pension scheme.
Reduction of the Standard Fund Threshold
Prior to the Budget, the maximum fund allowable on retirement for tax purposes known as the standard fund threshold (SFT) was €5,148,085. With effect from 7 December 2010, the new SFT is €2,300,000. Individuals with pension funds in excess of the new SFT can protect the capital value of their pension fund up to the previous SFT by claiming a Personal Fund Threshold (PFT). An application seeking a PFT certificate must be made to Revenue before 7 June 2011. This claim can relate to the capital value of crystallised and uncrystallised pension rights if, on 7 December 2010 that capital value is greater than €2,300,000 and lower than €5,418,085. Individuals who have agreed a higher PFT (above €5,418,085) under the original legislation can continue to use that limit. When the capital value of pension benefits drawn down by an individual exceeds the SFT or their PFT a tax charge of 41% is applied to the excess and is paid to the Revenue by the pension scheme administrator.
Restriction of Retirement Lump Sums
From 1 January 2011, the tax free lump sum on retirement is restricted to €200,000. This limit is a new lifetime limit and will apply to a single lump sum or where an individual is in receipt of lump sums from more than one pension arrangement, to the aggregate of those lump sums. All tax free lump sums taken on or after 7 December 2005 count towards the €200,000 limit. Amounts between €200,000 and €575,000 will be taxed at the standard income tax rate, currently 20%. Amounts in excess of €575,000 will be taxed at the individual’s marginal tax rate. Amounts in excess of €575,000 will also be subject to the universal social charge.
Extension of Retirement Options – Approved Retirement Fund
Prior to Finance Act 2011, members of defined contribution pension schemes could only exercise a tax free cash option and/or purchase an annuity. The option to invest in an Approved Retirement Fund (ARF) was available to directors with a shareholding in excess of 5% and members who had contributed additional voluntary contributions. The option to invest in an ARF has now been extended to all members of defined contribution pension schemes. Finance Act 2011, stipulates that pension schemes must offer the ARF option to members as a condition of Revenue approval. The ARF option is also available to members of defined contribution pension schemes who have already retired and availed of the “deferred annuity purchase” initiative announced by the Minister for Finance on 4 December 2008. Such individuals are required to exercise the option within one month from the date of the enactment of Finance Act, 2011 i.e. 6 March 2011. Such individuals will be subject to the previous lower income requirements.
In the case of members of defined benefit pension schemes, the existing ARF option in relation to additional voluntary contributions is retained.
Prior to Finance Act 2011, in addition to the eligibility criteria set out above, an individual had to have a guaranteed income of €12,700 per annum or approximately €63,500 placed in an Approved Minimum Retirement Fund (AMRF) before he/she could avail of the ARF option. These income limits have been increased and an individual must now have a guaranteed income for life of approximately €18,000 per annum or €120,000 to invest in an AMRF in order to avail of the ARF option.
The annual imputed distribution that applies to the value of assets in an ARF at 31 December each year is being increased to 5% from 3% in respect of asset values at 31 December 2010 and future years.
The option to invest in an ARF for all members of defined contribution pension schemes is to be welcomed. While there are advantages to purchasing an annuity on retirement, there is a loss of access to capital, in that once the fund has been invested in the annuity it cannot be retrieved. Also there is a lack of income flexibility, in that the income pattern is determined once the annuity has been purchased. The option of investing in an ARF should make members less vulnerable to annuity prices at the point of retirement and provide greater flexibility in determining the level of income required on an annual basis during their retirement.
However, the increased income limits to qualify to invest in an ARF may mean that many members will not qualify to invest in an ARF and will be forced to continue with the traditional tax free cash and annuity option. Further, there is a danger that the higher level of income drawdown now required from an ARF will lead to it being entirely depleted during the holder’s lifetime.
Social Welfare and Pensions Act 2010 – Sovereign Annuities
In our previous bulletin we had noted that the Irish Association of Pension Funds (IAPF) and the Society of Actuaries in Ireland had made a joint sovereign annuity proposal to the Government. The proposal involved the investment of at least €10 billion in Irish Government Bonds allowing defined benefit schemes to lower their deficits and to set aside less money to cover their liabilities in the event of a scheme winding up.
The Social Welfare and Pensions Act 2010 has placed this proposal on a statutory footing. The Act was signed into law by the President on 21 December 2010. The Act introduces a new Part IVA to the Pensions Act 1990 which enables the Pensions Board to approve certain contracts or policies of assurance where it is satisfied that the contracts or policies are capable of securing benefits for pensioners. The contracts or policies can either be held in the name of the pensioner or by the scheme itself. The Pensions Board will maintain a list of registered approved contracts and policies of assurance which can be accessed by trustees for this purpose. Part IVA also provides a form of statutory protection for trustees who exercise this option in securing benefits in circumstances where the Court finds that the trustee had acted honestly and reasonably. The National Treasury Management Agency (‘NTMA’) will set the interest rates for sovereign bonds. Until such time as the rate has been set insurance companies will not be in a position to market and package sovereign bonds to trustees. Therefore, what effect if any these products will have in assisting trustees in securing benefits for pensioners of defined benefit pension schemes remains to be seen.
Case Note – Boliden Tara Mines v Cosgrove & Ors, 2010 IESC 62.
The Boliden Tara Mines decision is an important one from a pensions perspective. The case is useful in its analysis of the circumstances in which a court will allow the remedy of rectification to be granted. The Supreme Court was satisfied that the trust documentation governing the pension scheme did not reflect the common intention of the employer and the trustees of the scheme regarding the benefit structure of the plan. In 1999, the principal employer of the plan agreed several benefit improvements in return for general cost savings and increases in productivity. One such improvement was the removal of "integration" with the state pension for all active members of the plan as at 20 February 1988 ("integration" permitted deductions to be made from employees' salaries to reflect state pension payments). The definition of "pensionable salary" was amended by deed to reflect this change.
Although the parties intended that the change should apply to active members only, the amended definition of "pensionable salary" was drafted widely and inadvertently applied to members of a separate plan set up specifically for former employees who had stopped work because of ill-health or disability. Although these members were technically active members of the plan, it was never intended that they should benefit from the removal of integration.
On appeal, the Supreme Court held that there was a “unanimity of evidence” that the parties shared intention had been to exclude that category of employee who was in receipt of the disability benefit. A more detailed note of the reasoning adopted by the Supreme Court is available by clicking on the following.