Main effects of the Pensions Act 2004 and other recent legislation with significant impact on pension rights

2004 saw pensions affected by several pieces of legislation, including two major ones, with far-reaching consequences for employers, pension schemes and their advisers. They reach also into other areas of law including corporate, insolvency, employment, and those giving financial and tax advice, whether to private clients or corporate bodies.

Most people must be aware that there is a pensions crisis. The causes of this and some of the effects which the crisis itself is causing were examined in Jenny Nobbs’ article in the February Journal (“Trouble at t’mill”, page 28). Clearly there is something wrong with the pensions system. Throughout 2003 and 2004, the Government took consultationitis with repeated reviews, reports and consultations, on the line that pensions should be encouraged and that they should simultaneously achieve the mutually exclusive objectives of costing less, being less regulated and being more secure.

The resultant Pensions Act 2004 has taken the more secure route rather than the other two. The announcement, buried deep in the Budget, that the Government may issue gilts dated up to 50 years may do more for pensions than all this legislation. As noticed in Jenny Nobbs’ article, the Pensions Act has three main pillars, although it does also contain a range of other more minor provisions. These pillars are the establishment of a new regulator, the establishment of the Pension Protection Fund (with the associated Financial Assistance Scheme) and the creation of a new funding regime, the statutory funding objective.

2004 also saw the passing of a Finance Act, a major part of which is given up to completely replacing the treatment of what hitherto have been referred to as “approved retirement benefit schemes”.

The purpose of this article is to give a broad brush outline of how these measures will affect various areas of the law.

Pensions Regulator

A new Pensions Regulator will be the successor to the Occupational Pensions Regulatory Authority (OPRA) from 6 April 2005. The intention is that it will take a proactive and big picture role. The hope is that inconsequential breaches will be filtered out of the system. Quite how that will be achieved in a bureaucratic environment may be open to question, but Parliament has created a non-executive panel of the Regulator which will be tasked with keeping it on the right lines.

Its functions and objectives are now set out more clearly, being principally:

  • To protect the benefits of occupational pension scheme members.
  • To protect the benefits of personal pension scheme members for whom direct payment arrangements exist, and members of stakeholder schemes.
  • To reduce the risk of situations arising which may lead to compensation being payable from the protection fund.
  • To promote and improve understanding of the good administration of pension schemes.

The Regulator will have extensive powers to investigate schemes; serve “improvement notices” to prevent a recurrence of breaches of the Pensions Regulations, and third party notices, which are similar but arise where the legislative breach is by a third party, for example an administrator or life office; enforce recovery of unpaid contributions; and make a “freezing order” to preserve the position under a scheme.

The Regulator will issue codes of practice. Drafts of those have begun to be issued.

The Regulator is empowered to receive reports of non-compliance. Previously trustees and advisers were authorised to give such reports, but only the actuary and auditor were obliged to do so. It is vital for solicitors to realise that this obligation is now extended to others authorised to do so, subject to an exception on the ground of legal privilege. Additional reporting obligations are imposed on trustees and employers in relation to “notifiable events” such as winding up, amendment or significant bulk transfer.

A month before it came into existence the new Regulator managed to issue a serious of booklets about itself and its work from its address, Napier House, Trafalgar Place, Brighton – in other words the same as OPRA under a slightly different name!

Scheme funding

Part 3 of the Act introduces a new funding regime, scheme specific funding, which replaces the current discredited minimum funding requirements (MFR). This implements the European Pensions Directive 2003/41(EC), which requires legislation to be in place by September 2005.

The expected date of implementation of this is September 2005, but on a rolling programme coming in with the first actuarial valuation report having an effective date after that date.

The Act is a general framework, giving not much more than a timetable of how this will be rolled out and a new regime for paying contributions. A draft code of practice with draft regulations has just been issued for consultation. Professional guidance notes from the actuarial profession will also be required. This measure will have to be much stricter than the MFR and consequently involve much more expense, particularly for employers. At present the MFR regime is very prescriptive and allows the scheme actuary ultimately to impose what is required by MFR. Scheme specific funding calls much more for agreement between employer and trustees, the tiebreaker being not the actuary but the new Regulator.

Theoretically making pensions more secure, this provides no further incentive to employers to provide pension arrangements for their employees.

Pension Protection Fund

The Government has chosen to use the American model for the Pension Protection Fund, despite its spectacular bankruptcy. Compensation will be provided for “protected liabilities” where rescue is not possible. Running of a scheme falling under the Pension Protection Fund will be taken over by the Fund.

“Protected liabilities” are:

  • benefits as per the scheme rules (except discretionary benefits in the last three years), subject to the following:
  • 100% for those over normal pension age, with a 50% survivor’s pension in respect of subsequent death;
  • 90% otherwise;
  • capped at an initial pension of £27,777 at age 65.

There is no pre-April 1997 indexation provided, and thereafter indexation is provided only at RPI and capped at 2.5%. Commutation of pension is allowed up to 25%.

The Act contains a number of provisions designed to protect the Pension Protection Fund, including creation of notifiable events (still to be fully defined). OPRA has already issued an Update 10 explaining the new Regulator’s new powers and setting out OPRA’s views regarding compromises of statutory debts, which in some cases may affect Pension Protection Fund liability. This is essential reading for lawyers involved in corporate recoveries. In addition there is a range of “moral hazard” provisions which are ostensibly to protect the Pension Protection Fund. It remains to be seen whether these will be used more widely. The Regulator will have increased powers, in certain circumstances, to impose liabilities on parties who, although not employers in the scheme, are connected with them. This may arise where there have been steps taken (other than in good faith) to reduce or avoid an employer’s statutory debt. It may arise in some circumstances when the employer itself is a service company or is “insufficiently resourced”.

There will be scope to obtain in advance a clearance system from the Regulator (OPRA began operating an informal clearance system) where there are concerns about the impact of these provisions.

These powers can be operated in respect of acts going back to 27 April 2004. This legislation in both its retrospective and prospective effect must be of great concern to corporate clients and advisers in transactions.

The Pension Protection Fund is to be funded by a levy on all pension schemes, yet another disincentive for provident provision. The levy can run into tens of thousands of pounds, another huge burden, but the size of these exactions pales into insignificance when one contemplates the extent of some of the liabilities which are likely to be dumped into the Pension Protection Fund.

At the time of writing that is about as much as can be said for the Pension Protection Fund, because the regulations are still not forward. Clearly corporate finance lawyers are going to have to include further very important due diligence checks and also new provisions in pension schedules and warranties with regard to this, payment of the levy, and to the effect that no event has taken place which might lead to the service of notice under the Regulator’s powers mentioned above.

Also, the order of priority in the winding up of a pension scheme has been changed yet again to keep it consistent with protection from the fund. It will be borne in mind also that where a deficit of assets against liabilities of a scheme arises after commencement of winding up of the scheme or liquidation of the employer, the employer will be liable for that deficit. Where the applicable time for ascertaining that deficit falls on or after 11 June 2003 its value is assessed by reference to liabilities on the basis of annuity purchase.

There is also to be a Financial Assistance Scheme set up for those whose schemes were wound up in the period between 1997 and the onset of the Pension Protection Fund. The Government has pledged £400m of public funds to this over the next 20 years. A believed 64,000 people affected by this gives an average of less than £6 per week. However the Government seems now to be targeting those who were within three years of scheme pension age on 14 May 2004, with a de minimis amount of £10 per week and a cap of £12,000 per annum, which they claim will provide 80% coverage for those thereby included in this scheme but nothing for those thereby excluded. Clients and their advisers will have to review their position in relation to this scheme and should visit the FAS pages of the Department of Work and Pensions website for details of how to claim. This is expected to be operational in August. Be alert: the claims window might be short.

Other changes

Here are some of the other items in the Act expected to come into force in either April 2005 or 2006.

Expected April 2005

Transfer of Undertakings (Protection of Employment) Regulations. At present rights at retirement in relation to an occupational pension scheme are excluded from the obligations which pass under TUPE to a transferee employer. This is now altered so that the transferee employer must provide either (whose choice it is, is not clear):

  • defined benefits on the basis of the reference scheme test under the Pension Schemes Act 1993 or
  • money purchase contributions matching those of the member up to 6%.

LPI: at present certain benefits, principally those accrued in respect of pensionable service after April 1997, must be increased in line with the retail prices index, limited to a maximum of 5% (limited price indexation (“LPI”)). That limit is now to be reduced to 2.5%.

April 2006

Trustees: The present requirement for one third of trustees to be member-nominated is to be increased to one half.

There are new requirements that trustees have knowledge and understanding of pension schemes and be conversant with key documents and legal issues.

Consultation: There is a new requirement for employers to consult over key changes to the scheme or in the employer. Some of this may be commercially very sensitive. The employer may wish to consider imposing (for example through the trust deed) an obligation on the trustees to keep such information confidential.

Simplification of Pensions Act 1995, section 67: The section prevents any modification from affecting the accrued rights or entitlements of a member without his consent or an actuarial certificate. This is to be “simplified” from a half page section to 11 sections, basically allowing the amendment where the rights are actuarially equivalent.

Planning for retirement: There are new provisions on financial planning, combined pension forecasting and the provision of financial advice by employers.

Investment: Again this is in light of the European Pensions Directive and makes a number of differences to the way trustees must address their investment duties.

Preservation: This is a heading generally applied to the protection given to the rights of those who leave before normal pension age. There are a number of amendments including a new right to a transfer value where the member has not qualified for preservation, and changes in relation to paternity and adoption leave.

Additional voluntary contributions: The Act will also remove the requirement for pension schemes to accept AVCs.

Finance Act 2004

This further piece of legislation effects another major change for pension schemes. Pension schemes capable of Inland Revenue approval have been divided into two types. Personal pension schemes (and the old retirement annuity contract) had limits based on the percentage of earnings which could be paid in. Employer-sponsored schemes had Inland Revenue approval limits based on what could be taken out – for example a maximum pension of two thirds of final remuneration.

The new regime is built around a lifetime limit on the fund at retirement of £1.5m and annual contribution limits of the lesser of earnings and £215,000 per annum.

Broadly individuals and their pension schemes will be much freer in how they operate and how they invest (including residential and foreign property), but if they go outwith what is permitted, punitive tax charges will be imposed.

The effect of this is likely to be to produce a much more benign environment for all, particularly the very rich. However the rich will have to carry out some careful planning before this comes to pass in April 2006.

Other legislation

Pension schemes and indeed employment conditions generally will also have to be reconsidered in light of two further enactments.

The Gender Recognition Act 2004, to put it at its briefest, legalises sex changes. This has a number of effects in relation to pensions, not least in relation to gender-based annuity rates. No special protections or savings are given to pension schemes other than the state pension scheme, which is of course elaborately protected from this.

The Civil Partnerships Act 2004, put again at its briefest, will allow from December 2005 the registration of homosexual partnerships in a way vaguely akin to marriage. Pension schemes are to be required to provide certain survivors’ benefits. However the Employment Equality (Sexual Orientation) Regulations 2003 (SI 166, amended by SI 2003/2827) may well take the position further and the whole thing really needs an article in itself!


It will be seen that those involved in various fields of law, corporate, insolvency and employment will have a number of areas where they have to consider these new provisions.

Matters will however have to be kept under review not only as at April 2005 but as further changes are rolled out up to 2006 and beyond – but enough for today!

Iain Talman,  Partner, Biggart Baillie


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