Issues for Defined Benefit Scheme Members

Defined Benefit schemes have traditionally been the main source of non-state pension provision in the UK, supported by generous employer funding. Key ongoing issues for Defined Benefit schemes are well known:

  • Increased life expectancy
  • Low gilt yields
  • Reduced investment returns

However, even smaller factors such as the reduction of the contracting-out rebate and the Pension Protection Fund levy have put further pressure on scheme finances.

Employers are continuing to examine ways to reduce scheme liabilities. More schemes are closing to new members (now fewer than 13% of existing final salary schemes are open to new members) with further closures and changes to scheme benefits likely in the future.

From the member’s perspective, Defined Benefit schemes, whilst offering valuable guarantees, do have a few disadvantages:

  • The pension may cease on the latter of the member’s or partner’s death and accumulated funds may be lost.
  • There is the additional risk of restricted pensions should the sponsoring employer become insolvent.
  • The Lifetime Allowance is becoming an increasing concern having reduced to £1 million on 6th April 2016. This translates to a reduction in real terms of 35% since introduction in 2006.
  • Some schemes may restrict the definition of a partner and look to reduce benefits if a spouse or partner is significantly younger than the member
  • The pension paid by the scheme is on a prescribed basis.

 

Benefits and Solutions

Whilst a transfer to an alternative UK scheme is an option, for some individuals a transfer to a suitable overseas pension scheme would be more advantageous, for example, where a pension fund is approaching the Lifetime Allowance.

A transfer to an overseas pension scheme such as the Dominion Malta Retirement Plan 2010 (the “Plan”)  is a Benefit Crystallisation Event, meaning the member benefits will be tested against the Lifetime Allowance at the time, whilst after the transfer the pension fund will not be subject to any further Lifetime Allowance tax charges.

Once within the Plan, members would have the ability to direct the investment strategy of the pension fund and draw flexible benefits to suit personal circumstances. On death, the member’s pension fund could also be retained to provide for the member’s beneficiaries.

Since their introduction in 2006, HMRC has continued to monitor the overseas pension’s marketplace and has actively pursued any schemes which they have felt to have abused the legislation. Therefore, choice of jurisdiction is paramount as the member could be exposed to tax charges of up to 55% if the scheme is found to have been ineligible for Qualifying Recognised Overseas Pension Scheme (QROPS) status.

Malta has many strengths when compared to other jurisdictions in this respect, and these are outlined in our ‘Why Malta?’ briefing note in further detail.

The facts

The reduction of the Lifetime Allowance has provided scheme trustees and employers an opportunity to reduce scheme liabilities by targeting scheme members who will now be subject to tax of 55% on the excess pension.  The decrease in the Lifetime Allowance is likely to mean that an overseas transfer becomes a viable and suitable alternative to a UK pension plan for a large number of individuals looking to protect pension savings from future Lifetime Allowance charges.

The transfer, ‘crystallising’ the member’s benefits from a UK perspective, can provide further headroom for the accumulation of further UK tax-relieved funds within the Lifetime Allowance.

Depending on the client circumstances, the 55% tax charge that can be incurred on death during drawdown can be reduced and potentially mitigated entirely.

Therefore such a transfer can provide individuals with a route to escape punitive tax charges applicable to pension funds both during their lifetime and in the event of their death.

Further information on lifetime allowance planning and on the various considerations for UK resident and non-UK residents with DB schemes is available on request.