NILGOSC
Circular
07/2004-1st December 2004
1 December 2004
To: Chief
Executive
Payroll Officer
Human Resources Officer
All Employing Authorities
Dear Colleague
On 4th October 2004 the office of the
Deputy Prime Minister (ODPM) issued a Green Paper, Facing the Future –
Principles and propositions for an affordable and sustainable Local Government
Pension Scheme in England and Wales for discussion and consultation. A copy
of the Green Paper and associated documents can be downloaded from our website www.nilgosc.org.uk/future, or
copies can be requested from NILGOSC if
you do not have Internet access. Although the ODPM’s proposals currently only
affect England and Wales, the resulting legislation will, inevitably, be
replicated in Northern Ireland and Scotland, so it is important that our views
are represented at the consultation stage.
The Green Paper states that the Government is
committed to introducing new pension arrangements for local government in
England and Wales, which could be introduced from 2008. Ministers have
expressed their commitment to retaining a defined benefit final salary
arrangement which is relevant to the local government workforce, provided that
it remains both affordable and sustainable. I attach a paper at Appendix A
which sets out the main proposals contained in the Green Paper and highlights
those areas which require consideration and comment by employing authorities.
The Green paper is out for consultation with a
closing date for comments of 31 March 2005. The Local Government Pensions Committee
has convened a Working Party of interested parties to consider the matters
raised and it will report its findings in a Circular at the beginning of 2005.
Employing authorities in Northern Ireland should
submit their opinions and views to NILGOSC by 31 January 2005 to enable them to
be collated and submitted in a formal response to the ODPM and DOE by the
consultation deadline of 31 March 2005. I cannot stress too strongly that this
is YOUR pension scheme and it is therefore of vital importance that you
make your views on the proposed changes known.
Yours sincerely
Lynda White
L M White (Mrs)
Pensions Manager
The Green Paper makes a number of propositions for the possible content
of a new-look LGPS. The main matters covered by the Green Paper are set out
below:
The Scheme would cover the same range of employers as
now, including contractors who wish to participate in the Scheme under an
admission agreement following outsourcing.
Employees could participate at any age,
and would be deemed to have opted into membership of the Scheme (apart from
employees employed on fixed term contracts of less than 3 months who would have
to elect to join the Scheme).
The Green Paper states that the various
propositions it contains for a new LGPS would, if taken together, result in a
total future scheme cost of about 21% of payroll. It suggests that employee contributions
could be varied, based on pay levels. For example:
<£5k Contribution
rate of 2.5%
£5k but < £7k Contribution rate of 5.5%
£7k but < £38k Contribution rate of 7%
£38k but < £80k Contribution rate of 9%
£80k and over Contribution rate of 10%
The Scheme could provide that employees
paid the contribution rate relevant to their level of earnings or,
alternatively, paid tiered contributions i.e. 2.5% on the first £5k, 5.5% on
the next £2k, etc. If the former approach were taken, the average contributions
from employees across all pay bands based on the above would be 7% of payroll.
If the latter route were taken the percentages shown above would need to be
higher. Please refer to the Green Paper for the ODPM’s rationale behind this
proposal.
[Comment:We would particularly welcome employers’ comments
on the feasibility of this proposal. Would your payroll software cope with
multiple and/or tiered contribution rates? How would you deal with employees
with multiple employments or variable hours, whose earnings for the year are
not known in advance? If employees paid a flat contribution rate according to
their level of earnings could there be a disincentive to apply for a higher
paid post on which the higher rate of contributions could lead to an overall
drop in take home pay? Given that 77 per cent of Scheme members will fall
within the middle (7%) contribution band and only 2 per cent in total are in
the top two (9% and 10%)bands, are 5 contribution bands not an unnecessary
complication? Why is no protection being offered to existing 6% and 5%
contributors? (When the Civil Service introduced its new Premier Pension Scheme
with a 3.5% employee contribution rate, existing civil servants who were paying
1.5% contributions had the option of remaining in the old scheme or
transferring to the new scheme). Is it the role of the LGPS to meddle with
redistribution of income?]
Any new arrangement would contain a normal
scheme retirement age of 65. Where
benefits are paid before this age, except on ill-health grounds, they would be
actuarially reduced to reflect the fact they were being paid early. Benefits brought into payment after this age
would be actuarially increased.
[Comment: The LGPS (Amendment) Regulations 2005 are expected
to afford some protection to scheme members who will attain age 60 with 25
years membership before 1 April 2013. It is not clear whether this protection
will be carried forward into the 2008 regulations. It does not seem equitable
that a member who has contributed to the Scheme for, say, 30 years, with the
expectation of retiring on full benefits at 60 should suddenly have this
expectation stripped away. Some phasing in of this measure will be required, as
well as, perhaps, the protection of benefits from past service from reduction
if 25 years can be completed by age 60, the reduction applying only to service
accrued after the introduction of the Regulations. It should be borne in
mind that the potential cost savings from increasing the retirement age are
likely to be offset to some degree by an increase in the number of applications
for ill-health retirement].
Benefits could accrue at 1.6% per annum,
i.e. after 10 years service a member would receive a pension based on 16% of
their basic salary and after 40 years service a member would receive a pension
based upon 64% of their basic salary. This is a slightly better accrual rate
than at present i.e. a 1/62.5th accrual rate rather than the present
accrual rate of roughly 1/64th (which a 1/80th pension
and a 3/80ths lump sum roughly equate to).
It is not intended with such an accrual
rate that the Scheme would provide an automatic lump sum, but could instead
allow members to commute up to 25% of the capital value of their pension for a
tax free lump sum at a rate of 12:1; in other words, for every pound of pension
foregone, £12 of lump sum would be awarded.
[Comment: While the slight increase in
accrual rate is to be welcomed, why not go for 1/60th accrual rate
as the Civil Service and Teachers’ Schemes have done? Why is the LGPS always
treated as the poor relation?]
Pensionable pay could be limited to basic
salary. All other payments, such as bonuses,
fees, overtime and allowances, would be excluded. The basic salary on which
contributions would be paid could be that at the start of the financial year
or, if employment commences or changes during the period, the salary on the
commencement of the job.
[Comment:This is all very well for new starts, but the
interests of members who have paid contributions for years on their bonuses,
fees, allowances and overtime need to be protected. Not all will be close
enough to retirement to benefit from a Certificate of Protection].
Provision could be made for flexible
retirement to ensure that members could, where this supports the business needs
of the employer, choose to make arrangements for a more gradual approach to
retirement, perhaps adjusting their work/life balance by reducing their hours
or stepping-down to a less onerous job but, at the same time, able to draw some
or all of their accrued pension whilst continuing to accrue further pension
rights.
[Comment: Welcomed, and if the member has attained 65, or
has accepted an actuarially reduced pension at an earlier age, there should be
no abatement of pension on account of continuing employment].
Tiered ill-health retirement benefits
could be introduced, with improved enhancement for members whose employment is
terminated on grounds of being permanently incapable of performing any gainful
employment by reason of ill-health.
Their benefits would be paid based on potential membership to age 65,
although a review mechanism could be considered to take account of future
improvements in medical science.
A second tier of un-enhanced ill-health
retirement benefits could be available to those who are incapable of continuing
in their role, but who are capable of undertaking other employment. The
un-enhanced benefit would be subject to review, and could cease or be reduced
if the member took up subsequent employment. Alternatively, the second tier
could take a more radical form. Instead of the Scheme paying an ill health
pension, employers could enter into income protection policies which are
commercially available, with the Local Government Pension Scheme benefits only
becoming payable when a member will not be, or will not be capable of, working
again.
[Comment: If enhanced ill-health benefits
are available only to those who are permanently unfit for all work, this
may have profound implications for your workforce management policies. It is
difficult to see how the provision of income protection insurance can reduce
employers’ costs overall. Anecdotal evidence from Schemes which have an
ill-health review mechanism suggest that it is a net cost to the scheme since
only about 10% of reviewed cases actually have their pensions reduced or
suspended].
[Comment: The
loss of the short-term survivors’ benefits will be made up for, in most cases,
by the increased death grant].
The death in service lump sum could be
increased to three times pensionable pay.
[Comment: In view of the anticipated reorganisation
of local government and the education and library boards, this is likely to
have significant impact on these authorities. Employers should also note that Regulations
are expected to be made in 2005 which will increase the earliest age at which
benefits can be paid on redundancy/efficiency grounds to 55. It is important
that employers who award discretionary compensation (either added years or lump
sum) make their views known on this, as it may have a significant impact on
their ability to manage reorganisation, down-sizing etc. in the future.
Employers are reminded that NILGOSC has no statutory responsibility for
administering the Compensation Regulations and as we have never awarded
compensation, have no particular stance on this issue].
Consideration could be given to the option
of the Scheme providing a defined contribution top-up arrangement. This would
negate the need for the Scheme to maintain the current Additional Voluntary
Contribution or added years provisions. Scheme members could pay additional
contributions into the top-up arrangement on their basic pay and on any pay
received in excess of basic pay (and potentially could transfer the value of
pension rights in other Schemes into the top-up arrangement). The Green Paper
also asks whether such an arrangement should be offered to employees as an
alternative to the defined benefit scheme, with an appropriate level of
employer contribution, in order to provide further flexibility and choice to
employees.
[Comment: As with other provisions, no mention is made of
members who are currently buying additional service or paying AVCs].
To ensure a simplified, single framework
for the future, the Green Paper says that any new look Scheme could provide
that every person who is contributing to the current LGPS on the date the new
scheme commences would be automatically transferred to the new arrangement and
be awarded a period of membership in the new scheme which is of equal
value.
Deferred and pensioner members, at the
date the new scheme commences, would be entitled to retain benefits in the
current LGPS.
[Comment: As noted under the proposals for contribution
rates above, this is not what happened in the Principal Civil Service Pension
Scheme. A period of membership “of equal value” may mean a reduction in length
which would be unfair and unacceptable to members within a decade or so of
retirement. Desirable though it might be for simplicity of administration, I
doubt very much whether it will be possible in practice to implement a “clean
break” solution].
The
Finance Act 2004 establishes a new tax regime for all pension schemes and comes
into effect on 6 April 2006.
The current LGPS will need to be amended
to take account of the changed tax regime and the new contribution and benefit
limits contained in the new regime. The Green Paper poses a number of questions
about how, and to what extent, the current LGPS should be amended (and the new
LGPS worded) to reflect the new tax regime which:
a)
removes the
current pensionable earnings cap of £102,000 and introduces a lifetime
allowance of £1.5 million, the latter being the amount an individual may accrue
in pension rights (from all sources) without being subject to a tax surcharge
on the excess. The Green Paper questions how the LGPS should be amended to
cater for high earners who joined the LGPS on or after 1 June 1989 and whose
pensionable earnings are currently capped at £102,000. Should the LGPS retain a
cap on pensionable pay for such members? If it does not, such members would
make a windfall gain in the value of their pension rights. For example, a
member who is currently subject to the £102,000 cap, but earns £153,000, would
(upon the removal of the cap) suddenly have a 50% higher pensionable pay figure
upon which benefits could be based, despite not having paid contributions on
the £51,000 excess above the earnings cap in previous years
b)
introduces
an annual allowance of £215,000, being the amount an individual’s pension
benefits may increase by in a year (other than the final year of membership)
without being subject to a tax charge (on the excess over £215,000)
c)
allows up to
25% of the capital value of the member’s pension to be taken as a tax free lump
sum (which exceeds the proportion currently allowed under the LGPS)
d)
permits
employees to pay up to 100% of their salary into a pension scheme (with tax relief)
rather than the current contribution limit of 15% into an occupational pension
scheme
e)
does not
limit the period of membership that can count for benefit purposes. For
example, a new joiner today (in 2004) aged 16 could, under the current Scheme,
only accrue a maximum of 40 years membership in the Scheme. Under the new tax
regime that employee could, for example, count 49 years membership at age 65,
or 51 years at age 67, etc.
The Green Paper proposes that a new LGPS
would, like the current Scheme, contain provisions related to the proper
governance of the LGPS Funds. It also discusses:
a)
the need for
high quality scheme administration and information / data flows, and questions
whether there are any regulatory approaches that can be adopted to improve
these, and
b)
considers
the options for simpler, clearer, regulation possibly linked to a greater use
of codes of practice
and comments on best practice issues such
as joint working, e-government and the importance of good communication strategies.
[Comment: In our opinion, the single
innovation which could most dramatically simplify and improve administration
for employers, members and NILGOSC would be to move away from the current “membership credit” based
system which necessitates keeping track of every slight fluctuation in the
number of minutes, hours or weeks worked, and every period of concurrent or
casual employment, however trivial, to a scheme where benefits are
directly linked to earnings. This could easily be achieved through a CARE
(career average revalued earnings) scheme, which would also benefit the
majority of members by having a higher rate of accrual, for example, 1/50th
or better, for the same cost. ODPM has stated that there is little support for
the CARE option, but it has not put forward a detailed proposal for a CARE
option with an enhanced accrual rate. Certainly a CARE scheme with a 1/80th
or 1.6% accrual rate is not particularly attractive, except from the point of view
of simplifying scheme administration. The reality of the LGPS today is that the
majority of members experience little or no career progression and the higher
accrual rate which a CARE scheme has the potential to offer would enable them
to build up better pension benefits at no additional cost to their employers.
For “career officers”, the breaking of the link to final salary would be offset
by the potential to accrue a higher percentage (e.g. 40 or 45/50th
of revalued average earnings rather than 40 or 45/62.5th of final
salary).
The Scheme could also be simplified, and cost savings made, by
abolishing the “Transfer Club”. When a member transfers from other public
sector employment to the Local Government Pension Scheme on a higher salary, his
previous pensionable service is protected at the higher salary rate and the
Fund bears the cost, whereas with a transfer from the private sector, the
transfer value available determines the amount of membership credit the member
receives. Given that arrangements exist to protect the pensions of members
subject to enforced transfers between local government and other public sector
employers, there seems little justification for offering protection to a member
who voluntarily changes jobs to gain a higher salary].