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LONDON-U.K. occupational pension plans likely will undergo changes in light of the withdrawal of tax credits on stock dividends announced in the U.K. budget earlier this month.
In the first Labour budget for almost 20 years, Chancellor of the Exchequer Gordon Brown abolished the 20% tax credit on advanced corporation tax, which is paid when dividends are distributed to tax-exempt shareholders such as pension funds. The change, which took effect July 2, will cause pension plans to lose more than (British pounds) 3 billion ($5.1 billion) each year.
The finance bill including the change eventually will need parliamentary approval, but because Labour holds a majority, there is little chance anything will change substantially in the bill.
In a statement, Her Majesty's Treasury explained: "Abolishing payable tax credits removes a distortion in the tax system that has encouraged the distribution of profits rather than their retention for reinvestment, and has favored investments yielding dividends rather than capital growth."
Describing the change as "the biggest attack on pension provision" since World War II, the National Assn. of Pension Funds likened the chancellor's move to the deceased media magnate Robert Maxwell's raid on his company's pension funds. However, "Robert Maxwell only took (British pounds)400 million ($675.4 million), and the pensioners got most of the money back," said an NAPF spokeswoman.
Meanwhile, the chancellor also reduced corporation tax to 31% from 33% on companies with profits of more than (British pounds)1.5 million ($2.5 million). Companies with corporate profits up to (British pounds)300,000 ($506,550) also saw their corporation tax reduced to 21% from 23%. Companies with profits between (British pounds)300,000 and (British pounds)1.5 million pay corporation tax on a sliding scale. The reductions are retroactive to April 1. Taxes were reduced to encourage reinvestment, the chancellor said.
In all, U.K. pension plans will lose a total of about (British pounds)3.5 billion ($5.91 billion in tax credits each year under the new rules, according to government calculations. This is equivalent to 5% to 10% of the plans' total investment and capital growth income, though the effect on pension plans will depend on a number of factors.
These include whether the plans have a surplus. Mr. Brown justified the changes by saying many pension funds have a substantial surplus, allowing employers to suspend new contributions, "so this is the right time to undertake a long-needed reform."
But pension experts disagree. "This was true a few years ago, but the position is changing," said Sue Pollock, research actuary with London-based benefits consultant William M. Mercer Ltd. Of the top 100 companies in the United Kingdom, 9% have deficits in their occupational pension plans, according to a recent Mercer survey.
As the government changes take effect, that figure will rise to 40% of the top 100 companies, said Ms. Pollock, under minimum funding requirements implemented by the 1995 Pensions Act. Another 25% of plans will show a surplus of less than 10%, according to the survey.
"A 10% (drop in income) is probably right for a typical scheme, if you don't take into account mitigating factors," said Ms. Pollock. These factors include the lower rate of corporation tax.
The chancellor also introduced the idea of Individual Savings Accounts, which he described as a "tax-favored" retirement savings plan for individuals that could be phased in by the end of the decade.
Mercer's Ms. Pollock said the increased contributions that employers with defined benefit pension plans will need to make, coupled with the tax advantages of ISAs, could compel some employers to abandon their private pension plans.
Employers operating defined benefit plans could see their annual funding commitment rise by 10%, and this could "inevitably lead to some companies questioning whether they want to provide (pensions) in that way," said Ms. Pollock. The alternative would be to operate defined contribution plans, with the benefit tied to the amount an employee accumulates in his or her account. In these cases, retirees would feel the impact of the chancellor's moves and most likely would see 5% to 10% reductions in their retirement benefits.
However, Ms. Pollock does not think employers will rush to switch to defined contribution plans, though she has seen a lot of interest. "There are other investment vehicles which are more efficient," she said, including the proposed ISAs, though these are to be designed for low- to medium-level wage earners. Another alternative would be to increase employee salaries and withdraw pension benefits entirely, she said.
Few occupational pension plans set up over the past 10 years have been on a defined benefit basis, said Alan Fishman, chief actuary at Croydon, England-based consultant Sedgwick Noble Lowndes Ltd., which advises 1,200 occupational pension plans. Instead, defined contributions are funding most new plans. In addition, a number of occupational pension providers now have both defined contribution plans along with the more traditional defined benefit plans, which are closed to new employees.
The chancellor's changes to the advanced corporation tax "could be the last straw which breaks the camel's back," said Mr. Fishman. "There are many employers who. . .now have given consideration to move to money purchase (defined contribution) arrangements," and "one or two" may now take that step, he said.
Mr. Fishman warned against the pension industry panicking in reaction to the chancellor's announcements. "I take the view that we. . .just need to keep a cool head to assess how this will affect us," particularly in regard to minimum funding requirements of pension plans.
A "windfall tax" of 23% on the profits of recently privatized utility companies also may hit occupational pensions' investment income, though Mr. Fishman pointed out its effect already may have been discounted.
Stacy Shapiro contributed to this report.