Guidance note on pan-European pensions
Those who have made contributions to a state pension in one European Union (EU) country have long had the right to receive their state pension if they retired to live in another EU country. This right was extended in 1998 to occupational pensions (Directive 98/49/EC).
In May 2003, the EU Council adopted a Directive (2003/41/EC) on the activities of institutions for occupational retirement provision (IORPs). This set out a general framework for the operation of pan-European pension schemes and established a deadline of September 23rd 2005 for the incorporation of its terms into national law
According to the Directive, there are two ways that a pan-European scheme may be established. Either a totally new scheme may be constructed, or an existing scheme may be adapted to meet the new rules. In the latter case, all that pension trustees need to do is add a distinct section to a scheme for each jurisdiction covered. This means, for example, that in a scheme established in Germany, additional sections may be added for those based in the Netherlands and Sweden. Those administering the scheme need to ensure that each section is operated in line with German, Dutch and Swedish legal requirements respectively. Curiously, the Directive does not cover group personal pensions or stakeholder arrangements
Pension administrators are required to carry out regular valuations and assessments of scheme liabilities. All schemes must have sufficient assets to cover their total liabilities, or have in place an adequate plan to make good any deficits over a reasonable time period.
Tax obstacles to the realisation of pan-European schemes are now being progressively removed. In October 2002, the European Court of Justice (ECJ) ruled in the Danner case (C-136/00) that the Finnish authorities were wrong to impose income tax deductions on contributions to a pension insurance scheme established in Germany. Hard on the heels of this ruling came an application by the European Commission to the ECJ to force the Danish tax authorities to amend their legislation so that contributions to foreign-based pension funds would be given full tax deductibility in line with contributions made to domestic funds. The Commission has made similar threats to tax authorities in Belgium, France, Portugal, Spain and Sweden.
The European Commission has also published a draft Directive on the portability of occupational pensions, particularly at a transnational level (Com (2005) 507 Final). The Commission would like to achieve a greater level of harmonisation in vesting periods and transfer rights, and also to establish a common requirement that dormant contributions from past employees are fully inflation-proofed.
An important but indirect boost to such schemes also arises from an agreement between twelve of the current EU member states to start exchanging information about the savings of non-residents and to allow each country to tax its own citizens on their EU-wide savings incomes. The agreement specifically excludes life insurance and pensions savings provisions. Three other EU countries - Luxembourg, Austria and Belgium - will apply a withholding tax on savings instead of participating in the disclosure pact.
Further pressure to overhaul many existing company pension plans arises from a change in accounting standards. New accounting rules under IAS 19 affect all companies that are listed within the EU and must now be applied in full, unless a company already uses a similar standard elsewhere in its global operations. The principal impact of the new rules has been upon companies that operate defined benefit (final salary) pension plans and generous retiree medical or death benefits. For these companies, the annual expense loading on accounts has been increased significantly and this could ultimately affect both corporate credit ratings and share prices. Consequently, many companies are seeking to phase out defined benefit plans in favour of schemes based on a defined contribution approach.
Location of schemes
The most popular locations for the central administration of pan-European pension schemes are Luxembourg, the UK and Switzerland. Luxembourg is leading the way with special safeguards in place for scheme contributors and beneficiaries. The Luxembourg authorities have also defined three types of fund:
SEPCAVs: This provides for defined contribution plans with a lump sum on retirement.
ASSEPs: The most suitable fund for multinational employers with scattered populations of employees. Members of such plans may be part of a defined benefit or contribution arrangement. They become creditors of the fund and may be able to escape tax obligations that exist in some countries for benefits in kind. Payments out of the fund may be in the form of a lump sum or an annuity.
CAAs: These are designed for smaller schemes that do not meet the capitalisation requirements set for SEPCAVs and ASSEPs. Pensions may be either defined benefit or contribution. They are, however, subject to direct supervision by the state insurance regulator - the Commissariat Aux Assurances (CAA).
By far the most developed system of private pension provision in the European Union is to be found in the UK. This is largely because the UK state pension is so low that most white-collar employees have had to rely on supplementary company schemes for their principal retirement provision. Consequently, the UK has developed more flexible pension products - such as the highly mobile personal pension plan and also fully-integrated pension and life insurance schemes. On the European continent, private pensions are still frequently regarded as little more than savings arrangements and life insurance is generally sold separately via brokers rather than directly by insurance companies.
The UK government is seeking to ensure the participation of employees and their representatives in key decisions about the future of their occupational schemes. For this reason, the UK is introducing a requirement for companies to enter into consultations with staff or their representatives at least two months before any change is due to be made. The requirement initially applies to companies with more than 150 employees, but will apply to all companies from 2008 onwards. Moreover, if an occupational pension scheme has its main administration outside the EU, it must be established as an irrevocable trust if it is to receive contributions from either employers based in the UK (wherever their employees work) or from employers in respect of their employees who work in the UK. (Section 253 of the Pensions Act 2004).
What employers want
During the next five to ten years, employers throughout Europe will be seeking to move away from burdensome defined benefit schemes and to develop more portable and easily administered pension arrangements. Financial institutions have long enjoyed an era where their expertise has been focused on complex schemes designed to maximise tax effectiveness and to provide complete customisation to client requirements. The sheer volume of reforms that have recently taken place have also led them to regard the emerging constraints as far more complex than they actually are. The market for pension and insurance products is, in fact, being opened up by these changes and the future lies with much simpler and more standardised financial products.
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