I propose to take Questions Nos. 57 and 58 together.
As Questions 57 and 58 both relate to the changes to the Standard Fund Threshold (SFT) regime introduced in Finance (No.2) Bill 2013, I propose to reply to them together.
At the outset, I want to reject the suggestion in these questions that changes being made in the Finance Bill will favour, and indeed are designed to favour, higher earning public sector employees in defined benefit pension schemes as compared to equivalent higher earning private sector employees in similar schemes. This is not the case.
As indicated in my response to Parliamentary Question No. 37 of 4 December 2013, it had come to the attention of the Revenue Commissioners that pension advisors and administrators had been interpreting the current SFT provisions in a manner that allowed the capital value of defined benefit pension arrangements with discretionary lump sum commutation rights to be calculated incorrectly at the point of retirement and not in accordance with the intention of the legislation. In light of that, one of the amendments to the SFT regime made in the Finance Bill is solely for the purposes of putting beyond doubt how the capital value of pension rights under such arrangements is to be determined.
This issue has to be looked at within the broad framework of the SFT regime as a whole. In that regard, the approach to calculating the capital value of defined benefit pension rights is best understood in the context of the Personal Fund Threshold (PFT) concept. The PFT concept allows individuals with pension rights valued in excess of the new lower SFT limit of €2m on 1 January 2014 to protect or “grandfather” those rights against any risk of chargeable excess tax when the pension is eventually drawn down.
The method of calculation of the PFT requires the capital value of defined benefit pension rights, where there is a discretionary lump sum commutation option (as in most private sector schemes), to be based on the annual amount of pension which the scheme would pay on 1 January 2014 (calculated in accordance with the requirements of the legislation) and before any commutation. This works to the advantage of the individual concerned as it maximises the amount of pension rights that are protected.
This is best illustrated by way of a simple example. Say on 1 January 2014 a private sector defined benefit scheme, with optional commutation rights, would pay a gross pension before commutation of €110,000 per annum. The capital value of those pension rights for PFT purposes is then €2.2m (i.e. €110k x 20). However, if the capital value of the rights were required to be calculated on the assumption that, on 1 January 2014, the individual fully exercised his rights to commute the pension up to the maximum allowable lump sum (using the same commutation factor of 9:1 as used in the example in the details supplied) the capital value for PFT purposes would then be €1.898m (i.e. a pension of €82,500 x 20 + a lump sum of €248,000). So the individual would not qualify for a PFT in the first place and the capital value limit of his or her pension rights at the point of retirement would then be the SFT limit of €2m.
Having calculated the PFT on the basis of the gross annual pension payable, it would be inconsistent, and would undermine the whole purpose of the SFT regime, to then afford the same individual the capacity to minimise the capital value of those rights at the point of retirement by permitting the calculation to be based on the capital value of the post-commutation pension added to the cash value of the lump sum. This inconsistency, if left unaddressed, would become even more pronounced now that the SFT regime is moving from a fixed conversion factor of 20:1 to a range of age–related factors which range as high as 37:1 where retirement takes place at age 50. Conceivably, €1 of pension accrued before 1 January 2014 which should have a capital value of €20 for chargeable excess purposes would be valued at just €9, based on a 9:1 conversion factor, and equally €1 of pension accrued after 1 January 2014 which should have a capital value of €37 for chargeable excess purposes, would also be valued at just €9 based on the same conversion factor.
The fact is that the SFT regime includes different methods of calculating both a PFT and the corresponding capital value of pension rights at the point of retirement for different types of pension arrangements and different types of pension benefits. But it equally seeks to ensure that it compares like with like and that similar pension arrangements with similar pension benefits are valued in a consistent manner. To repeat what I stated in my answer to the earlier Parliamentary Question, the same approach to the calculation of the capital value of defined benefit pension entitlements with optional commutation rights at the point of retirement applies whether or not an individual has a PFT, as it would be incongruous and indeed would give rise to more concrete claims of discrimination and special treatment, if the method of calculation for schemes of a similar kind was to vary depending on whether an individual had a PFT or not.
As regards, the particular hypothetical example which the Deputy included in the details supplied with Parliamentary Question No. 58, I would make the following observations. Firstly, the question itself implies that the scenario outlined in the example will arise as soon as the revised SFT regime comes into play from 1 January, but it is clear from the example that this cannot be the situation. The example is predicated on an age–related factor of 30 (applicable at age 60) applying to the whole of the annual pension benefits accrued at the point of retirement. By implication, this means that the individuals concerned would commence accruing benefits under their respective public and private sector schemes after 1 January 2014, as any rights accrued up to that date are automatically “grandfathered” using a factor of 20.
The example implies that a highly paid individual in the private sector who is a member of a defined benefit pension arrangement with optional lump sum commutation rights and, presumably, with knowledge of the SFT regime and how it could affect him or her would, nonetheless, continue to accrue pension benefits over their career in the fashion implied, regardless, and take no remedial action. Clearly this would not happen. Any individual in this situation would act rationally and stop accruing pension benefits and negotiate alternative immediate taxable compensation with their employer instead.
All the indications are that the pension funds of highly paid private sector individuals are being actively managed in this way with a view to avoiding a chargeable excess and the penal tax charges that go with it. This, of course, is how the SFT regime is intended to operate so as to restrict the capacity of higher earners to fund or accrue large pensions through tax-subsidised sources. By imposing penal tax charges on the value of retirement benefits above set limits when they are drawn down, it discourages the building up of large pension funds in the first place. Unlike highly paid private sector individuals who have the capacity to act to manage their pension funds with a view to avoiding a chargeable excess, the position for equivalent highly paid public servants is that the penal tax charge cannot be prevented as they have no means of ceasing to accrue benefits under their schemes in order to prevent a breach of the SFT or PFT, as appropriate.
