Defined-benefit pension schemes, often nicknamed “top-hat” schemes, are taking a roasting. Already limping after recent measures taken by the French government in a drive to neutralise certain uses seen as excessive, they are now under threat from the European parliament. Will they survive such caning?
Defined benefit plans are accused of hindering worker mobility
In a year’s time, before 21 May 2018, the European Union directive of 16 April 2014 on improving the mobility of workers between member States, will be transposed into French law. One of the directive’s provisions states that the benefit rights accumulated in a supplementary pension plan must be permanently vested in the employee after three years of membership. Although, in theory, the wording is aimed at workers who leave to go and work in another EU member State, it would seem extraordinary that this logic should not also apply to employees who stay in the country.
This new ruling will therefore have a direct impact on L.137-11css-type defined-benefit pension schemes (better known as “article 39” or “top-hat” schemes). At the moment, an employee who leaves a company with one of these “random rights” schemes loses all his/her accumulated pension rights. Brussels sees this aspect has tying employees all too much to their jobs and to their country.
Should defined-benefit schemes be saved?
Defined-benefit schemes have already been the subject of a series of regulatory and taxation amendments. Tax on such schemes already becomes almost confiscatory when pension amounts rise too high* and now the Macron Act, from now on, limits the cumulative rights acquired by company officers to 3% of their salary per year of service. The legal framework within which defined-benefit schemes operate has been tightened up due to their bad reputation. This is because of the top-hat pension amounts granted to certain senior managers in large corporations.
Nevertheless, Article 39 contracts are not reserved just for managers at Carrefour or Thales. There are 200,000 people benefiting from annuities averaging out at € 5,500 a year**; and companies pay in less than € 10,000 in contributions per year / per employee. This average figure, however, masks a strong disparity between small and large corporations. The figure reveals one of the objectives of such schemes, i.e. to provide a fast-track complement to pension savings for employees or senior managers whose chaotic career has not guaranteed them sufficient pension.
Several options to choose from before 2018
A straight transposition of the European directive would result in closure of L137-11 defined-benefit schemes. Will they be continued or even replaced within a new framework that is compliant with the new regulations? We will not know the answer until the 2018 Social Security Finance Act. However, the new regulatory constraint could be an opportunity to rethink such schemes. A number of ideas have been put forward: simplify and harmonise taxation and employment law provisions, place limits on their usage to avoid certain excesses and tackle the question of types of beneficiary. This could put new life into this original and useful complementary pension solution against the background of progressively falling benefits provided by the basic State schemes.
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* Defined benefit pension schemes
An L13-11-css (or Article 39, top-hat) pension scheme is a supplementary plan that guarantees a beneficiary a certain level of lifetime annuity.
- Tax and employment law framework for companies:
Company funds used to finance pensions are deductible from their taxable profit.
The premiums paid to the insurer, who will, later, service the annuity, are subject to 24% social insurance contributions. If the company decides to pay annuities itself, then the contribution rate is 32%. These are deducted at the time the annuity is paid out.
Whatever the option chosen – premium or annuity – the employer is charged an additional contribution of 30% on annuities that exceed 8 times the so-called Social Security Ceiling (i.e. € 313,000 in 2017)
- Tax and employment law framework for the beneficiary:
Such annuities are subject to the same taxation and employment law conditions as pensions. In addition there is a tax of 7% to 14% depending on the amounts received.
** Source DREES