Tailoring plans to mobile needs
Multinational companies are faced with a number of problems when providing retirement benefits for internationally mobile employees as they move from location to location.
Defined as Third Country Nationals (TCNs), they are people working for a parent company based in country A and whose nationality is with country B, and are working in a third country C. A major distinction between this type of worker and the expatriate is that the TCN will probably transfer to country D, then E and so on, until returning to retire in their country of origin.
The problem is that the employer does not know in advance where the employees will be sent or for how long. There may be a minimum residential period in particular countries for social security eligibility which, through no fault of his/her own, the employee may not attain.
If private plans are set up in each country of work, there may be minimum participation periods and different types and amounts of benefit, not to mention different actuarial practices. These are even before we take into account inflation, currency risk and whether the employee’s occupation is acceptable to an insurer (if applicable) based in the host country. Knowing what provision the employee has, whether he has adequate cover and how to go about claiming the benefit could be a logistical and administrative nightmare.
The primary consideration is the plan design – whether it is to be a host country, home country or standalone plan. Consideration also needs to be given to the amount of provision afforded by social security in particular countries in terms of the total benefit required by any plan or plans.
There are a number of possible solutions, each of which has pros and cons: q TCNs could receive individual treatment – this is flexible but ad hoc, involving duplication of administration with no guarantee of equality with other employees.
q A second solution is to put the employee in the ‘home’ plan or set up a plan in the first country to which they move. This is good if the country in question is industrialised and therefore has a sophisticated social security system, but invariably this is not the case and social security provision may be poor or non-existent. In addition, tax deduction for contributions to retirement plans outside the employee’s home country may not be allowed; moreover the employee could be subject to a tax assessment on employer contributions. Similar problems arise with a parent company plan.
q Many companies opt for the host country approach, which involves the setting up of a new scheme following each and every move. Each employee currently working in a particular country will receive equal treatment but this approach could lead to different levels of or lack of coverage across an employee’s working life, low benefits due to short contribution periods and problems updating records of past service.
q The worst case could be where the employee loses some accrued social security benefit because retirement takes place in a different country. Many countries have agreements that avoid duplication of coverage where total service in participating countries is recognised for the purpose of final social security benefit eligibility. Unfortunately these are mostly only between the US and Europe and intra-Europe.
q One further solution may be a non-integrated central plan to provide for all employees, ignoring social security provision in specific countries. This would allow costs to be controlled with no gaps in benefit. The downside is that this approach may lead to overfunding. Tax deduction may not be available on contributions to retirement plans based in one country and there would inevitably be unequal treatment of employees, particularly between mobile and non-mobile employees.
So how can we ensure that these employees are not disadvantaged by the nature of their jobs with a solution that caters for many of these problems and provides adequate aggregate benefit over their working lifetimes?
One solution is to establish an offshore trust-based scheme combined with an offshore investment vehicle. Typically, the investment vehicle will have a range of investment options, each having different investment objectives. This solution addresses the above problems – missing benefits are supplied, TCNs get equal treatment, overfunding is minimised and the TCN may be able to take advantage of tax deduction on contributions, regardless of the number of countries in which they work.
If solutions were types of suits, then the three basic options are ‘off the peg’ department store; tailor made (typically from trendier high street tailors) or bespoke tailoring to suit the individual.
‘Off the peg’ takes a one-size-fits-all approach. Individuals within a scheme are typically treated no differently to any other and contribution levels within each scheme tend to be fixed with a set choice of funds available. It follows that one price can be set for the whole scheme; reduced flexibility and individual ‘tailoring’ is traded off against lower cost and reduced input required from client Human Resources personnel.
The tailor-made approach allows more flexibility to cater for individuals within the scheme, allowing differing member and employer contribution levels for example. These two solutions are typically offered by insurance companies and suit small groups where individuals have similar requirements or where there is no necessity to cater for complicated individual circumstances.
Bespoke: Further along the scale, consultancy firms offer services that will take account of all the specific wishes of the client, typically bundling together an appropriate package that could involve a number of service providers. This additional layer of expertise does of course present an extra cost to the client.
In the final analysis of which ‘shop’ to visit, the requirement for larger, more diverse and complex solutions must be weighed against the additional cost and resource required to set them up.
To provide offshore tax-efficient financing, schemes can be set up via a trust deed that sets out the scheme framework and rules of operation. The trust regulates the rights and obligations entered into between the employer and employee regarding prospective entitlement to benefit.
To facilitate full portability, the trust deed should contain a trust export clause that would enable the trust by agreement between the trustee and the provider to be moved to another jurisdiction. This provides the trust with the requisite flexibility to operate within the most advantageous jurisdiction available.
Within the legal system, a trust is the most flexible instrument available for providing protection and security to beneficiaries.
The choice of the jurisdiction of the trust and the residence and structure of the investment vehicle all have an impact on the tax efficiency of the arrangement. From the investor’s point of view, all income can be immediately reinvested providing the potential for higher total returns. This income accumulates in a low-tax or tax-free environment. Growth in the value of the fund is also free of local capital gains tax. The investors may only have a tax liability when the investment is realised. Employees are comforted by the existence of a trust fund and the fact that it is separate from the employer’s assets.
Offshore centres offer a combination of large and small attractions to sponsors that help form a financially beneficial package. In Dublin for example, all dealings in stocks, shares and other securities are exempt from income and capital gains taxes. Lower costs are reflected in more competitive charges.
So what’s stopping this from becoming pan-European? Differences in local social security provision can be overcome using this solution. The same may not be true of the effects of legislative, taxation and cultural differences. These act as barriers to the delivery of the most appropriate investments for a particular individual at any point in time.
The main issue is in trying to resolve the frequently occurring conflict between the desire to have a common level of total benefit throughout the region and conforming to local competitive practice. The drivers of choice will often be the culture and practice of the parent organisation in other aspects of its business practice.
From a technical point of view, the investment freedoms for pension purposes granted to UK insurers are still not available in all member states. There are for example, a variety of restrictions on the percentage equity holding and percentage holding is overseas assets. While in other countries such as Spain, separate fund choices for members are still not allowed. One way to give the same investment choice might seem to be to use Luxembourg or Dublin Ucits funds as the unit-link.
There is an interesting conundrum around the taxation treatment of funds used for different purposes in different jurisdictions.
Dublin and Luxembourg-based funds, in general, cannot access the double taxation treaties of their domiciliary base. Where there is withholding tax on the income of the underlying assets these funds can be tax-disadvantaged compared with onshore funds.
However, the advantage of onshore insurances is only of any practical use if a network of insurers exists in the relevant territories. Even then, centralised funds may give operational economies of scale that outweigh the effect of the tax drag.
In any case, if we are to create a genuine pan-European pension scheme, the rest of Europe must first embrace the concept that a wide variety of investments play their part in pension provision if appropriate solutions are to be constructed for each individual.
Graham Charters is head of development at Swiss Life (UK)