From 6 April 2015, there will be much more flexibility as to how members can access their defined contribution (DC) pension savings. The Chancellor described these reforms, announced at Budget 2014, as the most fundamental change in the way people access their pension in almost a century.
The Taxation of Pensions Act 2014 (ToPA 2014) became law on 17 December 2014. The other key piece of legislation effecting the changes, the Pension Schemes Act 2015 (the “Act”), received Royal Assent on 3 March 2015.
It will be for schemes to choose the extent to which they implement the new DC flexibilities, if at all. However, there are important implications to consider in readiness for April and here we highlight some of the key issues for employers and trustees with defined benefit (DB) and/or DC schemes (or, indeed, a mixture of benefits such as a DB scheme with DC AVCs).
The DC flexibilities
From 6 April 2015, schemes will be able to offer members new ways of accessing their DC funds from (in most cases) age 55. These include:
- making a cash withdrawal of one or more uncrystallised pension fund lump sums (UPFLSs); and
- entering drawdown via a “flexi- access drawdown fund”.
In addition, it should be possible in future to purchase annuities which are more flexible, such as ones which decrease while in payment. Employers providing DC benefits will need to consider which options would be appropriate for their workforce and how these align with longer-term retirement planning objectives. For example, should members be able to access their benefits while remaining in pensionable service? Trustees and employers thinking about implementing flexi-access drawdown or permitting members to take a series of UPFLSs will also need to consider the administrative practicalities and costs of doing so.
It has been suggested that few occupational pension schemes will choose to offer the new DC flexibilities due to the cost and complexity of administration. However, the Act extends the statutory transfer regime and makes it easier for members to transfer their pension pots to an arrangement which does offer flexibility.
Currently, a member’s statutory right to take a transfer value to another pension scheme only applies up to one year before normal pension age (NPA). From 6 April 2015, deferred members with DC benefits will be entitled to take a transfer at any time up to, or beyond, NPA. Members with DB rights will continue to have a statutory right to transfer out only up to one year before NPA. Where the member is transferring DB rights of over £30,000 to a DC scheme, new safeguards will require the transferring scheme to check that the member has received independent financial advice. The DWP has just published the draft Pension Schemes Act 2015 (Transitional Provisions and Appropriate Independent Advice) Regulations 2015 which set out the steps trustees must take to satisfy the advice requirement.
In February 2015 the Pensions Regulator issued for consultation new draft guidance for trustees of DB schemes which explains the new requirements, sets out the Regulator’s expectations of how schemes should deal with a request for a transfer and prompts trustees to consider the impact of transfer values as part of an integrated approach to risk management of their scheme.
The DWP also published the draft Occupational Pension Schemes (Transfer Values)(Amendment) Regulations 2015, which are intended to make sure that the transfer process continues to operate smoothly. Although, due to the tight timetable for implementation (and to allow employers and trustees enough time to plan for the changes), there will not be a formal consultation on these draft Regulations, the DWP warns that they are still subject to final legal checks and Parliamentary approval in early March 2015, so they should not be treated as finalised.
The Guidance Guarantee
The Government has made a commitment that individuals will have access to guidance at retirement to help them make informed and confident decisions about how to use their DC savings. This guidance (branded as “Pension Wise”) will be free and impartial and will be delivered in partnership with the Pensions Advisory Service and the Citizens Advice Bureau. Trustees will be required to signpost members to Pension Wise. The DWP will introduce this requirement through amendments to the Disclosure of Information Regulations.
On 5 March 2015, the Pensions Regulator issued guidance to help trustees communicate with their scheme members about the impact and possible risks of the new DC flexibilities including directing their members to the new Pension Wise service as they approach retirement.
Trivial commutation/ Small lump sums
Following the 2014 Budget announcement, transitional changes improving access to ‘small’ pension pots were introduced with effect from 27 March 2014. Further changes from 6 April 2015 mean that:
- trivial commutation will not be available in respect of DC savings as members will be able to cash out all of such savings via a UPFLS if they wish to; and
- the age limit for members with DB rights taking trivial commutation, and members with DB or DC rights taking small pots, will be reduced from 60 to 55.
Employers and trustees should consider what amendments are needed to the commutation rules under their schemes as a result of these changes.
Liability management exercises
Employers may wish to consider whether the time is ripe to undertake enhanced transfer value exercises in relation to their DB schemes as there may be increased take up from members keen to transfer to another scheme to convert existing benefits to DC benefits. The voluntary Code of Practice on “incentive exercises” will need to be considered – it requires members to be provided with advice or guidance depending on the circumstances.
Employers planning to undertake a one-off trivial commutation or small lump sum exercise should note that the Incentive Exercise Monitoring Board has recently said that such an exercise will constitute an “incentive exercise” under the Code of Practice.
Investment options In light of the new flexibilities, traditional DC default fund options may no longer be fit for purpose. Typically, life-styling options and investment strategies target the member purchasing an annuity at a particular age or date. Trustees should therefore review their scheme’s investment strategy and the choice and design of the default fund.
The ToPA 2014 introduced a ‘permissive’ statutory override allowing trustees to make available certain of the DC flexibilities, including UPFLSs and drawdown pensions, without the need for a formal rule amendment and in spite of any obstacle in the scheme rules. Although the override is not subject to employer consent, in practice trustees may prefer to seek this comfort given the employer’s role in meeting scheme costs.
The reforms are complex and far- reaching so this article only touches on some of the issues which employers and trustees should consider in preparing for them. All parties will need to work closely, together with their advisors, to create a co-ordinated strategy which is in the best interests of members, the business and the scheme.