In yesterday’s Budget, the Government announced what it described as “the most fundamental reform to the way people access their pensions in almost a century”. Wide- ranging changes will be introduced, from removal of the requirement to annuitise to increase of the commutation limits. While some of the changes will not take place until April 2015, some will have effect from 27 March 2014.
Announcements taking effect from 27 March 2014
- The minimum income requirement for flexible draw- down will be reduced from £20,000 to £12,000. The minimum income requirement is the amount of income that a pensioner must receive from sources outside the pension scheme in order to take flexible (i.e. uncapped) drawdown.
- The capped drawdown limit will be increased from 120% to 150% of an equivalent annuity. The capped drawdown limit is the maximum amount which a pensioner using capped drawdown is entitled to take from their pension pot. The value of an “equivalent annuity” is determined using tables produced by the Government Actuary’s Department and published on HMRC’s website.
- The commutation limits will be changed as follows:
- the small pot (“de minimis”) limit will be increased from £2,000 to £10,000. Individuals aged over 60 whose pension benefits under a scheme do not exceed this limit can commute those benefits (irrespective of the value of any benefits they hold under other schemes);
- the maximum number of small pots held in a personal pension scheme that an individual can commute will be increased from two to three; and
- the trivial commutation limit will be increased from £18,000 to £30,000. Individuals aged over 60 whose total pension benefits under all registered pension schemes do not exceed this limit can commute all or part of their benefits. Announcements taking effect from April 2015
- The restrictions on drawdown of pension benefits will be removed, so as to let members of defined contribution (“DC”) pension schemes draw down all their benefits as cash from age 55 and effectively removing the requirement to annuitise. The current tax-free cash will continue to be available and mem- bers will pay tax on amounts drawn down above the tax-free cash limit at their marginal rate, even where they withdraw all their benefits. (Currently a 55% tax charge applies if a member does this.)
- All members of DC schemes – whether contract or trust-based – must be offered free and impartial face-to-face guidance at the point of retirement (the “guidance guarantee”). The Government will make up to £20m available over the next two years to develop this initiative.
The Government is consulting on a number of questions relating to these announcements, including:
- whether a statutory override should be put in place to ensure that scheme rules do not prevent individu- als from taking advantage of the new flexibilities (for example, where scheme rules require annuitisation of funds above the tax-free cash limit);
- whether differing approaches to the “guidance guarantee” should be taken for contract and trust- based schemes, and whether the guidance needs to be provided by an independent third party; and
- whether (as the Government currently thinks) the earliest age at which individuals can take their pension benefits (i.e. normal minimum pension age) should increase – it proposes that normal minimum pension age should increase to 57 by 2028 (with a phased transition before then) and then rise in line with the state pension age so that it is always 10 years below state pension age.
- The Government will legislate in the Finance Bill 2014 to give HMRC wider powers to prevent pensions liberation with greater control over the registration and de-registration of pension schemes.
- The Government will consult on options to simplify the rules relating to the taxation of dependants’ pensions.
- The Government will explore whether to amend or abolish the tax restrictions that prevent individuals aged over 75 from claiming tax relief on pension contributions.
While there had been pre-Budget rumours that the Government might relax some of the commutation limits, the extent of yesterday’s announcements far exceeds the industry’s expectations. On the one hand, many will welcome the greater flexibility that members will have in future when deciding how to take their pension benefits. On the other hand, there will be concerns as to how to ensure that members make the right choices – the guidance guarantee is designed to combat these concerns, but it remains to be seen whether it achieves its aim. There will also be concerns about the level of obligation the guidance guarantee will place on trustees and how much it will cost. In practice, the employer will probably have to meet the cost, but this may lead to some employers questioning whether they can afford more generous DC contribution levels in the light of increasing financial obligations towards DC members that were not anticipated when they set up the arrangement.
The flexibility in how benefits are taken will only apply to DC benefits. However, as both the Budget and the accompanying consultation note, an almost certain side effect will be an increased desire among some members of defined benefit (“DB”) schemes to transfer their benefits to a DC scheme to take advantage of the new flexibility. Given that most public service pension schemes are unfunded, and given the cash flow implications for the Treasury if there was a big increase in transfer requests to private sector schemes, the Government plans to remove the option to transfer from a public service scheme to a DC scheme in most circumstances.
The cash flow issue does not apply in the same way to private sector DB schemes. But DB schemes play an important role in funding long-term investment in the UK and the Government is therefore concerned about the possible impact if too many DB members transfer to DC schemes. The current consultation therefore asks for views on whether the Government should prohibit transfers from private sector DB schemes to DC schemes (this is the Government’s current starting point), or whether transfers should continue to be allowed and, if so, in what circumstances.
Yesterday’s announcements will therefore have major implications not only for DC schemes, but also for DB schemes. Trustees and administrators should ensure that, where relevant, their administration processes are updated to reflect the new drawdown and commutation limits that will apply from 27 March 2014. In the longer term, depending on the results of the consultation, trustees of DC schemes will need to think about what options they will offer members at retirement, and how they will comply with the requirement to offer members guidance at retirement.
The consultation closes on 11 June 2014, with a response promised promptly. In the meantime, trustees of DB schemes may want to alert members to the fact that if they are thinking about a transfer to a DC scheme, they may need to take prompt action in case one result of the consultation is an immediate ban on transfers to DC schemes.