LONDON, 25 September 2012 - As has been widely reported, Nick Clegg has announced a proposal for a "pension for property" scheme that would allow parents to use part of their future pension to fund the deposit on a house for their children.
It appears that the idea is that a fixed amount of debt would be attached to the pension fund, to be paid when the parent retires and draws benefits.
Current tax law allows individuals to take up to 25% of their pension fund as a tax free lump sum. For defined contribution (DC) schemes, the maximum lump sum is 25% of the value of the member's fund at retirement. For defined benefit (DB) schemes, the calculation is more complicated, and is based on a notional capital value of the member's annual pension.
Pension schemes are not required to allow members to take tax free lump sums, although most schemes do. In most private sector DB schemes the tax free cash is generated by the member giving up ("commuting") some of his or her pension income. The commutation rate is set under each scheme's rules and in many cases the lump sum received may not fully reflect the value of the pension given up.
There would be no guarantee that the fixed amount of debt attached to the pension fund, to be paid when the parent retires and draws benefits, would be available on retirement, because:
- The value of DC pots varies with investment performance and can go down as well as up. The parent with a £40,000 pot who committed £10,000 to their child's deposit could find that their fund value had declined to, say, £32,000 at the time they retired, leaving the maximum tax-free cash available as only £8,000.
- For DB schemes, commutation rates (the amount of lump sum the scheme will offer for each £1 of pension given up) are set in accordance with scheme rules and may be varied as economic conditions change. A parent might find that at retirement the debt owed exceeds the maximum lump sum that may be drawn from the scheme, or that he or she has to give up more pension at retirement than previously anticipated to release the lump sum needed.
- Individuals are currently able to take some or all of their pension benefits, including a tax free lump sum, from age 55 and so are already free to give their lump sum to relatives if they so choose. The proposals would suggest that the "pension for property" option would be available to younger parents. Such individuals would often be much further from retirement and be less likely to be able to plan their own future needs with certainty.
Commenting on the proposals, Jill Clucas, Of Counsel in Hogan Lovells' pension team, said:
"Decisions about whether or not to take a tax free lump sum (and the use to which it is put) are currently finalised at retirement. While individuals may have dreamed for years about spending their tax free cash on the holiday of a lifetime, many may find that, in reality, redundancy or ill health means that their working lives are shorter or less well-paid than anticipated. In such cases, parents may find they need all their pension savings as retirement income."