This year's Budget has grabbed the pensions headlines. The implications for pensions are likely to be significant, with consequences for defined contribution (DC) schemes and, indirectly, for defined benefit (DB) schemes. Will the changes be more far-reaching than the headlines have anticipated?
What did the Budget say about DC pensions?
This year's Budget changes in respect of pensions have had a lot of coverage but, in summary, can be split into two blocks: the 27 March 2014 changes and proposed reforms scheduled to take effect in April 2015.
27 March 2014 changes:
- Increasing the maximum amount which can be taken each year from a capped drawdown arrangement from 120% to 150% of an equivalent annuity;
- Reducing the amount of guaranteed income needed in retirement to access flexible drawdown from £20,000 each year to £12,000 each year;
- Increasing the trivial commutation lump sum limit from £18,000 to £30,000; and
- Increasing the size of a small pension pot which can be taken as a lump sum from £2,000 to £10,000.
April 2015 proposals
- From the age of 55, members will be able to withdraw the whole of their DC pot in one go (with 25% tax free and the remainder taxed at the member's marginal rate);
- DC members will be offered free and impartial face-to-face guidance on the range of options available to them at retirement.
Will there be an explosion in DC membership?
Looking at the big picture, will the anticipated flexibility of withdrawing the whole of a DC pot in one go (with 25% tax free and the remainder taxed at the marginal rate) – likely to become available from April 2015 – result in a surge in DC membership (or, once auto-enrolment applies to an employer, fewer opt-outs)?
Affordability is likely to remain key. If an individual is struggling to pay the bills then flexibility will be of little relevance to them, but it could still be a factor for people teetering on the cusp of affordability. At the other end of the earnings spectrum, any senior personnel who have felt less engaged with pension provision may take a renewed interest.
More generally, the Budget may accelerate workforce trends already in evidence, such as more members opting to delay retirement (a trend that may gather pace with the possibility that tax relief might become available for contributions after age 75), as well as pressure perhaps to introduce flexible retirement and the possibility of other employee benefits (such as workplace ISAs) becoming more attractive.
Are there likely to be governance implications for DC schemes?
The focus on governance has become a larger part of the regulatory landscape for DC schemes in recent years. The government clearly expects the future to be DC (or possibly collective DC, depending on what the defined ambition consultation response later this year decides).
As a consequence, the outcomes for members will need to be improved if hearts and minds are to be won and a large part of that equation will require a firm foundation in the form of good governance. But the Budget makes it clear that governance as we currently know it is not going to be enough. Face-to-face guidance will also form part of the governance picture. The range of options likely to be on offer from April 2015 will mean more complexity for members considering what to do at retirement. The face-to-face guidance requirement recognises this but whether that level of interaction will be sufficient remains to be seen.
The Pensions Regulator's renewed focus on record keeping is also part of the picture, as well as the DC Code of Practice.
What about DC scheme investments?
Full fund withdrawal will mean that members will no longer be required to purchase an annuity. This, in turn, will have implications for scheme investment. The years leading up to retirement often involve an element of 'lifestyling' aimed at investing in what might be considered to be more appropriate investments in the years leading up to retirement.
Whether lifestyling will remain appropriate (or a modified version of it) will be a key question for many schemes. Default funds are also likely to come under the spotlight once schemes start dealing with the government's response to its consultation issued on Budget day.
Do schemes have a clear enough picture of what is going to happen in April 2015?
There are several unanswered questions about this Budget. These questions range from the technical (such as whether there will be a requirement to purchase an annuity where the DC pot has a Guaranteed Minimum Pension element) to the more sweeping (will full fund withdrawal, and any DB to DC transfers, be the subject of restrictions? What does all this mean for additional voluntary contributions? What about hybrid schemes?). Face-to-face guidance will be required, the funding and arrangements for which are currently unclear.
These uncertainties mean that schemes will need to ensure that any decisions made in the interim must take account of the uncertainties currently attaching to the Budget and are reviewed in light of whatever comes out of the consultation process.
In the absence of more detail, what can schemes do in the interim?
Trustees will need to think about how they are planning to deal with particular groups of the membership. For example, trustees should note that the government has quietly announced (towards the end of a more general press release on the Budget and pensions, issued a few days after the Budget on 27 March) that it will drop the requirement for members taking their 25% tax free lump sum to purchase an annuity within six months.
Other factors relevant for people who have just retired include the 27 March flexibilities (which may, or may not, be available to them under the scheme rules) as well as the fact that some providers are offering extended cooling off periods.
Many schemes will have started thinking about what, if anything, they should communicate to members about the Budget. This will be a decision that each scheme will need to reach for itself, although schemes considering whether to issue a communication should aim to stick to the facts known so far, while making it clear that the proposed April 2015 flexibilities are the subject of a consultation and are therefore surrounded by considerable uncertainty. Any auto-enrolment member communications that cover more than the legal requirements for those communications may need to be revisited.
Given that the 27 March 2014 flexibilities outlined above (regarding increased drawdown flexibility and the higher limits for trivial commutation and small pots commutation) will only become available where the scheme rules allow, it would probably make sense for trustees to assess their scheme trust deed and rules to establish the position.
As the position regarding the proposed April 2015 reforms is currently uncertain (the consultation closes on 11 June), schemes will need to hold off making any changes to their trust deed and rules for the moment. However, some schemes may wish to hold high level discussions based around possible implications for the scheme and likely scheme responses to the changes under consideration.
As regards DC schemes receiving transfers from DB arrangements, it would probably be sensible for the receiving scheme administration team to take particular care in monitoring data relating to any amounts transferred-in from DB schemes. In the event of restrictions being applied to those sums (for example, the consultation document expressly says that the government is contemplating whether to restrict the transferring member's ability to make use of the full fund withdrawal in respect of such sums), the receiving scheme will need to be in a position to identify the sums in question.