In the Budget delivered this week, Chancellor George Osborne announced measures overhauling the tax regime in relation to defined contribution (DC) pension arrangements. The measures are intended to give greater flexibility to people to access their DC pension pots. The tax rules allowing individuals to take some or up to all of their DC pot as a lump sum will be relaxed as will the rules relating to 'income drawdown' (a facility that allows individuals to draw down income from their money purchase pension pot). Although the overwhelming emphasis of the Budget is on DC benefits, some of the changes proposed apply to, or will invariably have an impact on, defined benefits too.
Measures to be brought into force from 27 March 2014
A number of the measures announced will be in force from 27 March 2014 - these will pave the way for the more "radical" reforms announced on which the government has issued a consultation (the 'Consultation' can be accessed here).
Increase in trivial lump sum limits: The 'trivial commutation' rules will be changed so that members will be able to take all of their overall pensions savings as a lump sum, providing those overall savings are less than £30k (instead of, currently, £18k). The maximum size of a 'small pension' pot which can be taken as a lump sum from a single pension arrangement will also be increased from currently £2,000 to £10,000, and the number of pension pots that can be taken under these rules will be increased from two to three.
Income drawdown limits: The current "income drawdown" regime allows members to draw down pension from their money purchase pot. It has two elements, 'Capped drawdown' and 'Flexible drawdown', limits in relation to which will be changed. The limit under Capped drawdown, which is worked out using tables produced by the Government Actuary's Department and is, broadly, the amount of annuity that the amount crystallised for drawdown purposes would buy, will be raised from currently 120% to 150% of an equivalent annuity. Flexible drawdown is available to people who meet a minimum income requirement – this minimum income requirement will be reduced from £20,000 to £12,000, potentially giving more people access to flexible drawdown.
Proposals subject to consultation
Money purchase pots to be taken as cash at marginal rate of income tax: perhaps the most radical of the proposals is that allowing those with a DC pension to draw down some or all of it after age 55 from April 2015 as cash, subject to their marginal rate of income tax (whatever the size of the pot or the member's circumstances). Currently, this would attract an unauthorised payment charge of, broadly, 55%.
This change will not affect the current right to take a pension commencement lump sum (where 25% of a DC pot may be taken as a lump sum tax free).
Increase in minimum age from which a pension may be taken: to ensure people save properly for retirement, the minimum age from which a pension pot may be taken will be increased from currently 55 to 57 in 2028 (when under the Pensions Bill 2013-14, State Pension Age is timetabled to rise to 67). After then, the minimum pension age in the tax rules will rise with State Pension Age so that it is always ten years below.
Free financial guidance: measures will be put in place so that, from April 2015, all individuals with DC pots are offered free and impartial face-to-face guidance at the point of retirement. This duty to provide access to financial guidance will be imposed on 'pension providers and trust-based schemes'.
Dependants' pensions to be reviewed: as a result of the proposals in relation to scheme members' pensions, the government will consult on options to simplify the dependants’ pension scheme rules too, to ensure that the rules apply fairly, and reduce administrative burdens.
Pensions contributions of the 75 and over: the Government will explore with interested parties whether the tax rules that prevent individuals aged 75 and over from claiming tax relief on their pension contributions should be amended or abolished.
Qualifying non-UK pension schemes (QNUPS): consultation will be carried out on ways to give equivalent treatment to QNUPS and UK registered schemes to remove opportunities to avoid Inheritance Tax.
Measures announced in the Chancellor's Autumn Statement last November
The Chancellor also confirmed in the Budget some of the measures already announced in the Autumn Statement. These include broader powers to be given to HMRC to prevent pension liberation, with greater control over the registration and de-registration of pension schemes. These changes will begin to take effect from 27 March 2014. The Individual Protection 2014 (IP14) regime will also be introduced as a consequence of the reduction in the lifetime allowance to £1.25 million from 6 April 2014 (although HMRC has stated that members will not be able to apply for IP14 until August 2014). A new class of Voluntary National Insurance Contributions will be introduced to enable those who reach State Pension age before 6 April 2016 (when the new single-tier pension is introduced under the reforms to the State Pension under the Pensions Bill 2013 -14) to top up their Additional State Pension.
While the proposals to give greater flexibility to members to access their DC pots will be welcomed by members, pensions groups, like the National Association of Pension Funds, have warned that easier access could mean that individuals would deplete their pension savings and have little income left to cover them in retirement. The more radical of the pensions reforms announced in the Budged are, however, subject to consultation, and so it remains to be seen how many of these measures will actually be implemented in the form proposed.
If the proposals do go ahead, however, DC pension schemes would need to amend their tax and benefit rules to align the benefits they offer in line with the revised tax regime; they will also need to create new administration systems to enable members to access their pots under the revised tax rules. Schemes will also need to review their investment strategy and investment options available to members to reflect the fact that more members are likely to want to access their savings early (from age 55) and possibly while still continuing in employment. Those offering life-styling options in particular may need to review those options.
Depending on how scheme rules are worded, some rule changes may be needed quickly to accommodate the changes that are due to come into effect from 27 March 2014.
If the rules are changed to enable members to take their money purchase pots as cash (subject to paying tax at their marginal income tax rate and taking 25% as a pension commencement lump sum tax-free), annuities may well become less popular than they currently are. Certainly, if the overnight drop in shares of leading insurance companies reported in the press since the Budget was announced is indicative, the impact on the insurance market could be significant. Falling annuity sales could however benefit trustees of pension schemes looking to insure their pension scheme liabilities as a fall in shares of insurance companies may lead to increased competition in the bulk annuity market and better annuity rates being offered to pension schemes.
Although the overwhelming focus of the Chancellor's speech and the Budget was on defined contributions schemes, defined benefit (DB) schemes will also be affected. The proposal to increase the minimum age from which a pension may be taken from 55 to 57 in 2028 will apply to both DB and DC schemes.
Trivial commutation (whether there is commutation of all a member's pension savings in all registered pension schemes or of small pots in single arrangements) applies to both an individual's DB and DC arrangements. The current limits in relation to these are £18,000 and £2,000 respectively. As the legislation currently stands, if the Government were to simply amend the limits (to £30,000 and £10,000 respectively), they would apply in relation to both the individual's DB and DC benefits. However, the focus of the Consultation and the Budget speech is on giving individuals with DC benefits greater flexibility in accessing those benefits. With that in mind, and absent draft legislation at this stage, it is not yet clear whether the proposed new limits would only apply in relation to trivial commutation of all benefits where the individual has at least some form of DC benefit and would not apply if the individual only had DB benefits. Similarly, it is not clear with regards to a small pot in a single arrangement whether the proposed higher limit would only apply in relation to a DC pot.
With greater flexibilities for access to DC benefits, the Government has also said that it will be looking at imposing restrictions and conditions on transfers from DB to DC arrangements to stall a stampede from DB schemes to DC. Some of the proposals in this regard set out in the Consultation could, if implemented, be onerous for trustees, for example the proposal to place an obligation on DB scheme trustees to approve a transfer to a DC scheme before it is made. Whilst these proposals, if they go ahead, may make it difficult for members to convert their DB benefits to DC benefits, the overall proposals for easier access to DC benefits will make DC schemes more attractive to members and may give further justification to employers wishing to change employee's pension arrangements from DB to DC to initiate the change.