The 2014 Budget was heralded by George Osborne, the Chancellor, as introducing ‘the most far reaching reform to the taxation of pensions since the regime was introduced in 1921’. The most radical of the pensions reforms announced in the Budget are still subject to consultation and so we will have to wait and see how many are ultimately implemented in the form proposed. The general theme of the reforms is for greater flexibility for people to access their defined contribution (DC) pension pots.
Measures now in force
Trivial lump sum limit increased to £10,000
The trivial commutation rules have been altered so that the size of a small pension pot which may be drawn as a lump sum will be increased from £2,000 to £10,000 and the number of pension pots under the revised £10,000 threshold will be increased from two to three. This means that the overall amount of ‘trivial’ pension savings which may be taken as a lump sum has increased from £18,000 to £30,000.
Trivial commutation applies to both DC and defined benefit (DB) schemes. Given that the aim of the Budget was to provide more flexible access to DC pension benefits, and with no draft legislation upon which to comment, it is possible that the Government may seek in the future to restrict the changes in the new trivial commutation limits in relation to individuals who only have DC benefits.
Increase in income drawdown limits
The ‘capped drawdown’ and ‘flexible drawdown’ limits in relation to a member drawing down a pension from their money purchase pot have been increased. Under a capped drawdown, if a member does not satisfy the statutory income requirement of £12,000 per annum, his income withdrawals under the scheme cannot exceed 150% of the value of a comparable annuity (increased in the Budget from 120%). Under a flexible drawdown there is no limit on the annual income a member can draw, but he must qualify by satisfying a minimum income requirement of £12,000 per annum (reduced in the Budget from £20,000).
Proposals under consultation
Access to DC pension savings
It is proposed that from April 2015, the Government will allow people to access all of their DC pension savings as they wish from the point of retirement. Members will still be entitled to draw down the 25% tax free lump sum, however, they will be able to transfer some or all of the rest of their pension pot, subject to their marginal rate of income tax and whatever the size of their pension pot or their circumstances rather than at the current taxation rate of 55%.
Whilst many commentators and members alike have welcomed this increased flexibility, there is a fear that giving people unlimited freedom may result in the state ultimately having to step in to rescue pensioners who do not effectively plan their savings and have little income to fund their retirement.
Should the proposals be implemented as stated in the Budget, DC pension schemes will need to amend their tax and benefit rules to meet the new tax regime and to create new administration systems to allow members to access their pension savings under the revised tax rules. Many members may also see the proposed changes as a way of accessing their pension entitlements early and whilst they are still in employment, this may mean that schemes will need to review their investment strategy and the options available to members as they approach retirement.
Allowing members greater access to their DC savings may result in the purchase of annuities becoming even less popular, with a resulting negative impact on the insurance market. It will be telling to see whether the proposed amendments prompt such insurance companies to offer better annuity rates and to develop new products for trustees wishing to insure their pension scheme liabilities and purchase annuities.
In a similar vein, the Government has stated that they will look to impose restrictions and conditions on transfers from DB to DC schemes in order to prevent members flocking to make such a transfer. For public service DB schemes, which are largely unfunded, this could represent a significant cost to the taxpayer and so the Government will likely wish to remove the option to transfer for such members. For those employees in private sector DB schemes, it is likely that transfers will only be permitted if the risks and associated issues can be shown to be manageable. For example, one proposal in the consultation is to place an obligation on DB scheme trustees to approve a transfer to a DC scheme before it is made.
Minimum pension age to increase
It is proposed that in 2028, by which time the state pension age will have risen to 67, the minimum pension age will rise to 57, whereas it is currently set at 55. It will then increase so that it is always pitched ten years below the state pension age. This proposal will apply to both DC and DB schemes.
Free and impartial face-to-face guidance
To improve employees’ financial planning for retirement, the Government is introducing a guarantee that everyone who retires with a DC pension will be provided with free and impartial face-to-face guidance at the point of retirement. The Government is setting aside £20 million over the next two years to develop this concept.
Review of dependants’ pensions
Due to the proposals in relation to scheme members’ pensions, the Government is consulting on a range of options to simplify the dependants’ pension scheme rules. In this regard, the aim is to improve fairness and reduce administrative burdens.
Relief on pension contributions for those over 75
The Government is looking into the possibility of amending or abolishing the tax rules that prevent individuals aged over 75 from claiming tax relief on their pension contributions.
Should the pensions reforms proposed in the 2014 Budget be enacted, this will have a wide-reaching impact on pension schemes, employees’ financial planning for retirement and for the insurance market generally. We will keep a watching brief on the ‘Freedom and Choice in Pensions’ consultation, which is due to close on 11 June 2014, and will provide further updates as and when they are available.