In the Budget 2014, Chancellor George Osborne introduced a raft of proposals relating to pensions which were hailed as some of the most radical changes to the UK pensions system for a hundred years. From April 2015, individuals with defined contribution (DC) pension pots will be able to take 25% of their pot as a tax-free lump sum on retirement with the option of taking up to the remaining 75% as cash, subject to marginal tax rates (rather than the current 55% tax rate).

Pensions Minister Steve Webb added fuel to the debate with his talk of allowing pensioners to use their pensions pots to buy expensive Italian sports cars rather than being forced to buy an annuity. So, it is no surprise that a lot of the discussion around the Budget 2014 pensions proposals has focussed on the impact on individuals with DC pension pots.

Now that the dust has settled, it is time to pick up from where our Budget 2014 Update left off and to consider what the changes may  mean for trustees and employers of private sector defined benefit (DB) occupational pension  schemes.

Changes from 27 March 2014

From 27 March 2014, the Government has increased the amount of “small” lump sums that can be taken  on a scheme-specific basis (that is, regardless of individual pension wealth) from £2,000 to £10,000. In addition, the number of these pots that can be taken from a personal pension scheme has  increased from 2 to 3.

The trivial commutation limit has also been raised from £18,000 to £30,000 for DC and DB pension scheme members. These changes have been included in the Finance Bill  2014. Whilst schemes may choose to implement the proposed new limits from 27 March 2014, the ability to commute members’ benefits is still subject to a pension scheme’s rules. So, for example,  if trustee consent is required in order for the member to take a trivial commutation lump sum on  retirement, this requirement will not fall away. A specific amendment to the rules may also be  required to permit the new limits to be used.

The Government estimates that the package of changes introduced on  27 March 2014 will mean that  400,000 more people will have the option to access their savings more flexibly between 2014 and  2015. The changes may prove helpful where employers and trustees of DB schemes are undertaking  liability management exercises. It is to be expected that employers and trustees may have concerns  over short-term funding issues, especially as the increases in the commutation limits have the  potential to bring many more individuals into their scope. Commutations of up to £30,000 by  multiple members will have an impact on a scheme and a review of the asset classes in which the  scheme invests may be needed. However, this may be balanced by the potential long-term benefit of  removing  member liabilities from the scheme, thereby reducing long-term risk.

Trustees will need to consider carefully how they intend to exercise any discretion to allow  trivial commutation, taking into account the impact on the scheme’s long-term funding position and  their duties to all scheme beneficiaries. Trustees should also check whether the rules of the  pension scheme will permit payment at the increased amounts.

The consultation: possible changes from April 2015

The Government’s most radical changes are intended to be implemented from April 2015 and mainly  affect DC schemes. The proposed changes were subject to consultation until 11 June 2014. Although  the proposals are aimed at increasing pensions flexibility on retirement for members of DC pension  schemes, the Government has stated that it “would like to find a way” to extend the flexibility to  members of private sector DB pension schemes. However, it “will not do so at the expense of significant damage to the wider economy”.

The Government’s concern is that the large-scale transfer of benefits of members of DB schemes to  DC schemes could have a detrimental impact on UK growth and investment. Therefore, in the  consultation, it put forward several options including:

  • removing the right of all members of DB pension schemes to transfer to DC schemes, except in  exceptional circumstances (this is the Government’s starting point);
  • continuing to allow transfers from DB schemes to DC schemes, but requiring that funds which  are  transferred are ring-fenced  by the receiving scheme and remain subject to the current pensions tax  framework, not the new framework;
  • placing a cap on the amount that members of DB pension schemes can transfer to a DC scheme every  year;
  • allowing DB to DC transfers to continue but requiring that the trustees of the DB scheme approve every transfer before it is made;  and
  • extending the full pension flexibilities to members of DB pension schemes by leaving in place  the existing option to transfer to DC pension schemes; the Government will only consider this  option if it is clear that it “would not create significant risks for the UK economy”.

The ability to transfer from a DB to a DC scheme may be attractive to scheme members, employers and trustees of DB schemes for different reasons.

Employers, particularly those looking at buying-out scheme benefits, may find the increased  attractiveness to members of transferring to a DC scheme helpful in reducing long-term liabilities  and the eventual buy-out cost. Employers who are considering closing a DB scheme to future accrual  may find that access to pensions flexibility in a DC scheme is a more attractive alternative to  members than keeping their benefits in a frozen scheme. Trustees may view transfers as a method of reducing their scheme’s liabilities but may face a negative funding impact in the short  term, particularly if the members think that transfers to DC schemes will be banned and rush to  transfer their benefits to a DC scheme before a ban is introduced.

However, depending on the outcome of the Government consultation, the ability to transfer from a DB  scheme to a DC scheme may be time-limited or subject to other restrictions in the future.

Future changes

The Government is also considering increasing the minimum age at which members can take their  benefits  from a pension scheme from 55 to 57 from 2028. The transition to 57 will need to begin  before 2028 and from 2028 the minimum pension age will track state pension age so that it is always  10 years below. Employers and trustees will have looked at the rise in minimum pension age from 50  to 55 relatively recently. When details of the change and the transition to it are known, trustees  should review their scheme’s rules to check whether they will need updating.