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.
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.