THE REFORMS AT A GLANCE
- Benefits are being re-categorised as flexible benefits and non-flexible benefits (essentially defined benefits). The flexible benefits category is further divided into money purchase benefits and other flexible benefits (essentially cash balance benefits).
- Members will have separate statutory transfer rights in relation to each of the three categories of benefits. If a member has two different categories of benefit and makes a statutory transfer request in respect of one category, he or she cannot be required to also transfer the other category. A statutory transfer request can only be made in respect of all the benefits in a particular category.
- Members will be able to transfer each of the two categories of flexible benefits up until the point that benefits in that category are first crystallised. Benefit crystallisation will happen when a member starts to draw a pension, designates funds for drawdown or (in the case of a personal pension) buys an annuity.
- Schemes will be able to offer additional transfer rights e.g. a right to a partial transfer.
- Members wishing to transfer from a DB scheme to a DC or cash balance scheme or to convert DB benefits to DC or cash balance benefits must take “appropriate independent advice” from an independent financial adviser (“IFA”) authorised by the Financial Conduct Authority (the “FCA”) if the benefits are valued at more than £30,000.
- Trustees will need to receive confirmation from the IFA that the member has taken advice and will need to check that the IFA is appropriately authorised by the FCA. Trustees will not need to check the substance of the advice.
- Members will be required to pay for the advice unless the transfer/conversion request is the result of an employer- led exercise. In such cases, the employer will be required to pay for the advice.
- The Pensions Regulator is producing guidance for trustees of DB schemes to help them manage transfer requests and their impact on the scheme.
- Legislative changes have been made so that an underfunded bulk transfer on a “mirror benefit” basis should not result in an annual allowance charge for transferring members. Annual allowance issues may still arise where there is an underfunded individual transfer, even if it is on “mirror benefit” terms.
CHANGES TO TRANSFER RIGHTS
Members’ statutory rights to transfer their benefits from one pension arrangement to another will be changing from 6 April 2015.
What’s happening to benefit categorisation? New legislation (the Pension Schemes Act 2015) defines three categories of benefit:
- money purchase benefits;
- flexible benefits that are not money purchase benefits (such as cash balance benefits or other benefits calculated by reference to an amount available to provide benefits for a member); and
- benefits which are not flexible benefits (in other words defined benefits).
What’s the current position on transfers? Currently, a deferred member of an occupational pension scheme has a statutory right to take a cash equivalent transfer of their accrued benefits to another occupational pension scheme or a personal pension scheme. In most cases, the member must apply for a transfer at least 12 months before reaching normal pension age. The transfer request must usually apply to all of a member’s benefits under the scheme (other than GMPs if the receiving scheme will not accept them).
What’s changing? From 6 April 2015, the 12 month cut-off will only apply to transfers of benefits which are not flexible benefits. Members wishing to transfer flexible benefits will have a statutory right to do so up to the date that benefits in the relevant category crystallise. Benefit crystallisation will happen when a member starts to draw a pension, designates funds for drawdown or (in the case of a personal pension) buys an annuity. Trustees of DB schemes can nevertheless continue to allow members to take a (non-statutory) transfer of their cash equivalent up to (or beyond) normal pension age if their scheme rules allow.
What about statements of entitlement? The requirement to provide a member with a statement of entitlement will apply to categories (2) and (3) (i.e. benefits which are not money purchase benefits). A member with benefits in both categories under the same scheme will be able to apply for a statement of entitlement relating to one or both categories.
What about partial transfers? If a member has more than one category of benefits under a pension scheme, they will have a right to take a transfer of the benefits in just one of those categories. Schemes will not be able to make a transfer of one category conditional on the transfer of another category. So, for example, a member wishing to transfer their AVC account cannot be forced also to transfer their defined benefits.
As is currently the case, the legislation does not confer on members the right to transfer just part of their benefits in one category (unless the member has a GMP and is transferring to a scheme which will not accept it). Schemes can nevertheless allow members to take a partial transfer from a category if their rules allow.
INDEPENDENT ADVICE REQUIREMENT FOR DB TO DC TRANSFERS AND CONVERSIONS
What is the new independent advice requirement? Where a member has “safeguarded benefits” in a pension scheme, he or she must take “appropriate independent advice” from an FCA-authorised IFA before:
- making a transfer to a scheme under which the member would acquire flexible benefits;
- converting any of the benefits into different benefits that are flexible benefits within the scheme; or
- paying an uncrystallised funds pension lump sum in lieu of those benefits,
on the merits of the proposed transfer/conversion/lump sum payment. “Safeguarded” benefits are any benefits other than money purchase or cash balance benefits. The same requirement applies in respect of a survivor of the member who is entitled to safeguarded benefits from the scheme. The requirement will not apply where the cash equivalent value of the safeguarded benefits is less than £30,000. The member/ survivor will be required to pay for the advice unless the proposed transfer/conversion/lump sum payment is an employer-led exercise.
What checks must trustees carry out? Where the requirement to obtain advice applies, the trustees must receive a written statement from the IFA that, among other things, confirms that the member/survivor has received advice from the IFA on the proposed transfer/conversion/ lump sum payment. Trustees will not have to check the substance of the advice. Trustees will also be required to confirm that the IFA has the appropriate FCA authorisation by checking the FCA Register.
What if the trustees don’t carry out the checks? Failure to carry out a check may lead to a penalty being imposed on the trustees, but would not invalidate the transfer. If trustees have not been able to carry out a check due to factors outside their control, or their check did not confirm that the member/ survivor had received appropriate independent advice, the usual six month time limit for making the transfer does not apply. Regulations give trustees a power to amend their scheme rules by resolution so that they are not required to make a transfer payment if:
- because of factors outside their control, they have been unable to carry out the necessary checks to confirm that the member/survivor has received appropriate indepen- dent advice; or
- they have carried out the necessary checks and these did not confirm that the member/survivor had received appropriate independent advice.
Are there any new disclosure obligations?
From 6 April 2015, the basic scheme information to be provided to members accruing safeguarded benefits must contain a statement that the member may need to take appropriate independent advice before transferring/converting those benefits or taking them as an uncrystallised funds pension lump sum. The basic information to be provided to members accruing flexible benefits must include a statement explaining the circumstances in which those benefits can be transferred.
What about employer-led exercises? Regulations require the employer to arrange or pay for a member or survivor to receive appropriate independent advice for employer-led transfer or conversion exercises. An employer- led exercise is where the employer sends a written communication to two or more members/survivors setting out options available to them in terms that encourage, persuade or induce the member/survivor to request a transfer/conversion/lump sum payment. The member/ survivor will not be taxed on the value of any advice paid for by the employer under these provisions.
What about the Pensions Regulator’s guidance? In light of the new advice requirements and the potential for an increased number of DB to DC transfer requests, the Regulator has published draft guidance for trustees of DB schemes to assist them in managing transfer requests and their impact on the scheme. This guidance:
- explains the changes being made to DB transfer rights;
- summarises the new “appropriate independent advice” requirements; and
- provides guidance on trustees’ rights to changes the basis for calculating transfer values, to reduce transfer values to reflect underfunding in the scheme, and to apply to the
Regulator for an extension of the six month period in which to complete a transfer request.
Changes have been made to the treatment of underfunded transfers for annual allowance purposes.
What’s the current position? On a transfer into a DB scheme, the current law arguably contains a loophole that allows the receiving scheme to award a disproportionately large transfer credit that would not count towards the annual allowance. HMRC’s reading of the current law is different. If a member receives a transfer credit which exceeds what the transfer payment justifies, then in HMRC’s view the excess is an augmentation which counts towards the annual allowance.
While this reading would close the loophole, it could have serious implications for normal pension scheme mergers where transferring members are promised “mirror benefits”, i.e. the same past service benefits in the new scheme as they had in the old one. If the transferring scheme is underfunded, all the transferring members will be getting transfer credits in the receiving scheme that are more valuable than the transfer payment paid across. As a result, on HMRC’s reading of the law, there could be an annual allowance charge even though the transferring members have not accrued any new benefits. Many scheme mergers have been cautiously put on hold waiting for clarification.
What’s changed? The legislation has been changed to ensure that underfunded block transfers will not count towards the annual allowance provided that the receiving scheme promises mirror benefits, or benefits that are “virtually the same” as in the transferring scheme. This correction applies to all block transfers from 6 April 2011 onwards.
What about individual transfers? The exemption for “mirror benefit” transfers applies only on block transfers, i.e. where a group of members are being transferred in a single exercise. It does not apply to individual transfers. The rules about individual transfers have been clarified to reflect HMRC’s original reading of the current law more clearly. In future, the transfer credit awarded to a transferring member could count towards the member’s annual allowance if it exceeds what the transfer value alone justifies. There is no automatic exemption for individual transfers just because the benefits awarded are the same as the member had before the transfer. This correction applies to all individual transfers from 6 April 2011 onwards.
WHAT SHOULD TRUSTEES BE DOING?
DC schemes: Administration systems should be updated to reflect the extended time for members to exercise their right to a statutory cash equivalent. The request form for statements of entitlement should be modified to allow members to make a request in relation to just one category of benefits.
Trustees should consider whether to allow members to take a partial transfer from within one category of benefits. If they decide to do so, they should ensure that an adequate discharge is included in the scheme rules or the transfer request form.
DB schemes: The request form for statements of entitlement should be modified to allow members to make a request in relation to just one category of benefits. Administration processes for transfers should be updated to include the additional steps involved in checking whether appropriate independent advice (a) is required and (b) has been taken.
Trustees should consider whether to allow members to take a non-statutory transfer of DB benefits after the cut-off point of 12 months before normal pension age. If they decide to do so, they should ensure that an adequate discharge is included in the scheme rules or the transfer request form. Trustees should also consider whether to allow members to take a partial transfer from within one category of benefits. If they decide to do so, they should ensure that an adequate discharge is included in the scheme rules or the transfer request form.
All schemes: Member communications should be updated to reflect the new transfer rights and the associated new disclosure requirements. The changes to basic scheme information are likely to be considered to be material changes and should therefore be notified to existing members by 6 July 2015.