From April 2015, individuals will have total freedom over how they use their pension savings. This could have significant implications for employers whose staff will be free to use their pension savings for any purpose and not necessarily to secure an income for themselves in retirement. These changes may also prompt employers to consider the need to provide financial education to their staff to help prepare them for the life-shaping decisions that they will have to take.
Currently, individuals who have pension savings in a defined contribution (DC) scheme have the right to take 25% of their savings as tax free cash. The vast majority will then use the rest to secure an income in retirement with an insurer (by purchasing an “annuity”), because the tax rules do not really give them any other option.
However, the Government has announced that it is planning to change the tax rules from April 2015 to enable people to use their DC pension savings as they wish. Under the new rules individuals:
- will still be able to take 25% of their retirement funds as tax free cash but, significantly, they will be able to take the excess as cash, subject to their marginal income tax rate (rather than the current rate of 55%)
- will have the option of leaving some, or all, of their savings invested with the ability to draw them down as and when required to provide themselves with an income in retirement (this is know as “income drawdown”); and
- will still be able to purchase an annuity if they want to, but they will not have to.
Implications for employers
The changes to the tax rules could potentially have some significant implications for employers. For example, under the new rules individuals will be able to take all of their pension savings as cash from age 55 (age 57 from 2028) while they are still working. This means that employers could find that individuals have spent their pension funds and are unable to retire because they have little or no savings left for their retirement.
The new rules will also require individuals to make some difficult decisions, such as:
- How much money will they need in retirement and how much can they spend now?
- Should they purchase an annuity or would they be better off investing the money themselves?
People generally underestimate how long they are going to live. Therefore, even if individuals try to make sensible decisions they could still face the prospect of exhausting their savings.
As part of the reforms, every individual with DC savings will have a new right to free and impartial guidance as they approach retirement. This guidance will be provided by independent organisations, including The Pensions Advisory Service and the Money Advice Service and it will be paid for by a levy on financial services firms. However, employers might want to consider the need to offer financial education to their staff to ensure that they are prepared to make these life-shaping decisions.
Employers with DC schemes will also need to form a view on the extent to which they want this new flexibility to be offered to their staff under their workplace pension scheme. This is something that they will need to discuss with their pension provider or their scheme’s trustees.
Implications for pension schemes
Pension providers and trustees of DC schemes need to decide to what extent they will enable their members to take advantage of the new flexibilities under their scheme and update their scheme’s rules accordingly. They will also need to update member communications before April 2015 to ensure that they reflect the new options and highlight the new guidance service that will be available to individuals.
Pension providers and schemes will be under a duty to ensure that they make individuals aware of their right to guidance and signpost them to the guidance service within four to six months of the individual’s intended retirement date.
Individuals who are members of private sector defined benefit (DB) pension schemes will also be able to take advantage of this new flexibility by transferring their benefits into a DC scheme before they retire, subject to them obtaining independent financial advice before they do this. The Government is also planning to consult on allowing individuals to be able to access their savings flexibly direct from a DB scheme without the need to transfer.
The planned changes to the tax rules which govern how individuals can access their pension savings will re-define the way in which people think about and use their pension savings. This will create opportunities and challenges for employers.
Giving people complete freedom over how they use their pension savings is likely to increase people’s engagement with and value for saving in a pension and it may encourage people to save more in the knowledge that they will be able to get their hands on the cash. However, employers also face the prospect of their staff being unable to retire because they have spent their ‘pension’ savings on other things and there will be plenty of scope for people to make poor financial decisions.