The history of UK pensions has contained some radical changes and many twists and turns. The sheer number of pension proposals and policies alone has made the industry somewhat blasé about the concept of change in our industry. However, the events of 19 March 2014 were a shock to the whole industry, as the Chancellor announced what, according to him, was "the most far-reaching reform to the taxation of pensions since the regime was introduced in 1921" by which the method of pension decumulation would not affect the tax charge. In effect, members of pension schemes would be permitted (from April 2015) to take their whole pension pot on retirement and be subject to no more than marginal income tax rates on doing so.
Whereas George Osborne's description of his changes might, to purists, be unfair given the "tax simplification" changes of the Finance Act 2004, these proposals certainly received more press coverage than any pension issue for many years. The idea that a pension pot does not need to be used to buy a pension is definitely far-reaching, and perhaps requires us to rethink the whole purpose of a pension fund.
With so much written on the subject, it has been hard to distinguish the certain from the speculative, and what has been drafted into legislation from what is proposed or suggested. The Finance Bill is expected to be passed into law in July, with some provisions already in force following the Budget Resolutions, which provide temporary effect before the Finance Bill is enacted. The more radical changes to pensions are due to be passed in a separate act, presently proposed to be finalised before the end of the year, to come into effect from April 2015.
The changes to decumulation
By far the most talked-about change is the announcement that members of defined contribution pension schemes will not be subject to anything more than marginal tax in taking the whole of the pension pot on retirement, or at any later time. The budget announcement was that:
- This would come into force by April 2015;
- The government would consult with a view to doing something similar for defined benefit schemes, once there was some clarity as to how this could operate; and
- "Free" guidance on the decisions to be made on retirement would be provided.
As yet, we have little more colour on this. The consultation on the matter was launched on 21 March 2014 (entitled "Freedom and Choice in Pensions") and as the consultation only closed on 11 June 2014, there is unlikely to be much detail for some time.
The general change for defined contribution schemes may cause serious issues for trustees. As with the problems relating to transfer requests to pension liberation schemes (see our article in Pensions Pieces July 2013), trustees' duties to administer the scheme for the purpose for which it was established (which is usually to provide pensions) and to act in the interests of the scheme beneficiaries may render them unable to provide the member with their full benefits in a lump sum.
The consultation suggests that it may be necessary to compel trustees by legislation to offer a full commutation at retirement, which would of course simplify this issue for the trustees.
The concept of providing something similar for defined benefit schemes may conjure up some images of the pensions mis-selling scandal of the late 1980s, when members of defined benefit schemes were encouraged to leave and transfer out benefits to a more portable and flexible defined contribution personal pension, providing neither employer contributions nor a guarantee. Some commentators have suggested that this will be insurmountable and the changes will be restricted to defined contribution arrangements.
The "guidance guarantee", as the promise of "free" guidance is now known, has provoked the most comment. Inevitably, the biggest concern is who will foot the bill to ensure that the guidance remains free for individuals. The position in the consultation document, reiterated by Steve Webb, the pensions minister, is that the cost is born by providers (that is, the insurer for a personal pension, and the scheme itself for an occupational pension). The extent and timing of this being worked into fund costs is still being examined.
The government has indicated that they do not expect this to be a significant cost, which then leads into questions of what the "guidance guarantee" will actually encompass. The consultation states that it is to be:
- "impartial and of consistently good quality"
- "covers the individual’s range of options to help them make sound decisions and equip them to take action, whether that is seeking further advice or purchasing a product"
- "offered face-to-face".
The government appears to be moving away from point three, suggesting that technology renders this unnecessary (and certainly face-to-face meetings contribute significantly to cost). However, it is interesting to see what is suggested here. It is clear that the guidance is not expected to be the same as independent financial advice, not least because the second point specifically suggests that the result of the guidance may well be that people choose to seek (and presumably pay for) advice. It also does not suggest that the person providing the guidance will need a full understanding of the individual's financial situation and views, perhaps only clarifying what options are out there and, possibly, a generic concept of the advantages and disadvantages of each route.
The industry has expressed two conflicting concerns about the guidance. The first is that it may well not be sufficient to assist the average member to make good choices at retirement. The second is that it may be expensive to provide, as good quality independent financial advice has necessarily always been. The response to the consultation will presumably walk a tightrope between these two issues.
Transferring to a defined contribution pension scheme
The consultation paper also dealt with the concern that the changes would encourage defined benefit members to transfer into a defined contribution pension scheme so as to take all of their benefits straight away. It states that members of public sector defined benefit schemes will not be permitted to transfer to defined contribution pension schemes (except in limited circumstances), and that legislation will be introduced to deal with this, although no details have yet been produced.
The consultation also suggests doing something similar with private defined benefit pension schemes, acknowledging that, particularly following the changes to defined contribution pension schemes, it will rarely be in a member's interest to make such a transfer. The consultation is very open on this issue, with the government suggesting it is considering everything from a full ban, through the use of caps, the requirement of trustee consent and the ring-fencing of transferred defined benefit funds in a defined contribution scheme from the right to take a full commutation, to a proposal that no change is made, and that defined benefit members can transfer to a defined contribution scheme and take a full commutation of their benefits.
The uncertainty in this area has led to wide speculation, and concerns about how this may be communicated to members. However, given the range of potential outcomes, it would appear difficult to appropriately advise members of how their options might change in the future and most schemes are well advised to refrain from any communication to members whilst there is nothing clear to say.
The changes to flexible drawdown and trivial commutation
One of the criticisms that has been levelled at the Budget changes is that for those with larger pension pots, they do not herald a revolution, as they could already take advantage of flexible drawdown and that for those with small pension pots they should not be encouraged to make a change anyway. The rejoinder to that is that flexible drawdown for those with large pots, introduced in 2011 by the present government, is complex and restrictive to operate.
Both these statements could be supported, and the concept behind flexible drawdown is one with which many on both sides of the argument would agree. Effectively, if a member can demonstrate that he can and will provide himself with a certain minimum pension on retirement, he may use the rest of his pension pot as he sees fit, subject to the same marginal tax rate as the budget proposals provide.
The immediate change to flexible drawdown in 2014 was to the limits involved. The pension required reduced from £20,000 to £12,000 per annum, so that an individual with at least £12,000 per annum secured pension may take the rest of the pot immediately. The obvious reason for this is to increase the number of individuals who can consider this option.
In addition, changes have been made to reduce limits for other alternatives to annuities. Changes have been made both to the trivial commutation amounts, which are the amounts that can be taken as a single lump sum because the pension is so small, and to the amounts that can be drawn down each year under capped drawdown.
If a member's total pension in all his pension schemes is less than £30,000 (up from £18,000), he may take the total amount as a lump sum. Similarly, if his pension in one scheme (no matter what else he has in other pension schemes) is less than £10,000 (up from £2,000), he may take that amount as a lump sum from that scheme.
Under capped drawdown, the amount that a member can draw down each year is limited to a percentage of the value of the pension which his funds would purchase. This has increased from 120% to 150%.
All these changes came in with immediate effect, and have been enshrined both in the draft Pensions Bill and in the Budget Resolutions which give them immediate effect. This means that it does not just affect those considering their options after the budget date, but also, in certain circumstances, those who have done so before, but are still within a period where they can rescind their instructions, for instance using the "cooling off" period after entering into an annuity contract.
From the point of view of pension schemes, this can be complex. Not only do new rules apply, but given that there has been a higher profile for these changes than other budgetary measures, there are likely to be more members considering changing their minds, with all the administrative difficulties that this gives rise to. In addition, it is important to ensure that documentation going to retiring members is up to date and reflects the new and, to some extent, the future reality.
The radical changes heralded by the budget this year have already caused challenges for pension schemes which are trying to communicate with members. It is important to ensure that members are aware of the changes that have already been introduced, but care must be taken when communicating on future changes, many of which remain uncertain in detail and scope.