It is rare for the pensions world to be quite as surprised as it was on 19 March 2014 when Mr Osborne, as Chancellor of the Exchequer, announced the proposed changes to the pensions regime (see here for our e-alert on the subject). These, he said, consisted of "the most far reaching reform to the taxation of pensions since the regime was introduced in 1921". Some may dispute this claim, but there is no question that the change was both unexpected and significant.
Legally, the budget changes are coming into force in three different processes:
- the proposals to reduce the limits on flexible drawdown and increase the limits for commutation of small pots came into effect from 6 April 2014 and were then confirmed in the Finance Act 2014;
- the Taxation of Pensions Bill is intended to be introduced in Autumn 2014 to provide for pensions to be able to be drawn down in full at the marginal tax rate; and
- amendments to the Pension Schemes Bill which primarily deals with defined ambition arrangements are to be made to add the concept of the guidance guarantee, to be provided at retirement to all defined contribution members.
At present, the timetable is that the provisions under the latter two steps will be in place in good time for 6 April 2015 when they are intended to come into force. There is of course a political will to get these changes in place in that timescale but there is also a great deal to cover. At present there is significant uncertainty and it is important for trustees and employers to think carefully about how the changes should be communicated to employees whilst matters are still uncertain.
The 2014 changes
A number of changes have been introduced in the Finance Act 2014 and in particular these include:
- Changes to flexible draw-down
Flexibility in drawdown was introduced by the Finance Act 2011. Under its provisions, an individual can take, at marginal tax rate, the whole of his or her pensions pot so long as there is sufficient pensions to provide a minimum income of £20,000 per annum. The amendment changes this minimum income to £12,000 per annum, effectively significantly increasing the number of individuals for whom this option is available.
- Drawdown limits
The provision of a drawdown pension (originally an "unsecured pension" under the Finance Act 2004) allows an individual to retain their pension as a pot and drawdown an amount not exceeding 120% of the basis amount (effectively, the amount of annuity that could be bought with that fund) in any one year. This has been increased to 150% to allow greater drawdown amounts.
- Trivial commutation lump-sum
The whole pension may be taken as a lump sum if it is less than a certain amount so as to deal with the "small pots" issue of schemes having to provide a very small pension which is of little financial value to a member rather than providing a lump sum which could be used elsewhere. The previous rules limited the lump sum to £2,000 or alternatively to £18,000 as a total of all the benefits held in all registered pension schemes. These two figures have risen respectively to £10,000 and £30,000, a very significant increase. Commentators have noted that a significant proportion of the population have total pension benefits of less than £30,000 and this change should give the opportunity for members to take those lump sums immediately.
The effect of these changes is incremental but significant. Certainly they have given rise to greater flexibility in dealing with pensions for a large number of people. However, they are not in any sense as radical as the other announcements made by Mr Osborne in March.
The title of "Freedom and choice in pensions" relates to the whole of the government consultation on the budget changes, but as a policy statement it applies particularly to the concept of allowing individuals to take the whole of their money purchase pensions pot as and when they like at retirement, paying only the marginal tax rate (over and above the tax free element). The Chancellor's comments in his budget speech suggest a belief in the importance of giving individuals freedom and choice as to how their benefits are provided so that if they did not wish to have the security (and inevitable cost) of an annuity they should have the option to take the funds in another form. Whereas this may or may not be the most radical reform since 1921, it certainly is the most radical reform to the Finance Act 2004, particularly in relation to the provision of benefits. The provisions are expected to come into force from 6 April 2015 and details (as we have them) are set out in the first draft of the Taxation of Pensions Bill introduced to Parliament on 14 October. The basic details are as follows:
- The new "flexi-access" drawdown is to be available from 6 April 2015, at which point funds can be allocated for full drawdown on this basis. Members who are already in drawdown can notify their administrator to change their fund to flexi-access drawdown. In addition, it is possible to take a new type of lump sum, an uncrystallised funds pension lump sum, for which the tax charge is on 75% of the whole, to retain the 25% pension commencement lump sum tax free status.
- Trust-based schemes will not be obliged to allow flexi-access drawdown of pension for members. The bill provides for a permissive power to allow flexi-access drawdown so that trustees may do so, "despite any provision of the rules of the scheme (however framed) preventing such payment". Whether the trustees will be able to do so or in those circumstances be willing to permit flexi-access drawdown is another question. Depending on the purpose of the scheme, it may be that trustees will feel constrained that they are acting outside the purpose in providing a drawdown of funds rather than a pension to a member, which is unlikely to be held to be "a provision of the rules of the scheme", and is rather a constraint of trust law.
- An anti-abuse rule is proposed to deal with the risk that members might take their salary as a pension contribution and draw it straight away, once working past the age of 55, effectively taking 25% as a tax-free salary (because of the 25% tax free lump sum). Under the rule, once flexible retirement commences, the annual allowance for contributions is limited to £10,000 in relation to money purchase contributions.
- A number of existing restrictions on the way that annuities must be structured for the purposes of the Finance Act are to be relaxed. These include the requirement that an annuity must be of a fixed or increasing rather than reducing amount, that it must have a 10 year guarantee and that a member or a dependant must have had an opportunity to choose the dependant's annuity provider. Again, with an occupational pension scheme it may be difficult for trustees to comfortably agree to provide an annuity that reduces over time given the risk of inflationary loss and the likely increase in expenditure in old age.
- The 55% tax change on death benefits for those who have reached the age of 75 is being reduced to 45%. This was heralded in Mr Osborne's conference speech last month.
In addition, there are other proposed changes that are yet to be included in the legislation, in particular in relation to the right to make transfers under the Pension Schemes Act 1993. The following amendments have been proposed in the response to consultation, and are expected to be in either the Taxation of Pensions Bill or the Pension Schemes Bill as follows:
- In order to allow members of occupational pension schemes the opportunity to use drawdown if the scheme does not provide it, the present right to transfer to another scheme only up to one year prior to retirement is proposed to be extended so that a member can on reaching retirement transfer to another fund immediately in order to draw down the pension as they wish.
- After some concerns about the treatment of defined benefit pensions, there has been a decision that defined benefit members will still be permitted to transfer to defined contribution schemes (and no doubt take advantage of the new flexibility) but that they may not do so without independent financial advice being given to them in advance. Notwithstanding the budget changes, this proposal appears to deal with an issue that has already existed: the risk that defined benefit members transferring to defined contribution schemes do not appreciate what they are giving up. This would also have a significant effect on incentive exercises and other activities of companies and trustees. It does however ensure a simpler communication plan for those trustees and companies who have been considering warning defined benefit members of the feared deadline for making transfers into defined contribution arrangements as it is clear that this will be possible in the future.
The government has announced that from April 2015 it is to abolish the current 55% tax charge on DC pensions for individuals who die before age 75. The government has also stated that it is considering some further changes, in particular whether drawdown will be permitted for a defined benefit arrangement. Neither of these are reflected in the draft bill. There is no certainty about what will be proposed or the timetable but there is clearly an acknowledgement by the government that these matters need further addressing.
The guidance guarantee
Following the Government's response on its consultation, it has been the so-called "guidance guarantee" that has received the most publicity. This is to be the free guidance which was mentioned in Mr Osborne's speech and in the attached consultation paper acknowledging that decumulation – that is, the process by which a pension is taken by a member – gives rise to a number of complex decisions by members even without the proposed changes. As more and more individuals have significant money purchase pots, a number that is expecting to increase significantly with auto enrolment, decisions on decumulation become paramount.
The industry's concerns relating to the guidance guarantee included the concept that it was to be free, which clearly made it uncertain as to who was to meet the cost. The issue has become substantially more clear following the consultation and the initial amendments to the Pensions Schemes Bill. In particular:
- Trustees of occupational pension schemes and contract based scheme providers will be under an obligation to ensure that guidance is provided although it is uncertain as to whether they will have an obligation to ensure that it is taken up by the individual.
- The guidance will be free at source and will not be paid for by employers or trustees directly but instead funded by a levy on the financial services industry. Inevitably financial services providers including contract based schemes will find their costs rise which it is likely will then be reflected in the fees that they charge. Arguably, this ultimately becomes a cost to schemes, their employers and their members but the intention is that there is no direct cost to a member in taking the guidance or to the employer or trustee when it is provided. The draft legislation also allows the Treasury to make grants to fund the guarantee.
- The guidance will initially be provided by the Pensions Advisory Services (TPAS) and the Citizens Advice Bureau (CAB) as two neutral bodies which are already involved in providing advice to individuals. These bodies may not presently employ people with the appropriate skill set for providing the guidance but as both have been keen to engage in the process they will no doubt set about ensuring that they have the appropriately trained staff. The provision of guidance will be regulated by the Financial Conduct Authority (FCA).
It is clear that guidance is not to be "advice" and therefore it may well be a relatively limited explanation of the issues and risks rather than detailed advice or anything particularly personal to the individual. Details of what is required are yet to be confirmed but the FCA has issued a consultation in relation to the guidance, its provision and the levy. This is discussed in our article on this but in summary it envisages:
- Guidance will involve obtaining information about the individual for the guidance to be given, suggesting that this will not simply be a provision of generic information that some commentators had feared.
- Guidance will end with the individual having a series of next steps to consider and take in order to take matters forward.
- There are some suggestions about guidance being provided using web-based tools, but also suggestions that individuals will be involved in directly providing the guidance
- Financial service companies would be obliged to notify individuals of the availability of guidance and not discourage them from using it.
- Financial service companies in the sectors of deposit taking, life insurance, portfolio management investment fund managers and financial arrangers and brokers should contribute to the levy.
The consultation closed on 22 September and of course these provisions may change, but they do give an indication of the shape of the guidance guarantee to come.
What to do next
It is clear that the proposals are now taking shape and there will be a need for occupational schemes and employers to consider the options they intend to make available to members, how this affects the scheme (in particular investment funds and any default fund) and how to communicate this to members.
As matters become clearer, communications will need to explain to members about the guidance guarantee, any change to plans relating to pensions flexibility and investment and the changes to provisions for the transfer to other arrangements. Although there is a lot more detail than was available in the summer, there are still a number of uncertainties and trustees and employers would be advised to keep matters under review as the shape of the changes becomes still clearer.