Freedom and Choice in Pensions - Decisions

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1 2014/25 22 July 2014 Freedom and Choice in Pensions - Decisions Introduction In the Budget of 19 March 2014, the Chancellor announced that tax law would be amended to give members with defined contribution (DC) pension savings the flexibility to take their retirement benefits as they choose (including taking as much or as little of their fund as a lump sum as they liked), subject to paying income tax at their marginal rate. The Government s consultation on the implications of the reforms, Freedom and Choice in Pensions (see Spotlight 2014/08), ran until 11 June The Government published its response to the consultation on 21 July This response dealt with the three crucial issues of the tax framework that would apply to the new flexible arrangements, the delivery of the promised guidance guarantee and whether or not to impose restrictions on transfers from defined benefit schemes to defined contribution schemes. Designing the New Tax Framework Scheme rules Generally, the only benefits a pension scheme can provide are those stipulated or permitted by its scheme rules. Legislation can override a scheme s rules and the Government consulted on imposing a statutory override to ensure that scheme rules did not prevent members from taking advantage of the increased flexibility for DC savings. However, this would have compelled schemes to provide flexible drawdown; a serious problem for schemes that were not designed with this in mind or that had inflexible systems. Accordingly, the Government decided that it would not impose the flexibility but instead would legislate for a permissive statutory override that would allow schemes to adopt the new flexibility in place of their current provisions if they wished. The consultation response does not state whether employer consent is required to adopt these reforms, but we anticipate that this will be determined by each scheme s existing documentation. In addition, some trustees and employers may wish to adopt only a part of the flexibility regime (for example, allowing the taking of the whole DC fund as a lump sum but not providing a drawdown option) and may therefore look to amend their scheme rules rather than make use of the intended statutory override. This document is based on our understanding of current law and taxation at the date shown above. Policy, practice and legislation may change in the future. For more information on how your particular circumstances may be affected, please contact us. This document is for reference purposes only and does not constitute financial advice. Capita Employee Benefits is a trading name of Capita Employee Benefits Limited and Capita Employee Benefits (Consulting) Limited. Part of Capita plc. Capita Employee Benefits Limited and Capita Employee Benefits (Consulting) Limited are registered in England & Wales No: and respectively. Registered Office: 17 Rochester Row, Westminster, London SW1P 1QT. Separately authorised and regulated by the Financial Conduct Authority

2 Scope of the flexibilities There has been some uncertainty as to the scope of the new flexibility. The Government has now confirmed that, where the scheme rules allow it, the flexibility will be available to occupational DC schemes, group personal pensions, cash balance schemes and DC arrangements within non-dc schemes (such as AVCs within a defined benefit scheme). The extent to which this flexibility will be available where a hybrid scheme benefit is provided will depend on the specific nature of the hybrid benefit when the pension promise matures. If the benefit is a DC benefit and the hybrid scheme rules allow, then the new flexibility should be available. In addition, the Government also intends to amend the right to transfer between DC schemes to ensure individuals are permitted to transfer at any point up to their scheme s normal pension age (as opposed to one year before that is currently the case). However, permitting transfers from DB schemes at any point up to the scheme s normal pension age was not mentioned by the Government in the response. Lower annual allowance for flexible drawdown The Government had to take some steps to protect the tax system from manipulation. The risk was that individuals would use the reforms to divert earnings into a pension savings vehicle, obtain full tax relief on those earnings, swiftly take their pension benefit as a single lump sum with only three quarters actually taxed and the remaining quarter tax free. This would have been an unintended tax privilege for those aged between 55 and 75. (Previously the necessity of having to lock up at least three quarters of the fund to secure a retirement income for the rest of a person s life deterred this kind of behaviour.) Accordingly, the Government plan to amend the tax rules on the annual allowance. The reforms are to be: Those taking flexible drawdown (i.e. after April 2015 drawing more than their tax-free lump sum) will have permanently reduced annual allowance of 10,000 each year. This will mean that, following their first flexible withdrawal, an individual will only be able to contribute up to 10,000 a year in a taxefficient manner to a DC pension. This annual allowance will only apply if an individual accesses a DC pension pot worth more than 10,000. Individuals can make withdrawals from three small personal pension pots and unlimited small occupational scheme pots worth less than 10,000, without being subject to a 10,000 annual allowance on subsequent contributions. Those currently in flexible drawdown who at present have an annual allowance of 0 will, from April 2015, be able to benefit from the higher annual allowance of 10,000 for taking flexible drawdown. There will be grandfathering for those in capped drawdown on 5 April 2015 to protect them from having their annual allowance reduced from 40,000 to 10,000. Under capped drawdown, an amount can be taken up to limits based on the Government Actuary s Department tables. However, in the future at the point that they withdraw more than the capped amount, their annual allowance will be permanently reduced to 10,000. The Government estimate that 98% of pension savers over the age of 55 currently contribute no more than 10,000 per annum. Lifetime annuities In the light of reforms to flexible drawdown and with an eye on social care costs in future, the Government has agreed to relax the rules on lifetime annuities. These relaxations will apply only for new contracts and only if specified in those contracts at the time that they are taken out. The intended relaxations are: Lifetime annuities will be able to go down as well as up. This flexibility would allow more income to be received during the early part of retirement when the member is in better health and best able to make the most of it, followed by a more modest regular income from the middle period of retirement. Spotlight: Freedom and Choice in Pensions - Decisions 2

3 It will be possible to permit lump sums to be paid by the annuity contract at certain times or in the event of certain contingencies (e.g. an insured lump sum to support care needs if they arise). The ten year limit on the maximum guaranteed period of income will be removed. Payments from guaranteed annuities can be paid as lump sums to beneficiaries where they are under 30,000 (rather than these payments having to be spread out over several years). The Government believes relaxations in the tax rules around annuities and drawdown will trigger greater innovation by providers to establish products which better meet the needs of consumers. Normal minimum pension age (NMPA) The NMPA is the minimum age that retirement benefits can be taken without the member having to meet the ill-health condition. The Government consulted on increasing the NMPA in line with State Pension Age (SPA) and looked at the options that it would be linked to ten or five years below SPA. The Government has decided to increase the NMPA from 55 to 57 in Thereafter, it is planned to remain ten years below SPA. The Government agreed that it would be a disproportionate change at this time to move the NMPA to within five years of SPA. Arguably, this may still leave the door open to further reform. Following lobbying, the Government confirmed that this rise in NMPA will not apply to public service schemes for Firefighters, the Police and the Armed Forces, where pension ages reflect the unique nature of those occupations. Tax charge on death Currently, there is a tax charge of 55% levied on funds on death during drawdown or on death where there are uncrystallised funds after age 75. Feedback from the consultation confirmed that this 55% rate may be too high but the Government is concerned about the risk of unforeseen and unintended consequences. It will consider this matter further and a decision will be announced in the Autumn Statement. Supporting Choice - Guidance Guarantee The Government has committed itself to supporting pension scheme members to understand this new pension flexibility along with wider financial issues such as debt, savings, state benefits and care costs. This is the guidance guarantee that was first promised by the Chancellor, George Osborne, in the Budget. Delivery partners It has been confirmed that the delivery partners of the guidance guarantee must be impartial they must not have any actual, or potential, conflict of interest. This principle is seen as very important to the Government and it has named the Pensions Advisory Service (TPAS) and the Money Advice Service (MAS) as the two independent organisations already committed to delivering the guidance guarantee. The Government is to approach other similar organisations with a view to bringing more bodies into the delivery of the guidance guarantee. This is positive, but in practice the Government will need to take care as such organisations can and do use commercial partners to offer services nationally. This may breach the independence requirement if steps are not taken to prevent such partners providing this additional service. The flip-side of this is that the delivery partners will need to recruit significant numbers of staff who are able to provide pensions and wider non-regulated financial and benefits advice. These will be people with a very specific skill-set and it remains to be seen if there are sufficient staff available, particularly given the relatively short time to recruit these people. Standards and consistency are key to the success of the guidance guarantee, so this is an area that ideally needed more time. Spotlight: Freedom and Choice in Pensions - Decisions 3

4 Timing The response confirms that the guidance guarantee will be available in good time for April In practice, this is four to six months too late as many people have delayed retirement since the Budget announcements in the hope of using the new flexibilities. These people should be given guidance in advance of April to help them to avoid acting to their own detriment. The proposed guidance is to be delivered four to six months before retirement, once the process is up and running. Scheme trustees and providers will be required by law to signpost members about the guidance guarantee, via the disclosure rules and Financial Conduct Authority (FCA) rules respectively. It is to be hoped that the Government encourages greater integration between the delivery partners of the guidance guarantee and schemes to make this process more efficient and cost effective, whilst not breaching the independence principle. Guidance or advice? The Government has made it very clear that the guidance guarantee is not regulated financial advice and it will introduce legislation to confirm this. The consultation response says the guidance service is intended to equip and empower people to make confident and informed choices on how they put their pension savings to best use; it will help people to ask the right questions, but will not itself make specific recommendations. In effect it is likely to be a decision tree tailored to the individual s circumstances. Individuals will then be referred to their scheme, providers and IFAs for scheme specific and financial advice where this is needed. There is not currently any requirement to offer statutory guidance during service or retirement although many schemes have specific communication and education programmes for members which the Government continues to welcome, but they should not undermine the effective signposting of the guidance guarantee. Delivery method The Government has promised that individuals will be able to access and use the service in a range of ways, including face-to-face, online and over the phone, according to their needs and preferences. In practice face-to-face meetings are expensive and logistically difficult, although the Government is still clearly putting them at the heart of this initiative. Governance of the process The Treasury is maintaining overall responsibility for the process until it has bedded down. The FCA has been given key statutory roles in the delivery of the guidance guarantee. It will be setting and maintaining standards for delivery of the guidance, and monitoring compliance with these standards. The FCA is consulting on high-level standards in its consultation paper, published on the same day as the Government s response. Currently, the FCA is proposing that the signposting to the guidance guarantee that trustees and providers must do should include certain basic information: That the guidance is available, free and impartial to help members understand their options. Give clear guidance on how to access the service and say that face-to-face meetings are available. Give members sufficient information about their benefits to make an informed decision about their benefits. The FCA will police this requirement in respect of contract-based schemes. The disclosure requirements for trust-based schemes will be extended to include this requirement. In this way, the requirements are intended to be the same for trust-based and contract-based schemes. Spotlight: Freedom and Choice in Pensions - Decisions 4

5 Also, the FCA has outlined in the consultation what the key stages in the customer journey should include as part of the guidance guarantee: Scope, purpose and limitations of the guidance. A request to the member for relevant pension information. A request to the member for relevant financial information. Discussion of the members options, including key facts and consequences and other issues the member should consider. A next steps conclusion with guidance on organisations that can give specific advice on any options the member might take up. Members cannot be required to give personal financial information, but they will be encouraged to do so to ensure they get the best guidance possible. The exact format of the guidance guarantee may change once the FCA has finalised its consultation. A Treasury-based team will continue to work on the design of the service into the Autumn. Cost The guidance guarantee must be free to the member, so an important question has always been who will pay for this free guidance? The Government has now confirmed that there is to be a new levy payable by regulated financial services firms to fund the cost of the guidance guarantee service. The levy is to be based on the potential benefit the service may be of to each firm. The expectation is that financial advice and sale of financial products should increase as a result of individuals being talked through their options and where to get advice on specific products. The FCA has been tasked with designing and collecting this levy, and it has included this in its consultation paper. It has suggested that following this principle it will use the existing A fee-block framework used to collect the existing levy. This will be used to identify those organisations providing regulated advice. There are already calls from a number of advisers claiming the proposal will result in them paying the proposed levy without gaining, or in some cases wanting further work, so there could be a lot of negotiation over the next few months over who pays the levy and who is exempt. Next steps The Government is not going to be in a position to confirm what the guidance guarantee will look like until the end of this year. The short period between this initial announcement and implementation does introduce a real danger that the guidance process will not be fully functional at the start. It does mean that the pension industry must support the delivery partners in getting the guidance guarantee up and running effectively as soon as possible. Defined Benefit (DB) Transfers Although the Budget announcements were primarily aimed at DC pension savings and taking benefits flexibly, the Government did ask a number questions in its consultation about DB schemes because it was concerned about the effects on the UK economy of large numbers of DB members potentially transferring benefits out to DC schemes from April Retaining current flexibilities for private sector schemes Over 85% of respondents were in favour of retaining the right to transfer for three broad reasons: transferring from a DB scheme is unlikely to be in most individuals best interests, the asset base which will eventually be transferred is likely to be an extremely small fraction of the overall asset base (estimated at 1.2 billion), and Spotlight: Freedom and Choice in Pensions - Decisions 5

6 any impact on the demand for long-term fixed interest and index-linked assets is likely to be offset by schemes continuing to de-risk their investments typically, moving from equities to less risky fixed income assets. The good news is that the Government has accepted the arguments made and will continue to permit transfers from DB private sector schemes to DC schemes. However, there will be two additional safeguards introduced. Firstly, it will be a statutory requirement on the transferring DB scheme for members who want to transfer out to take advice from a professional financial adviser, who is independent from the scheme and authorised by the FCA. Transferring schemes will be required to check that this requirement has been met before a transfer may proceed and in most cases the member would pay for this advice. This is an extension to the current requirement that where an employer commences a transfer value incentive exercise it must offer and pay for members, to receive financial advice. However, where the pot that is being transferred is worth less than 30,000, the requirement for advice will be waived on the basis that the pot is small and could be trivially commuted. The second requirement is for trustees to be given guidance on protecting DB schemes from excessive transfer requests using existing powers under legislation. Issues to be covered include reducing transfer values where a scheme is underfunded and an insufficiency report has been obtained from the scheme actuary; and requesting extensions for paying a transfer value if the scheme generally would be prejudiced by making payments within the usual timescale. Public service schemes Transfers from public service DB to DC schemes will be banned where the public service scheme is unfunded. The Government intends to legislate to this effect in this Parliament, but there is still a window for these transfers to take place. However, where the public service scheme is funded; e.g. the Local Government Pension Scheme, transfers to DC schemes will still be permitted because these schemes hold assets and therefore the risk to the Exchequer is less direct than with unfunded public service schemes. Future changes to private sector DB schemes During the consultation process, a number of stakeholders raised the issue of allowing full or partial withdrawals from a DB schemes rather than requiring a member to transfer out to a DC arrangement to get access to the new flexibilities. The Government will hold a consultation on this issue, although no timescales have been given for this. Trivial commutation and small pots It has been confirmed that under the new system the trivial commutation and small pots rules will continue to apply to DB schemes and it is proposed the age at which these lump sums can be paid will be reduced from 60 to 55. Legislative Timetable The Government plans to introduce a Pensions Tax Bill in the Autumn which will set out the details of the new system. Draft legislation to be included in this Bill is expected in August The reforms will take effect from April In addition, the Pensions Schemes Bill already introduced into Parliament on 26 June 2014, that amends the legal framework to facilitate defined ambition (or risk sharing) pension schemes, also includes a clause that allows the Government to make regulations to prevent a transfer out of a public service DB schemes. Spotlight: Freedom and Choice in Pensions - Decisions 6

7 Comment These announcements make the Government s direction of travel much clearer and we are pleased that transfers from private sector DB schemes will be allowed to continue, so giving DB members potentially the option to access the new flexibilities. We are also pleased that further liberalisation of the rules on lifetime annuities will ensure that there is an opportunity for genuine innovation and a greater range of choices for members on retirement. However, we caution against a multitude of complex products which may cause confusion for members and are outside of scope for the guidance guarantee. It is disappointing that there is only limited clarity on how the new tax framework will operate and that we will have to wait until the draft legislation is published before all the intended policy elements of the regime are clarified. Also, the guidance guarantee will initially focus on supporting decision-making at retirement only, rather than throughout an individual s membership which is what we would support to improve financial education and better outcomes. There may be a lingering concern that the reduced annual allowance may not eliminate the risk of tax arbitrage whereby income is washed through the pensions system to achieve a lower effective tax rate. Accordingly, it cannot be ruled out that further reforms around the level of tax free cash that can be taken from a pension fund will take place. However, such reforms are much more likely to be after the General Election rather than before it. Spotlight: Freedom and Choice in Pensions - Decisions 7