Pension age: occupational and personal pensions

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1 Pension age: occupational and personal pensions Standard Note: SN/05847 Last updated: 1 February 2011 Author: Section Djuna Thurley Business and Transport Section Before 6 April 2006, the pension tax rules specified that the normal retirement date for most occupations should be between 60 and 75. Since April 2006, under the pension tax simplification regime introduced by the Finance Act 2004, there has been more flexibility. This legislation set a minimum pension age (55 from April 2010) and required people to turn their pension fund into an income stream by the age of 75. Within those limits, schemes are free to set a normal pension age. This is the age from which (other than on ill-health grounds) a person can draw an unreduced pension. The Conservative-Liberal Democrat Coalition Government has announced its intention to abolish the requirement to annuitise at age 75. For further details, see SN/BT 712 Pensions: requirement to annuitise. Recent reforms to the public service pension schemes have, for the most part, resulted in the pension age increasing to 65 for new entrants. The Independent Public Service Pensions Commission is looking at how to ensure that normal pension ages are in line with the latest developments in longevity. This note looks at the rules regarding the age at which occupational and personal pensions can be drawn. The age from which the State Pension can be drawn is dealt with in a separate note SN/BT 2234 State Pension age. It is important to stress that the retirement age and the pension age are not synonymous. The retirement age is the age at which one can be required to leave work. The pension age is the age at which one can start to draw an unreduced pension. The retirement age is covered in a separate standard note, SN/BT/961 Retirement age. This information is provided to Members of Parliament in support of their parliamentary duties and is not intended to address the specific circumstances of any particular individual. It should not be relied upon as being up to date; the law or policies may have changed since it was last updated; and it should not be relied upon as legal or professional advice or as a substitute for it. A suitably qualified professional should be consulted if specific advice or information is required. This information is provided subject to our general terms and conditions which are available online or may be provided on request in hard copy. Authors are available to discuss the content of this briefing with Members and their staff, but not with the general public.

2 Contents 1 Occupational pensions Minimum pension age Normal pension age 5 2 Public service pensions 6 3 Personal pensions Protected rights 9 2

3 1 Occupational pensions Before 6 April 2006, the pension tax rules specified that the normal retirement date for most occupations should be between 60 and 75. Since April 2006, under the pension tax simplification regime introduced by the Finance Act 2004, there has been more flexibility. The legislation now sets a minimum pension age (55 from April 2010) and requires people to turn their pension fund into an income stream by the age of Within those limits, schemes are free to set a normal pension age. This is the age from which (other than on illhealth grounds) a person can draw an unreduced pension. If drawn earlier, the pension will generally be actuarially reduced to reflect the fact that it is likely to be in payment for longer. 1.1 Minimum pension age The minimum pension age increases in April Until April 2006, HMRC rules allowed pension schemes to permit people to take early retirement on a reduced pension at any age from 50. The Pensions Green Paper, published in December 2002, proposed that the earliest age at which a pension could be taken should increase from age 50 to age 55 by 2010, and that people should be able to continue working for their employer while drawing a pension: 60. Currently, tax rules allow people to work and draw an occupational pension, but only where they no longer work for the company that is paying the pension. Often people who would like to carry on working do not want, or are unable, to change employers at this stage in their career. So they end up retiring when they would have preferred instead to stay in work in a reduced capacity, supported by a combination of earnings and pension. The Government proposes to remove this constraint. As part of the Government s consultation on the simplification of the pensions tax regimes, we are proposing to allow schemes to offer people the opportunity to continue working for the sponsoring employer while drawing their occupational pension. In the future the concept of normal retirement age will no longer feature in the tax rules, although some pension schemes may choose to continue with it if they find it makes sense to do so. 61. In addition, we propose that the earliest age from which a pension may be taken should increase from age 50 to age 55 by This would offer an effective signal that work up to age 55 at the very earliest is the norm. 2 The Treasury document, Simplifying the taxation of pensions: the Government s proposals, published on 10 December 2003, set out the Government s approach and proposed that schemes should be free to decide how and when to move to a minimum pension age of 55 by 2010: 2.1 A simpler regime with fewer controls will provide greater flexibility for employees and employers to agree the pension arrangements that are best suited to their respective needs. An important area where greater flexibility is desirable is around pension age. 2.2 People who are fit and able as they approach the end of their careers may want to withdraw gradually from the labour market: combining work and retirement in ways that suit their circumstances. The tax rules will no longer dictate that it must be one or the other: work or retirement. 1 This is discussed in more detail in Library Standard Note SN/BT 712 Pensions: requirement to annuitise 2 DWP, Simplicity, security and choice: Working and saving for retirement, December 2002, Cm 5677, paras

4 2.3 The reality is that people are now working longer and to reflect this the previous consultation document proposed that the minimum age for taking benefits should rise from 50 to 55 by This would apply to all pension schemes that qualify for tax relief. 2.4 The consultation document asked for views on whether pension schemes should be left to decide how to move to a minimum age of 55 by 2010 or whether Government should prescribe a phased introduction between A-Day and It also asked for views on the need for special transitional rules for people who have already built up rights to a pension before the age of 55 in existing schemes. Phasing the change in 2.5 There was recognition of the need for the Government to encourage people to work longer to reflect increasing life expectancy. Some respondents agreed that schemes should be allowed to phase in the change up to 2010 in a way that best suits their needs. Others thought the Government should specify how it should be phased in. 2.6 The Government continues to believe it is right to make the change, and by Government policy is to encourage greater participation in the labour market by older workers. 2.7 The Government proposes that schemes should be free to decide how and when to move to a minimum pension age of 55 by Protection for existing rights 2.8 Respondents were concerned that there should be protection for active and deferred members of occupational schemes with an existing contractual right to draw a pension after age 50, typically in the event of redundancy. To meet the concerns of those with existing contractual rights at A-Day, the Government proposes that any member of an occupational scheme, active or deferred, with a contractual right to draw a pension after age 50, may have that right honoured, so long as: that right was extant before the date of issue of this document; the pension is fully vested when the right is honoured; and the employment terminates before the pension is vested. 3 As explained above, it was proposed that there should be some protection for existing rights. In response to representations during the passage of the Finance Bill 2004, a Government amendment extended this protection to people who joined such schemes between 10 December 2003 and 6 April 2006 ( A-day, the date when the pension tax changes come into effect). Ruth Kelly, the then Financial Secretary to the Treasury, described the Government policy and its limits, when moving this amendment during the Committee stage of the Finance Bill: It would, of course, be unfair to introduce such a change in a way that cut across people's contractual rights to take an occupational pension at an earlier age. People with such rights may well have planned for their future on that basis, or even taken redundancy from their employer in the expectation that their occupational pension would become payable before they reached the age of 55. Because of that, provisions in the schedule protect the rights of employees in occupational pension schemes to retire before 55, provided certain conditions are met: first, that the right was in place 3 HM Treasury and Inland Revenue, Simplifying the taxation of pensions: the Government s proposals, December

5 before 10 December 2003 and, secondly, that the right is an absolute right and not subject to any conditions such as the consent of the employer. [...] Amendments Nos. 523 and 524 would extend the protection to individuals who join their occupational pension scheme after 10 December 2003 but before 6 April 2006 A-day. They will be able to retire at the scheme's minimum pension age or normal retirement age provided that on 10 December 2003 the occupational pension scheme offered such a date to all existing members. Amendment No. 393 is also about rights to take an early pension. We have always been clear that the contractual rights under discussion are those conveyed by membership of an occupational pension scheme rather than by a contract of employment, on the basis that contractual rights in an occupational pension scheme apply to all members, while rights in a contract of employment apply on an individual basis at the discretion of the employer. Those latter rights could, for instance, be used to sugar a redundancy programme, or finesse the retirement package of senior executives. We see no reason to give protection to such rights. 4 This protection applies only to occupational schemes, not to personal pension schemes (see section 2 below). Provision to increase the minimum pension age from 50 to 55 from 6 April 2010 is in the Finance Act Normal pension age Figures produced by National Statistics suggest that very few (if any) occupational schemes have a NPA higher than In recent times, many schemes have raised or considered raising their NPA, in response to increases in life expectancy. 7 However, legislation restricts the changes that can be made affecting accrued (or subsisting) rights. Under section 67 of the Pensions Act 1995 (as amended by the Pensions Act 2004), a change that is detrimental to a subsisting right can only made with the member s consent, or without it if each member from whom consent has not been obtained retains benefits that are actuarially equivalent to those they had prior to the change. As explained in a consultation paper published in March 2007 as part of DWP s Deregulatory Review of Private Pensions, this can lead to complexity: 47. Many schemes have raised or are considering raising NPA. Under current law, such an adjustment can normally be made only for future accruals. Members accordingly have accrued benefits in relation to one NPA for one period of employment, and in relation to a later NPA for subsequent pensionable employment. Other trustees and employers are considering offering incentives to members in order to obtain their consent under section 67 Pensions Act 1995 (which governs changes to benefits attributable to past service) to changes to NPA covering both past and future 4 SC Deb (A), 19 th sitting, 22 June 2004, cc The transitional protection is contained in paragraphs of Part 3 of schedule 36 of the Finance Act Part four, section 279 (1) 6 ONS Occupational Pension Schemes Survey 2008, Table Lewin and Sweeney, Deregulatory Review of Private Pensions. A Consultation Paper, March 2007, para 46 5

6 service. Neither approach is ideal from the point of view of clarity, efficiency or fairness. 8 The review consulted on a proposal that legislation schemes should be allowed to adjust the NPA with any changes effective for the entire period of scheme membership, subject to certain safeguards for those near retirement age. 9 However, it was decided that the new section 67 should be given time to bed down following the amendments made under the Pensions Act This is covered in more detail in Library Standard Note SN/BT 4515, Deregulatory Review of Private Pensions. 2 Public service pensions The Labour Government introduced reforms to public service pensions. The schemes for the uniformed services were the first to be reformed. Changes, mainly for new entrants, included a limited increase in pension ages. 11 Then, in June 2003 the Government announced that it intended to raise the pension age in public service pension schemes from 60 to 65 by the end of By that date, all new staff would join on the new conditions. Pension rights already accrued from past service by existing staff would be fully protected, but reviews of the individual schemes would have to decide how the higher pension age will apply to the future service of existing staff and how to ensure that transitional arrangements are fair and balanced. 12 Following the threat of industrial action before the May 2005 general election, the Government agreed to a fresh start on discussions with unions. Rather than imposing the increased pension age there would be genuine negotiations on all aspects of possible change. 13 On 18 October 2005, a meeting of the Public Services Forum agreed the principles which would underlie these negotiations as far as the NHS, teachers and civil service schemes were concerned. One of these principles was that existing scheme members would have the right to suffer no detriment in terms of their normal pension age. The pension age for new entrants is set at The Local Government Pension Scheme (LGPS) already had a pension age of 65. The LGPS rule under which people could retire earlier than this on a full pension (the rule of 85 ) is being phased out. 15 Since these reforms were introduced, a number of commentators argued that the pension age in the public service pension schemes should increase further. 16 In June, the Conservative-Liberal Democrat Coalition Government set up the Independent Public Service 8 Ibid; See also, the survey by the Association of Consulting Actuaries, Twilight or a new dawn for Defined Benefit Schemes? September Lewin and Sweeney, Deregulatory Review of Private Pensions. A Consultation Paper, March Lewin and Sweeney, Deregulatory Review of Private Pensions, An independent report to the Department for Work and Pensions, July 2007, p15; DWP, Deregulatory review Government response, October 2007, p Independent Public Service Pensions Commission: Interim Report, 7 October 2010, p39 12 DWP, Simplicity, security and choice: Working and saving for retirement. Action on occupational pensions, June 2003, Cm 5835, para Letter from Alan Johnson, Secretary of State for Work & Pensions, to Brendan Barber, General Secretary of the TUC, 18 March Reform of public service pension schemes: the way forward for teachers, the NHS and the civil service, 18 October A summary of reforms made to public service pensions by the Labour Government can be found in Independent Public Service Pensions Commission: Interim Report, 7 October 2010, p39, chapter 2 16 See, for example, Institute of Directors, Pensions Apartheid, January

7 Pensions Commission, chaired for former Labour Work and Pensions Secretary, Lord Hutton of Furness, to: undertake a fundamental structural review of public service pension provision by Budget 2011 and consider the case for short-term savings in the Spending Review period, by September The Commission published its Interim Report in October It said there was a case for longer-term structural reform to deal with issues not dealt with effectively under the current system, including: The rising costs of benefits due in particular to increasing longevity; The changing periods of time spent in work and retirement and how pensions and pension ages in particular can respond more flexibility to these changes. 18 For its final report, the Commission is to consider how to ensure normal pension ages are in line with latest developments in longevity. 19 The Financial Times reported on 2 November that Lord Hutton was considering whether pension ages might rise gradually in line with a formula that took account of increases in life expectancy: Rising longevity is a key factor in the increased cost of pensions, and in recent years each forecast of how fast it will rise has proved an underestimate. "We come back to it because we don't get it right," [Lord Hutton] said, "and each time there is a row about changing it. It would be far better to have a formula to keep it under review, rather than just have to come back and have another row." Options for doing that might include a regular review of pension age by a standing commission or a formula that raised it gradually to keep the number of likely years of retirement, or proportion of life spent in retirement, broadly constant. 20 These issues are discussed in more detail in SN/BT 5768, Public service pension reform 2010 onwards and SN/BT/2209, Public service pension age. 3 Personal pensions Prior to the Finance Act 2004, Inland Revenue rules provided that personal pensions can be taken at any age between 50 and 75. The Pensions Green Paper and Finance Act 2004 proposals for increasing the minimum age at which tax privileged pensions can be taken from 50 to 55 (see section 1.1 above) apply equally to personal pensions. However, the transitional protection beyond 6 April 2010 for members of occupational pension schemes which, at 10 December 2003, granted all members a contractual right to draw a pension at age 50 does not apply to personal pensions. This difference in treatment and the cliff edge for people reaching age 50 shortly after 6 April 2010 were debated in Finance Bill Standing Committee. The then Shadow Chief Secretary to the Treasury, George Osborne, said: First, why have the Government decided not to use the tax rules to phase in the new minimum retirement age? Of course, it is up to schemes how they do that, which is made quite clear in the consultation. However, the December 2002 consultation paper asked for further consultation on using the tax rules to achieve that as well as how 17 HM Treasury, Budget 2010, HC 61, June Independent Public Service Pensions Commission: Interim Report, 7 October 2010, p Ibid, p Nicholas Timmons, Hutton favours gradual pension age rise, Financial Times, 2 November

8 schemes might go about it. It is perfectly possible that that might be included in the Bill so that, for example, the minimum retirement age would be 50 in 2010, 51 in 2011, 52 in 2012 and so on. That would avoid the cliff edge whereby a person born on 6 April 1960 could not take a pension at the age of 50 but would have to wait five years longer to retire than someone born the day before. ( ) A person born on 6 April 1960 will not be allowed to retire at 50, unlike a person born the day before. That has created quite a cliff edge. As I said, there are other ways of making the change; for instance, the Government could have phased it in over a period of years. I will be interested to hear an explanation from the Financial Secretary since the change will affect many people, and they will feel that they have been unfairly treated. The Government have also said that people can keep a contractual right to retire at 50 in an occupational scheme. However, that will not apply to people with personal pensions. Some people will have paid higher contributions in order to retire at 50, but will not be able to do so, even though they have paid for the privilege, because it is not a contractual right. Is that another example of one rule for defined benefit schemes and a less generous rule for defined contribution schemes? Does the Financial Secretary have any idea how many people who have defined contribution schemes were planning to retire at 50 and have paid higher contributions to be allowed to do so? 21 The then Financial Secretary, Ruth Kelly, responded by stressing the discretion given to individual schemes to phase the change in before April 2010 and deferring further discussion of subsequent protection to the later debate (quoted in section 1.1): As the hon. Member for Tatton knows, the increase in the normal pension age from 50 to 55 is an integral part of our simplification reform. It is part of the policy agenda put forward and advocated by the Department for Work and Pensions to encourage active ageing rather than ageing actively and to push up the distribution of ages at which people retire, so that on average people can stay in the work force longer. As he knows, and as I am sure my hon. Friends know, we have a real problem in this country with people being forced out of the labour market when they are over the age of 50 and in some cases even earlier or finding it difficult to stay on after that age. That is why we have introduced the new deal for older people. This tax reform fits in neatly with our overall agenda of encouraging people to stay longer in the work force. The reform is part of a package that facilitates flexible retirement for the first time. If people want to stay in the work force beyond the age of 55, they can now do so on a part-time basis, while drawing down a pension to supplement their income. The Treasury has been considering that idea for many years, but it has not proved possible to come up with a scheme to accommodate it. We have now been able to produce a package that does that, obviously taking the overall cost to the Exchequer into account. The increase in the minimum normal pension age is essential to allow us to bring in flexible retirement. I hope the hon. Gentleman would agree that that is a useful and essential reform. We had a choice as to how to bring in the reform. We were aware of the human rights implications and how people would adjust. We carefully considered whether to bring it in at a specified date, or whether we should allow schemes to choose when to bring it in to suit their members and indeed to reflect their members' demographic make-up. We put out that precise question for consultation. The consultation document asked for views on whether it should be left to schemes to decide, or whether the Government should prescribe a phased introduction between A day the date we turn on the 21 SC Deb (A), 18 th sitting, 17 June 2004, c 645 8

9 pension simplification and The document also asked for views on the need for special transitional rules for people who have already built up rights to a pension before the age of 55 in existing schemes. I intend to deal with the relevant clauses when we debate the transitional provisions next week. The response to the consultation was mixed. Some respondents agreed that schemes ought to be allowed to phase in the changes. Others argued that the Government should prescribe them. On the whole, we thought that there was more force to the argument that the schemes should be allowed to bring in the changes in a way that suited their members best, which is why we decided to introduce the changes as we did. That is an integral part of our reform. 22 The issue of the requirement to turn their pension saving into an income stream by age 75 is covered in a separate standard note SN/BT/712, Pensions: Requirement to annuitise. 3.1 Protected rights In some cases, a personal pension may have been used to contract out of the additional state pension (commonly known as SERPS, now S2P). If so, the rules provide that a minimum payment or contribution (equal to the national insurance rebate from contracting out) must be made to the scheme. The benefits secured by those payments were called protected rights and had to meet certain conditions. 23 One of these conditions was that the pension from protected rights could only be paid from age 60. The Pensions Act 2004 changed this so that a pension based on protected rights could be taken from the same age as any other pension. The rules were also changed to allow 25% of protected rights to be taken as a pension commencement lump sum. A DWP consultation document set out the background and detail of the proposed changes: Background 2. Under current arrangements contracted-out rights cannot be paid before age 60/65 and are not permitted to be commuted as part of a tax-free cash lump sum, except in certain limited circumstances including trivial commutation and serious ill-health commutation. 3. Section 284 of the Pensions Act (PA) 2004 makes a number of amendments to the Pension Schemes Act (PSA) Subsections (6) and (7) make amendments to sections 28 and 29 of the PSA These amendments remove the minimum age from which protected rights in contracted-out money purchase schemes can be paid, allowing them to be paid at the same time as all other rights in line with the Inland Revenue s minimum pension age. 4. The remaining subsections (1) to (5) make further amendments to the PSA 1993 inserting a number of powers enabling the circumstances in which contracted-out rights may be paid to be prescribed by regulations. 5. The draft regulations make amendments necessary to: allow protected rights in contracted-out money purchase schemes to be commuted on retirement. We are proposing amendments to allow protected rights to be paid as part of a pension commencement lump sum on Ibid, cc See, for example, DWP consultation document, Abolition of defined contribution (DC) contracting out: treatment of protected rights accrued in the past and proposed operational arrangements, September 2006, Annex A, para 6 9

10 retirement. The intention is that this commutation should be on a pro-rata basis. This is to ensure that where there are both protected rights and nonprotected rights held in the scheme, a greater proportion of the protected rights are not commuted in order to avoid the other conditions i.e. the requirement to provide a survivors pension, placed on the protected rights; increase the trivial commutation limit. Under current arrangements commutation of pensions on grounds of triviality is permitted where the annual rate of pension is less than 260 per annum or a fund value of less than 2,500. We are proposing amendments that will have the effect of increasing the trivial commutation limit from its current level of 260 per annum to an aggregate fund value of 15,000 in line with Inland Revenue rules. Commutation of contracted-out rights on grounds of triviality and where an occupational pension scheme is winding up will be permitted providing the Inland Revenue s conditions as set out in the relevant sections of the Finance Act 2004 are met. Amendments also increase the trivial commutation limit in respect of Pension Credit Benefits derived from a Pension Sharing order; allow serious ill-health commutation of all contracted-out rights in all schemes, excluding any entitlement to a survivor s pension. Under current arrangements serious ill-health commutation of protected rights in Appropriate Personal Pensions (APPs) is not permitted. We are proposing to amend regulations to permit the commutation of all contracted-out rights in all schemes on grounds of serious ill-health providing the Inland Revenue s conditions as set out in the relevant sections of the Finance Act 2004 are met. A serious ill-health lump sum payment will be prohibited from including any entitlement to a survivors benefit derived from contracted-out rights; and allow protected rights in contracted-out money purchase schemes to be paid at the same time as all other rights. We are proposing amendments which remove references in regulations to the age from which protected rights in contracted-out money purchase schemes can be paid. These amendments supplement the provisions in section 284 of the Pensions Act 2004 and are required to allow protected rights to be paid at the same time as all other rights in line with the Inland Revenue s minimum pension age. 24 Under provisions in the Pensions Act 2007 and the Pensions Act 2008 the protected rights rules are to be abolished from a future date, probably This is discussed in more detail in SN/BT4822, Contracting out of the State Second Pension. 24 DWP, Pensions: Contracted-out Benefits and Miscellaneous Amendments. Consultation on Draft Regulations, March The Government response was published in February