Page 1 of 7 News Alert 2014/01 20 March 2014 Budget 2014: radical changes to pensions (and not just DC) At a glance On 19 March, the Chancellor announced a number of shock changes to pensions from April 2015 that can be expected to have a significant impact on the development of employer sponsored pension schemes, both in the short and long term. Key Actions DC SCHEMES For trustees of trust-based schemes and for employers sponsoring contract-based schemes The vast majority of members of UK DC schemes invest in lifestyle funds that aim to match annuity prices at a single retirement age. The proposed new flexibilities mean these may no longer be appropriate as default funds and may need immediate review. Await further details on the new duty coming to offer a guidance guarantee and take advice on how to implement. Review retirement process and options immediately and some individuals may want to hold off drawing their benefit until 2015. Review all DC communications, to ensure members are aware of the expected direction of travel probably they will not need to buy an annuity. DB SCHEMES For employers There are some real uncertainties here until the Government finalises its intentions on transfer options/blocks. If the option for members to transfer from DB to DC schemes is removed, it will close the door on many forms of liability management exercises. If it remains, then the impact will be significant on DB schemes. A new exit for employer pension liabilities becomes available and all employers will need to review their pension
Page 2 of 7 strategy. Review current plans for de-risking exercises such as PIEs, enhanced transfer values take advice and maybe bring-forward or defer! For trustees Watch developments on the member option to transfer from DB to DC. Funding and investment strategies will need early review if a significant proportion of members are expected to transfer out before they retire. If in the process of securing liability in a buy-in or out, take advice. The announced changes seem unlikely to impact exercises securing current pensioners but deferred pensioner exercises raise more questions. For pension managers Review current booklets and communications with members to consider whether they need to acknowledge the possible changes. Be ready to handle a possible increase in requests for DB transfers-out ahead of the possible closure of this option. FOR BOTH DB AND DC trust-based schemes For trustees Consider whether you want to use next week s newly raised trivial commutation limits (which may need a scheme rule change). The Detail For all the changes made to pensions in recent years it is hard to think of a time where pensions have figured so prominently in the Budget Speech itself. The Chancellor claimed he has made the most far-reaching reform to pensions for a century and he may well be right. The details of these radical reforms are contained in the Government paper Freedom and choice in pensions. The core change is that tax rules will permit all individuals with DC funds to access them when they reach retirement age with new very broad flexibility: annuity purchase, flexible drawdown, or full one-off withdrawal, without a tax penalty. No conditions will apply to this flexibility, such as proving existence of other minimum income. Other important changes (to DC and DB) are proposed as a consequence.
Page 3 of 7 The move to the new regime is extraordinarily fast given the fundamental nature of the changes. The Government intends to make them in a new Act of Parliament to take effect from April 2015, with consultation on some key areas open until 11 June 2014. Some other changes (welcome ones for DC and DB pensions) will be made from 27 March 2014. It is unclear at this stage whether the Government intends to require that all DC schemes offer members the new flexibilities, but it has stated that under the proposed new tax framework, the Government is keen that scheme rules do not prevent an individual from accessing their pension flexibly, should they wish to do so. The Government makes many of its statements in terms of DB schemes and DC schemes. Many schemes of course have both sorts of benefits (and members with both), but the paper says the Government is still considering how the provisions will work for hybrids. This is indeed radical stuff. The flexibility will be welcome by many but the consequences will be profound on retirement provision with far-reaching knock-ons also for DB schemes. The headline changes from April 2015 Flexibility for DC The Government proposes that from April 2015, any person with DC pension savings will be able to draw down on them with much more flexibility as and when they wish after the age of 55 (the normal minimum pension age but see below), irrespective of the size of these DC savings, or their other retirement income. The 25% tax free lump sum will continue to be available; other drawings being subject to income tax. So individuals will be able, for example, to take part of their pension pot as their tax-free lump sum and then designate the rest for income drawdown and/or use it for annuity purchase then or later or draw the rest as (taxed) cash. This is a change from the current system where unless the pot is small, or the individual can prove significant other secure retirement income and uses flexible drawdown taking an entire pension pot as cash would mean much of it counts as an unauthorised payment taxed at a penal 55%. The Government hopes that the introduction of more choice for DC pension savers will encourage innovation by providers of retirement income products and that the shape of the market will be driven by consumers and savers.
Page 4 of 7 The Government states that individuals with an annuity already in place before this new regime will remain bound by that contract; but individuals in drawdown should be able to benefit from the new flexibilities. Attractive as a cash sum may be, of course if a lower rate taxpayer decides to draw on his retirement fund in one go, he may find that much of it falls into a higher rate tax band than he is used to. Changes to Normal Minimum Pension Age for DB and DC schemes The minimum age at which an individual can take retirement benefits from a pension scheme without triggering tax penalties (the Normal Minimum Pension Age (NMPA)) is currently usually 55. The Government proposes increasing this to 57 by 2028, the same time that the State Pension Age will increase to 67 (with transitional arrangements before 2028 to be announced in the autumn). Thereafter NMPA will rise in line with State Pension Age so that it is always 10 years below (unless consultation suggests an even higher age). (The possibility of drawing benefits earlier on ill health grounds will continue as will we think previous protected ages.) The Government indicates that it has taken this action to try to extend individuals savings periods but if savers think that their pension funds can be locked away longer than they expect, this might undermine their confidence in making those pension savings despite the other new flexibilities. It will certainly be unpopular with current 41 year olds! Financial guidance at retirement on DC choices, free to the consumer The Government intends to introduce a new guarantee that all individuals with a DC pension in the UK approaching retirement will be offered guidance at retirement, and that guidance will be impartial, good quality, covering the individual s range of options, free to the consumer and offered face to face. From April 2015 pension providers and trust-based schemes will have a duty in law to offer a guidance guarantee at the point of retirement to each of their DC customers. The Government intends to consult on the details of this policy but it has pledged a development fund of 20m to get the initiative up and running (with a suggestion that the funds could be used to support development of guidance material, training and capacity building in the charitable advice sector). After this initial guidance individuals may then want to take advice before they take their decisions.
Page 5 of 7 Not explained is how this will be funded on-going if free to the consumer, then presumably the cost will fall ultimately on the employer for trust based schemes and to the insurer provider of personal pensions. Restrictions on members rights to take a transfer from a DB scheme to a DC scheme The Government has recognised a danger that the new flexibilities being introduced may encourage individuals with DB pensions to transfer to a DC pension vehicle in order to cash out their benefits. For unfunded public sector schemes, this would create an immediate cost to the Treasury. Therefore the Government intends that members of a public sector DB scheme (funded or unfunded) will no longer be able to take a transfer to a DC scheme, except in very limited circumstances. (Fair Deal and Public Sector Transfer Club arrangements will not be interfered with.) The Government may need to make the same restriction on transfer rights for members of private sector DB schemes on the grounds that these schemes are major UK investors in longer term UK assets, so there could be real implications for the UK economy if there were large scale transfers out of them. But its preference is for a lighter touch a key consultation point, options specifically mentioned including: removing the right of a member to transfer his benefit from a private sector DB scheme to a DC scheme, except in exceptional circumstances; allowing such transfers, but only if the monies received into the DC scheme are ring-fenced away from the new DC flexibilities; allowing such a transfer, but requiring approval by the DB scheme trustees before it can be made; placing a cap on the amount that people in DB schemes can transfer to DC schemes each year; keeping the current regime allowing transfers but only if the Government is satisfied that the risks to the economy are acceptable. The consultation on whether to extend the restriction to the private sector is likely to generate strong views on both sides. The Government s stated concern is the macroeconomic impact for investment (with some pointers at admin and tax complexity), but if it chooses a lighter touch this could have massive implications for all sorts of aspects of DB scheme management, funding and its long-term future, as well of course as for member choice.
Page 6 of 7 Changes from 27 March 2014 There are immediate changes, the first pair being interim steps for DC schemes, but also being made for DB schemes, relating to small funds at retirement and very welcome: For DB and DC schemes: higher limits for cashing out small funds at retirement Currently, an individual whose total pension savings across all schemes are less than 18,000 can be allowed to take this as a one-off retirement cash sum (three quarters of it taxed). The limit in tax law for this Trivial Commutation Lump Sum will now increase to 30,000. Broadly, current tax law allows small pensions worth less than 2,000 in a scheme to be cashed out at retirement (without regard to pension savings held elsewhere). This limit will increase to 10,000 and the number of pots from personal pensions that can be so cashed out will increase from two to three (there is no cap on how many occupational scheme small pots can be cashed out). As part of the 2015 reforms for DC the current block to using these facilities before age 60 will be removed so that it will be available when other retirement benefits are (ie the new NMPA). It is not clear whether this timing change will apply to DB too. But no change to the Winding up Lump Sum limit (WULS) When a scheme is being wound up it is possible for trustees to pay a one-off cash sum to members in lieu of their benefits if the sum involved is less than 18,000. The draft legislation for the above changes does not change this and HMRC has confirmed to us that this is deliberate given the very different nature of this option. Note that if Trustees want to put forward these changes in their schemes they may have to change their scheme rules. Changes to drawdown, in the run up to the bigger changes in 2015: The Minimum Income Requirement (MIR) for flexible drawdown will be reduced from 20,000 to 12,000. Currently if an individual can demonstrate that he has a secure retirement income of 20,000 or more, then using a flexible draw down product, broadly he can take any other pension funds as cash (some tax free, some subject to income tax). This limit will reduce to 12,000 (before the effective change to nil next from 2015/16). The maximum annual pension for capped drawdown set by the Government will increase from 120% to 150%. On the face of it, the Budget announcement on the changes to the DC system looks like good news for pension savers. But whilst this will offer significantly greater
Page 7 of 7 flexibility to scheme members when they retire, the reality is that it poses a number of serious challenges and questions which the Government and the industry will have to answer including significant social issues. This News Alert should not be relied upon for detailed advice or taken as an authoritative statement of the law. If you would like any assistance or further information on the contents of this News Alert, please contact David Everett or the partner who normally advises you at LCP on +44 (0)20 7439 2266 or by email enquiries@lcp.uk.com www.lcp.uk.com LCP is a firm of financial, actuarial and business consultants, specialising in the areas of pensions, investment, insurance and business analytics. Lane Clark & Peacock LLP London, UK Tel: +44 (0)20 7439 2266 enquiries@lcp.uk.com Lane Clark & Peacock LLP Winchester, UK Tel: +44 (0)1962 870060 enquiries@lcp.uk.com Lane Clark & Peacock Belgium CVBA Brussels, Belgium Tel: +32 (0)2 761 45 45 info@lcpbe.com Lane Clark & Peacock Ireland Limited Dublin, Ireland Tel: +353 (0)1 614 43 93 enquiries@lcpireland.com Lane Clark & Peacock Netherlands B.V. Utrecht, Netherlands Tel: +31 (0)30 256 76 30 info@lcpnl.com Lane Clark & Peacock UAE Abu Dhabi, UAE Tel: +971 (0)2 658 7671 info@lcpgcc.com All rights to this document are reserved to Lane Clark & Peacock LLP ( LCP ). This document may be reproduced in whole or in part, provided prominent acknowledgement of the source is given. LCP is part of the Alexander Forbes Group, a leading independent provider of financial and risk services. Lane Clark & Peacock LLP is a limited liability partnership registered in England and Wales with registered number OC301436. LCP is a registered trademark in the UK (Regd. TM No 2315442) and in the EU (Regd. TM No 002935583). All partners are members of Lane Clark & Peacock LLP. A list of members names is available for inspection at 95 Wigmore Street, London, W1U 1DQ, the firm s principal place of business and registered office. The firm is regulated by the Institute and Faculty of Actuaries in respect of a range of investment business activities. The firm is not authorised under the Financial Services and Markets Act 2000 but we are able in certain circumstances to offer a limited range of investment services to clients because we are licensed by the Institute and Faculty of Actuaries. We can provide these investment services if they are an incidental part of the professional services we have been engaged to provide. Lane Clark & Peacock UAE operates under legal name Lane Clark & Peacock Belgium Abu Dhabi, Foreign Branch of Belgium. Lane Clark & Peacock LLP.