Page 1 of 7 News Alert 2014/07 23 July 2014 A new age for accessing DC retirement savings moves a step closer At a glance On 21 July 2014 the Government announced its main decisions following the March Budget consultation on introducing Freedom and choice in accessing defined contribution (DC) retirement savings. More choice and flexibility must be good news for pension savers and will encourage more savings. Details that might be important are still awaited, but trustees, scheme managers and sponsoring employers of any type of pension scheme need to start planning now for the new possibilities and responsibilities of wide ranging implications that will open up in just eight months time. Key Actions Pension managers DC trust based review your scheme s retirement options with a view to introducing greater flexibility in April 2015 or decide to give access solely by transfer. DC contract based check what your provider will offer. DB be ready for a likely increase in transfer requests close to retirement as some members wish to move to DC schemes to take advantage of the new flexibilities. All cases communicate with members now about the coming changes, and review all communications Trustees and Employers DC review any lifestyle investment strategies (particularly any default option that assumes members are aiming to buy an annuity at a fixed retirement age). The new flexibilities could sweep away the previous rationale for these. DB consider new possibilities for member options and one-off bulk exercises that will help manage risk in the scheme, such as small sum cash-out to retirees and current pensioners aged 55 or more.
Page 2 of 7 These are just a few of some possible actions to respond to what is a substantial change in the pension landscape. The Detail From next April those with defined contribution 1 (DC) retirement savings will be able to access them with much greater flexibility than at present. They will still be able to take part as a tax-free lump sum; and in addition to taking the balance as a lifetime annuity, will have the choice (if their scheme permits) to access it through much more flexible drawdown rules, including, crucially, taking the entire balance in one go in either case, being subject to income tax on this balance at their marginal rate(s). From next April DC schemes will be able to deliver retirement income in a much more flexible manner In this News Alert we summarise the government s latest decisions, including its allimportant conclusion that there should be no ban on private sector defined benefit (DB) to DC transfers (so DB members can also access the flexibility). We also set out some initial thoughts on what they mean for DC and DB schemes, their members and their sponsoring employers. The government will take forward two separate pieces of legislation in the autumn in order to deliver these reforms the Pension Schemes Bill and the Pensions Tax Bill. Until we see the proposed legislation, particularly in the Tax Bill (for which a technical consultation is promised shortly ), a lot of the important detail remains uncertain. Designing the new tax framework The government needs to adjust the pension tax framework in order to deliver the flexibility it seeks. The key changes are discussed below. Providing access to flexibility for DC benefits The government intends to introduce a permissive statutory override that will enable all schemes to change their rules to permit these new flexibilities to be used for DC benefits where the rules otherwise prevent this. However, this override is not mandatory and so trustees and managers can choose whether, and the extent to which, to introduce the new flexibilities. Two measures will be implemented whose purpose is to provide those with DC benefits access to the new flexibilities Given that adjusting schemes is not mandatory the government will extend the right of members of DC schemes to transfer their benefits to another DC scheme right up to their normal retirement age. Currently, DC members do not have a right to transfer once they are within one year of their retirement date. (There is no news as to whether this 1 For this purpose defined contribution means both money purchase and cash balance savings. A hybrid arrangement may also be defined contribution but this will depend on its nature at the time benefits are taken. Those with AVCs will also be able to access them flexibly, subject to their pension scheme rules.
Page 3 of 7 extension will also apply to DC benefits within DB schemes, or indeed all rights within DB schemes.) Enabling insurers to innovate The government believes that many of the pension taxation rules in relation to lifetime annuities need to be adjusted to encourage innovation, thus allowing insurers to develop new retirement income products that meet the needs of modern society. Therefore the government intends to make changes that will enable lifetime annuities to: decrease (so that, for example, annuity payments can reduce when an individual becomes eligible for the State Pension); The tax rules surrounding lifetime annuities will be opened up to encourage insurers to deliver more flexible retirement income solutions have lump sums taken from them (such as to meet care needs), if so specified in the contract at the point of purchase; contain a guarantee period greater than ten years, so that more of an individual s fund can be returned to their dependants on their death; and allow the balance of any guarantee to be paid as a lump sum where it is under 30,000. Limiting the scope for abuse of pension contribution tax relief The government is concerned that this new DC retirement income flexibility could lead to abuse by those over 55 diverting part of their salary into DC retirement savings, only to immediately withdraw it thus avoiding national insurance contributions and picking up 25% of the diverted salary free of income tax. To prevent this, the government is introducing a new and conditional 10,000 DC pseudo annual allowance. Some of the detail of this is unclear, but it seems that once an individual cashes out more than their tax-free lump sum from any DC retirement savings pot that is worth more than 10,000 (including the lump sum) they will only be able to gain tax relief on further contributions to DC retirement savings vehicles up to 10,000 pa in aggregate. The DC flexibilities enable those aged 55 and above to engage in abusive practices the government intends to limit their scope through introducing a conditional 10,000 DC pseudo annual allowance It seems that the current 40,000 annual allowance remains in place across all schemes, so anyone triggering the 10,000 pseudo annual allowance continues also to be tested against the 40,000 annual allowance (with separate tax charges potentially arising). We hope that this new allowance will be kept as simple as possible to understand and to manage for example, no complex carry forward. The new allowance lessens, but does not eliminate, the scope for manipulation of the tax rules. However, the government warns that it will be closely monitoring behaviour under the new system.
Page 4 of 7 Normal Minimum Pension Age to increase but not quite yet The government is pursuing its plans to increase Normal Minimum Pension Age (NMPA), the earliest age at which retirement savings can be accessed, from 55 to 57 in 2028. Thereafter it will rise in line with State Pension Age so that it is always ten years below. This will apply to both private sector and public service schemes, other than the Fire-fighters, Police and Armed Forces schemes. The age at which retirement benefits can be taken will be tied to State Pension Age but there is to be no legislation in this Parliament The government is considering whether there should be protections for those who have built up savings with a right to take benefits from an earlier pension age. Given this, the government does not intend to legislate on NMPA in this Parliament. Reducing the tax rate on unutilised funds on death The government reaffirms its view that the current tax rate of 55% for funds within drawdown products on death or un-crystallised pension funds on death after age 75 is too high, given the new flexibilities from April 2015. But due to the complexity of this area the government is still considering its options and will make a further announcement in the Autumn Statement 2014. 55% is too much to charge on unutilised funds on death, but the Government has yet to decide on the new rate Impact of DC flexibility on means-tested welfare and social care benefits Introducing DC flexibility has important implications for certain means-tested benefits. The government intends that capital held in drawdown type products will continue to be excluded from the capital means tests, but treated as generating a notional income for the purpose of the income means tests. To that end it will examine the notional income rules for consistency between drawdown products and annuities, with any changes being made before the new rules are published in October. The government intends to address welfare entitlement inconsistencies arising from replacing potential income with capital held within drawdown products Capital held within retirement products that have yet to crystallise should continue to be ignored from both the capital and income tests. As capital actually drawn down will count in the capital tests, the government cautions that those who choose to draw down their DC pot quickly will need to consider how it could affect their entitlement to welfare and social care support. These matters will be one aspect covered under the guidance guarantee. Providing DC members with access to free and impartial guidance The government s key safeguard for the successful delivery of DC retirement income flexibility is a properly functioning new guidance guarantee service available at retirement to all individuals with DC savings. Some more detail of this policy has emerged but there is still a lot of work to be done to get this running by April 2015. More detail is given on the guidance guarantee, but much more work needs to be done The guidance will be provided by independent organisations including the Pensions Advisory Service and the Money Advice Service, as well as possibly
Page 5 of 7 other consumer-facing organisations this is to avoid actual or potential conflicts of interest in order to ensure complete impartiality; The guidance will be delivered through a strong, recognisable brand across all providers of the service in order to distinguish it from sources of information or other services; The government intends that measures should be implemented to enable individuals to have drawn together information about all their pension wealth ahead of accessing the service; The proposed face-to-face guidance is now one of a number of communication methods, such as online or telephone support; All DC schemes will be required to signpost their members towards the service (through amending the disclosure requirements for DC occupational schemes); Standards for the guidance will be set by the FCA and its operation will fall under a new FCA standards regime; and The on-going costs will be funded by a new FCA-collected levy on regulated financial services firms (the initial preparatory costs of 20m are being met by the Treasury) it therefore seems that occupational schemes will not have to contribute directly. The government states that every individual with defined contribution pension savings will be able to access this guidance. Therefore, on the face of it a member of a DB pension scheme with DC AVCs will be eligible. Enabling DB scheme member to access the DC flexibilities One of the Government s key concerns in delivering DC retirement income flexibility was that this could introduce instability within DB pension schemes and through this on to financial markets. Significantly it has been persuaded that this is unlikely to be the case. No ban on private sector DB to DC transfers, but the member must take advice and trustees will receive new guidance The government has listened to the overwhelming majority of responses it received and has decided not to implement a ban on transfers from private sector DB schemes to DC schemes. The status quo also remains for transfers of DB pensions in payment a transfer to a DC scheme is an unauthorised payment with penal tax charges. The government refers to this as a ban but we think this is not the case, although the government could take further action to make it so. In order to access the new flexibilities private sector DB members will be able to transfer to a DC scheme if they wish But not if their DB pension is already in payment
Page 6 of 7 There will be a new requirement on trustees of DB schemes to check that a member has taken advice from a professional financial adviser who is independent from the DB scheme and authorised by the FCA before allowing the transfer out of the scheme. In most cases the member will pay for this advice but if the transfer is from a DB to DC section within the same scheme, or as a result of an employer led incentive exercise then the employer must pay. The requirement to take advice will not apply where the transfer value is less than 30,000. Members will have to take advice where they initiate a DB to DC transfer This is in effect putting on a statutory footing the current practice in relation to DB transfers to personal pensions. But through extending it to occupational schemes a side-effect could be to make it more difficult for the individual to transfer to pension liberation vehicles. New guidance to DB trustees will be produced reminding them of their existing powers to maintain the sustainability of their schemes when faced with requests for transfers such as reducing transfer values and delaying payment. Trustees will be reminded of their existing powers Could DB schemes introduce retirement income flexibility directly? As the government has not banned private sector DB to DC transfers it will be possible to cash-out DB benefits via transferring them to a DC vehicle. Several respondents suggested that DB schemes should be able to cut out the middle man and permit DB schemes to also directly cash-out benefits. The government appears to accept this argument has some merits and will consult further on this issue, although no timescale is given, and we believe it is unlikely to be before the General Election in 2015. The tantalising prospect of greater flexibility within DB schemes remains Whether or not the government is minded to proceed on this point, its other decisions have already opened the door for a range of DB de-risking ideas for trustees and employers. Ban on transfers from unfunded public service DB to DC The government had concerns that the introduction of the new DC flexibilities could cause a rush of transfers from unfunded public service DB schemes into DC schemes, thus causing a strain on the Exchequer s finances. To prevent this, the government announced at the March Budget that it would ban transfers from all public service schemes to DC schemes. However, in a change of position, the government has now decided the ban will apply only to unfunded public service schemes. The legislation to do this is now in place in the Pension Schemes Bill so the ban will implemented at an unknown future date after this Bill has passed into law. Members of unfunded public sector DB schemes will be prevented from transferring to DC schemes
Page 7 of 7 DB Small funds age restrictions reduced The government has confirmed that the trivial commutation and small lump sum options will continue to apply to DB schemes, but allowed from age 55 on 6 April 2015, rather than the current age 60. A welcome decision simplifying retirement processing and meaning that those aged 55 to 60 can be included in sweep-up exercises to use the higher limits ( 10,000 and 30,000) introduced at the Budget. Overall comment The next eight months will be interesting times for all pension schemes whether occupational, contract-based, or indeed in the public sector (which will have their own issues). The reforms change the fundamental outcomes of saving in any DC arrangement and will have knock-on consequences for DB schemes as well. 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 w 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 Lane Clark & Peacock LLP Lane Clark & Peacock Lane Clark & Peacock Lane Clark & Peacock London, UK Winchester, UK Belgium CVBA Ireland Limited Netherlands B.V. Tel: +44 (0)20 7439 2266 Tel: +44 (0)1962 870060 Brussels, Belgium Dublin, Ireland Utrecht, Netherlands enquiries@lcp.uk.com enquiries@lcp.uk.com Tel: +32 (0)2 761 45 45 Tel: +353 (0)1 614 43 93 Tel: +31 (0)30 256 76 30 info@lcpbe.com enquiries@lcpireland.com 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. 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.