This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.
Summary and implications
The changes announced in the Budget in March 2014 give individuals with money purchase or cash balance pension savings (referred to in this briefing as "flexible benefits") more flexibility as to how and when they access their funds. In this briefing we discuss some of the major points employers and trustees should be considering. The majority of the changes will come into effect on 6 April 2015 and schemes must be ready.
Benefit design options for schemes holding flexible benefits
From 6 April 2015, schemes will be able to allow members with flexible benefits to:
- take the entire amount as a lump sum from age 55 (subject to the payment of tax);
- draw tranches as lump sums from age 55 (this may be attractive for members but less so for trustees having to administer it);
- take a tax free lump sum and then draw down an income (this not something most occupational schemes are likely to offer);
- purchase an annuity (with some of the current restrictions removed); and
- transfer all or part of their benefits to another registered pension arrangement.
Most schemes are likely to want to offer their members a lump sum option, technically an uncrystallised funds pension lump sum (UFPLS), as an alternative to securing their benefits on retirement with an annuity. The trivial commutation option will no longer be available for flexible benefits but a UFPLS could be offered instead, with similar tax consequences for the member. This gives rise to a number of supplementary decisions and considerations:
- will members be able to take all their benefits in one go or will tranches be available?
- will partial transfers be allowed?
- can benefits be taken or transfers made while the member is still in pensionable service?
- will employer consent be required where the member is still in service?
- what to do about automatic enrolment for those still in service?
The Budget changes give more scope for removing small benefit pots. Benefits valued up to £10,000 can be commuted from age 55 regardless of other pension savings as long as it extinguishes the member's rights under that particular pension arrangement. The old rules for trivial commutation of sums up to £30,000 (£18,000 before March 2014) are being removed for flexible benefits. As mentioned above, a UFPLS option could be offered instead.
Employers may wish to consider a communication exercise to encourage members with small benefit pots to take them as lump sums. In some circumstances, this might bring into play the voluntary code of practice on incentive exercises, in which case members will have to be provided with advice or guidance.
New transfer requirements
A member's statutory right to take a cash equivalent transfer value of accrued rights to flexible benefits is to be extended up to the point of crystallisation (in most cases, the date on which a pension is first paid) but only if the member first opts out of pensionable service. Employers and trustees should be considering together whether they want to allow anything in excess of the statutory minimum. One option would be to allow a member to transfer only part of their accrued benefits.
Once a decision has been made on what transfer options to offer, trustees need to:
- review and revise communications with members (including scheme booklets) to reflect the new provisions; and
- adopt sufficiently robust discharges for any transfers which are outside the statutory minimum requirements.
Communication with members
There will be a number of key new disclosure requirements for trustees. Regulations setting out the detail have not yet been published.
A major new requirement will be to signpost members to "Pension Wise" (the name for the guidance guarantee). This applies where a member has a right or entitlement to flexible benefits. Very broadly, trustees must inform the member of his right to obtain guidance in order to assist him in making decisions about his flexible benefits. The guidance itself will be delivered by the Pensions Advisory Service or Citizens' Advice Bureau. The requirement to provide the information is likely to be triggered by a member request for information about their benefits (including by telephone) or when a member is approaching retirement age.
It has recently been announced in the House of Lords that trustees will also be responsible for a "second line of defence". This will mean that when a member seeks access to his benefits, trustees will be required to ask about key aspects of the circumstances relating to the choice which is being made and give relevant risk warnings. This is in line with requirements which the FCA will be introducing for personal pension providers.
Once a member has taken a flexible benefit (whether as a lump sum or drawdown), new annual allowance provisions will apply, with the member having a future annual allowance of £10,000 for further flexible benefits savings and £30,000 for other tax relieved pensions savings (or an aggregate annual allowance of £40,000 where this results in a higher tax liability). Trustees will be obliged to notify a member within 31 days of him first accessing flexible benefits, confirming the new annual allowance provisions and informing the member of his own obligations to report the information to the scheme administrator of any other registered pension schemes under which he is accruing benefits.
Trustees should also be considering the investment offering. This is particularly relevant to lifestyle-type funds, where the assets are moved into gilts or bonds in the period before retirement. This strategy may no longer be appropriate for members intending taking lump sum benefits rather than purchasing an annuity.
Trustees intending offering partial UFPLSs or transfer payments should also check that the investment options offered to members enable this sort of flexibility.
The tax legislation will in practice allow a beneficiary to receive any remaining flexible benefits on the death of a member either as a lump sum or as drawdown income. This will be tax free as long as sufficient lifetime allowance remains and the member dies before age 75. Tax will be payable where the member dies aged 75 or over. In practice, it would seem sensible for schemes to provide for the death benefits to be paid as a lump sum in most cases. Members wishing to use their benefits for inheritance tax planning reasons may want to transfer to a personal pension arrangement offering flexible drawdown.
The legislation gives trustees a discretion to make certain payments (including partial UFPLSs or drawdown pensions) despite them not being provided for (or even being expressly prohibited) in the scheme rules. This means that trustees could be placed in a position of having to at least consider making such a payment where requested by a member, even if the trustees and employer have decided that this was not a benefit that would routinely be offered by the scheme. It is perfectly permissible for trustees to have a policy of making benefit payments only as provided for under the scheme rules (or as set out in announcements to members or as agreed with the employer) but, as a result of this new statutory discretionary power, they must at least be open to considering requests from members for an alternative benefit on a case-by-case basis. Generally cost or administrative complexity may provide a reasonable basis for not moving away from the established policy.
Below are action lists for employers and trustees, picking up on the issues considered above.
|Action points for employers |
|Decide what, if any, new lump sum optionsare to be made available. |
|Decide whether to offer any transfer options in excess of the statutory requirements. |
|Decide whether to offer income drawdown from the scheme. |
|Consider whether any changes in practice oncommutation of small pots is desired. |
|Discuss and communicate any proposed changes with the trustees. Where there will be a cost impact on the scheme (including administrative cost) or where benefits are to be made available to those still in servicethen the decision should primarily lie with the employer but early engagement with the trustees is desirable (and in some schemes may be required in order to effect scheme amendments). |
|Action points for trustees |
|Decide what, if any, newlump sumoptions are to be made available. |
|Decide whether to offer anytransfer options in excess of the statutory requirements. |
|Review the transfer process and documentation to ensure it complies with the new statutory requirements and any new scheme provisions. |
|Review and revise pre-retirement literature andscheme booklets (and all other communication material) to bring it up to date with any changes. |
|Ensure all staff dealing with member queries are fully trained on the changes. |
|Review the suitability of scheme investments. |