Freedom and choice in pensions: Sackers’ response to consultation

Background

The 2014 Budget proposed significant changes on the use of individuals’ DC pension pots at retirement.  HM Treasury’s consultation “Freedom and choice in pensions”, published alongside the Budget, proposes a general overhaul of the rules relating to the options for DC benefits on retirement, with the intention of giving individuals more choice and flexibility as to how they use the funds accumulated in their pension pots at retirement.

The consultation also proposes restrictions on the transferability of DB benefits to DC schemes.

In this response:

• General comments
  
• A new tax framework for retirement
  
• Supporting choice
  
• Defined benefit schemes
  

General comments

The Government’s proposals to broaden the options available to individuals at retirement are to be welcomed, and may help promote engagement with pensions generally.

However, there are a number of aspects of the proposals which need attention before implementation.  In particular, further work is needed to ensure that the legal framework – comprising both tax and DWP legislation – can accommodate the new flexibilities.

Whilst we understand the Government’s desire to allow individuals to take advantage of the new flexibilities as soon as possible, the proposed timeframe is very tight.  Administration systems need to be adapted, suitable products developed and care needs to be taken to ensure that the guidance guarantee can be implemented effectively.

Definitions

If the proposals proceed on the basis of different treatment for DB and DC schemes, the appropriate definition of “money purchase benefits” will need to be clarified.

For example, if the proposed flexibilities are linked to the definition of money purchase benefits set out in the Finance Act 2004, thought will need to be given to the treatment of benefits which fall within this definition, but which would not be classified as money purchase for the purposes of section 29 of the Pensions Act 2011, such as a DC benefit with a reference scheme test (RST) underpin, or DC benefits being drawn down.

Hybrid schemes

The consultation is largely silent on the potential impact of the proposals for hybrid schemes.  We consider that there are a number of aspects which are specific to hybrid schemes that will need to be considered and/or clarified before any of the proposals are implemented.  These include the treatment of:

• benefits that are hybrid for the purposes of the Finance Act 2004.  For example, is it intended that the options available will depend on the classification of the benefit when the benefit crystallises?
• DC benefits with an RST or GMP underpin;
• DB benefits with a cash balance underpin.

These are fully covered in the response of the Association of Pension Lawyers, which we support, and as such, are not repeated here.

Additional voluntary contributions

Many DB schemes continue to offer members the option of paying money purchase AVCs.  In our experience, AVC fund values tend to be modest in relation to the value of main scheme benefits, and AVCs are often taken as cash, making up all or part of the member’s pension commencement lump sum (PCLS) on retirement.

Clarification is needed as to whether the proposed changes to allow flexibility are intended to apply to AVCs within a DB scheme, in the same way as to other DC schemes (or sections of schemes), on the basis that the DC element forms a separate “arrangement” within the scheme.

In particular, is it the Government’s intention to require DB schemes with DC AVCs to meet the proposed DC guidance guarantee to the same degree as a pure DC scheme?  In our view, such an approach would not be proportionate.

A new tax framework for retirement

Statutory override

The consultation asks whether a statutory override should be put in place to ensure that pension scheme rules do not prevent members from taking advantage of increased flexibility.

Without a statutory override, it is likely that some schemes would be unable to introduce the proposed new flexibilities, due to the structure of their amendment provisions.  To the extent that a statutory override would assist schemes wishing to take advantage of some or all of the proposed flexibilities, we agree with the introduction of a statutory override.

However, as we explain below, we do not consider that workplace pension schemes will necessarily be an appropriate vehicle for providing all such flexibilities, as the cost and further complexity of administration may be disproportionately burdensome.

Innovation in the retirement income market

Whilst we recognise that giving individuals flexibility over the way in which they use their retirement income is likely to afford significant advantages, we do not consider that responsibility for providing the full flexibility should fall on traditional workplace pension schemes.  Within the current regime, for example, there are valid reasons why many such schemes have chosen not to offer drawdown.

As individuals will have many options to choose from outside the sphere of their employment relationship, we do not consider workplace pension schemes to be appropriate vehicles for offering all the flexibilities contemplated in the consultation.  By way of example, whilst it might be feasible for workplace pension schemes to offer full commutation, we do not consider that they should be required to offer staged drawdown (which would be inconsistent with the new definition of “money purchase benefits” under section 29 of the Pensions Act 2011).  Care therefore needs to be taken to ensure that schemes are not required to offer options that they have already chosen not to provide.

Minimum pension age for accessing private pension income

In our view, there are various reasons against increasing the age at which individuals can access their private pension wealth in line with State Pension Age.   These include:

• the risk of such a move being counterproductive and potentially discouraging individuals from saving into private pensions.  The existing ability to take a cash lump sum from age 55 is a useful financial tool for many, for example, allowing individuals to pay off a mortgage or other debts before retirement.  Putting back the age at which such funds can be accessed may act as a deterrent from pension saving;
• impeding the take-up of flexible retirement and flexibility within the labour market.  If workers are unable to leave employment until later, this can create difficulties for younger individuals in joining the workforce;
• the recent reductions in the Lifetime Allowance.  The LTA has been significantly reduced since the 2011/12 tax year and, as a result, many more individuals are being affected, not just the highest earners.  As such, a requirement for individuals to wait a further two years (or more) before they can access their private pension savings may discourage saving in pension funds, and lead to alternative savings vehicles being sought.

For these reasons, we do not consider this proposal to be in line with the Government’s stated policy aims of encouraging retirement saving and promoting flexibility.  Similarly, we do not agree with further increases in minimum pension age, for example to bring it within five years of State Pension age.

In the event that this policy measure is adopted, consideration would need to be given to those individuals who have a “protected pension age” under age 55, under the Finance Act 2004.  Consideration should also be given to transitional protection for individuals who currently have a right to take benefits at age 55.

Application to all schemes

If such a change were to be introduced, we consider that it should be applied across the board to all pension schemes which qualify for tax relief.  The introduction of different minimum pension ages could give rise to a risk of regulatory arbitrage, with individuals deliberately opting for schemes with the lowest minimum pension age, which may not otherwise be the most appropriate type of arrangement to meet their needs.

Supporting choice

The “guidance guarantee”

Given that the Government’s proposals are designed to provide individuals with significantly more choice for dealing with their pension pots, the broad concept of a requirement for members to receive guidance to assist with this choice is helpful.  However, whilst the consultation notes that the guidance is to help individuals approaching retirement “make the choices that best suit their needs”, the overall aim and extent of the guidance guarantee is not entirely clear.  For example, is it the Government’s intention that the guidance is to serve as a form of notification to members of the variety of options that will be available to them on retirement and a prompt for them to seek financial advice?

Whatever form of guidance is ultimately implemented, we do not consider there to be any reasons for a difference in treatment between contract-based pension providers and trust-based pension schemes.

The retirement pipeline

In terms of timing, the consultation notes that the guidance guarantee should be offered to all DC customers “at the point of retirement”.  However, with more choice on offer, receiving guidance at the point of retirement could come too late to enable individuals to take full advantage of the new options.  In particular, the tax implications of the various options and relevant investment considerations (such as appropriate fund selection and risk profile) need to be flagged in advance to pension savers as these can make a significant difference to an individual’s retirement income.  An appropriate timeframe for the provision of guidance might therefore start ten years or more from normal pension age and, with the anticipated rise in drawdown, such guidance will potentially be needed beyond retirement too.

In our experience, many employers already provide information relating to personal finances and retirement planning, for example as part of their employee benefits and/or pre-retirement counselling.  However, such practices are not universal.  Taking the proposed new flexibilities together with the increase in the number of people saving into a pension as a result of auto-enrolment, further thought needs to be given to the way in which the guidance guarantee forms part of a general programme of workplace financial education and awareness.

Providing guidance “face-to-face”

As set out in the consultation, we note that the Government’s current intention is for retirement guidance to be provided face-to-face.  We are concerned that where guidance is provided in this way, there is risk that members assume they are receiving “advice” as opposed to generic guidance.  This in turn may lead to a risk of mis-selling, if individuals are under the impression that they have received tailored guidance.

A reasonable, more cost-effective and quality controlled alternative could be to use a web-based programme/decision tree to help inform individuals of the options available and factors they should consider, and point them in the direction of further guidance and advice where necessary.  Such a platform could be accessible from an earlier point in, or even throughout, an individual’s pension saving lifetime, helping to ensure that they have the necessary information and tools to be able to target their retirement income appropriately.

In our view, the Pension Regulator’s (TPR) Trustee toolkit is an excellent example of an interactive online programme which could usefully be used as a model.  We also consider that there is scope to build on the pre-retirement information that is already available to individuals, from organisations such asTPAS and the Money Advice Service.  Standardising information in this way may reduce the risk of mis-selling claims.

As noted above, this proposal is likely to take some time to introduce, to ensure that the quality of the guidance provided is appropriate.  In our view, the proposal that it be available from April 2015 is highly ambitious.

Costs

The cost of providing the guidance guarantee is an important consideration.  We note the recently reported comments of the Pensions Minister at a retirement income event hosted by the NAPF, to the effect that the guidance guarantee should form part of a scheme’s administration costs.  This is one option.  However, we consider that an important factor in determining who meets the cost of the guidance guarantee will be the practical value of the guidance to the individual receiving it.  Basic guidance provided by a scheme may well fit within a general administration charge.  However, to the extent that such guidance is tailored to the circumstances of each individual, and as such constitutes more than universal information (for example, of the kind that could be provided in a standard information leaflet), it may be reasonable to pass the cost of providing the guidance directly to members, subject to an overall cap for this service.  If this route is pursued, it would need to be determined whether this charge should fall within the general 0.75% cap on charges.

Subscription to an online “guidance toolkit” might help to minimise costs by reducing duplication of effort and would enable these to be spread between employers.  Employers could be required to pay a subscription based on the number of employees, to assist with set-up and ongoing costs.  Employers might be encouraged to see this as integral to other employee assistance programmes that they operate.  An idea of the set-up and ongoing costs of a web-based guidance toolkit could be established by reference to TPR’s toolkit.

Defined benefit schemes

Transfers from DB to DC arrangements

The consultation asks whether the Government should continue to allow private sector DB to DC transfers.

To date, we have not seen a rush of requests from members to transfer out their DB benefits and we do not foresee a significant flight from DB as a result of the new options if the transfer rules remain as they are now.  It seems to be generally recognised that for the majority of DB scheme members it is likely to be more advantageous to retain DB membership than to transfer out, irrespective of the new options that are proposed.  We anticipate that most new interest in transfers from DB schemes is likely to come either from individuals with very large pension benefits (generally sophisticated investors seeking greater flexibility for their funds), or from those with small pots over the trivial commutation limits, who may get more benefit from a lump sum payment than from a very small annual pension.  There may be some for whom this represents a one-off opportunity to reduce their debt (and therefore the ongoing cost of servicing that debt).

We do not agree with the suggestion that transfers from DB to DC arrangements should require the prior approval of the DB scheme’s trustees, as this would impose an unduly onerous burden on them.  In practice, it should not be the role of trustees to make decisions which affect individuals directly, in terms of their financial choices and which depend materially on a member’s individual circumstances.  Furthermore, we do not consider that putting such a decision in trustees’ hands would address the Government’s concern regarding potential risks for the UK economy.

EU legislation

In introducing any changes at national level, the Government should take into consideration current EU proposals for a Directive on improving the portability of supplementary pension rights.  The proposed directive seeks to require Member States to implement minimum requirements for acquiring and preserving the pension rights of people who go to work in another Member State.  While Member States are to remain responsible for the conditions under which people change jobs within the same country, the EU Commission expects them to apply the standards laid down by the portability directive to internal mobility as well.

There is also an argument that the introduction of a ban on transfers, from DB schemes to DC, could amount to an infringement of an individual’s right to peaceful enjoyment of their property under the European Convention on Human Rights.  It would be for the Government to demonstrate that such a restriction is in the wider public interest.

Public v private sector pensions

We note the Government’s intention to remove the transfer option from a public service DB scheme to a DC scheme, except in very limited circumstances.  Given the fundamentally different nature of the two sectors in terms of DB scheme funding (as public sector schemes are unfunded), we agree with the Government’s proposal to treat public and private sector schemes differently in this regard.

Hybrid schemes

In the event that the Government does introduce a ban on transfers from DB to DC in the private sector, thought would need to be given as to whether it is intended to introduce a restriction on the conversion of DB benefits to DC within a hybrid scheme, and any subsequent transfer of those benefits to another DC arrangement.

Again, the position of money purchase AVCs should be considered.  For example, is it intended that a statutory right to transfer AVCs in isolation would be introduced, leaving the DB benefits behind?

No ban on transfers

For the reasons outlined above, we consider that the ability to transfer benefits from DB schemes should continue to be permitted as currently.

Alternatively, preserving the flexibility to transfer benefits from DB arrangements subject to the ring-fencing of transferred funds within the receiving scheme and subject to the existing framework for DC is a possible alternative.  However, whilst the latter option would preserve existing flexibilities within the pension system, it would introduce unwelcome additional complexities, for example, in terms of increased administration and monitoring.