Employers have faced wave upon wave of new pension legislation this year, and making sense of it has never been more challenging.
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- Major changes are coming to a head next April concerning how pension schemes can be charged and how benefits can be taken, which will have a huge impact.
- One of the most urgent actions is to ensure default funds are appropriate for income drawdown, or that there is a good mechanism for employees who plan to use the new freedoms.
- A raft of legislation is being rushed through by the coalition government, but could be reversed by a Labour government.
The pension tax simplification regulations that were introduced in April 2006, and caused huge consternation at the time, were simple compared with the four major pension bills seen this year, which cover everything from the structure of pension schemes to how benefits are paid.
But while the pace of change is furious, the legislation is fragmented and sometimes contradictory.
In January, the Financial Conduct Authority (FCA) launched its ‘Scorpion’ campaign to tackle unscrupulous salespeople encouraging pension-holders to cash in their pension, often channelling them into dodgy alternative investment schemes.
But just six months later, chancellor George Osborne says he thinks the public is responsible enough to do whatever they want with their pension pots, despite the FCA warning of mis-selling and “an urgent need for a coherent risk mitigation strategy”.
Default fund cap due in April
Employers are also right to be concerned about the 0.75% cap on default fund charges which was confirmed on 17 October and comes into force next April.
Pensions minister Steve Webb says he hopes the charge cap will transfer about £200 million from the pensions industry to the pockets of savers over the next decade. Some providers will try to make up lost revenues by charging employers additional administration costs, but overall the cap will deter workplace schemes from using the best funds.
This will become critical next year when scheme members have more flexibility about how to take their benefits. Most schemes will need to review their default funds because lifestyling is completely unsuitable for members who choose income drawdown.
These recent draft regulations also ban ‘active member discounts’, the system that imposes higher charges on deferred members than on those still working for the employer, and call time on ‘consultancy charging’, so employers will no longer be able to pass on any consultancy fees to scheme members.
End of death tax on pensions
Even proposals that first appear to have a limited impact on the day-to-day operation of workplace pension schemes could have far-reaching consequences. For example, the proposal to abolish the 55% ‘death tax’ on pension funds , announced by George Osborne to rapturous applause at the Conservative party conference, means that from next April, beneficiaries can inherit a pension pot completely tax-free, and will only have to pay tax (at their marginal rate) if the person who has died is aged 75 or more. Research by Axa Life Invest suggests this will encourage one in five employees to step up their pension contributions.
Bob Scott, a partner at financial consultants Lane, Clark & Peacock, says: “Each of this year’s four pieces of pension legislation could have a material impact on certain schemes that may have to implement a major revision, certainly by April 2016, regarding the flat rate state pension and contracting out. It is a lot of work on top of new codes of practice on funding on DC [defined contribution] plans and initiatives such as the requirement for independent governance committees.”
Nest restrictions due in April
There have also been other developments, such as the Department for Work and Pensions’ announcement that restrictions on Nest will be relaxed from April 2017 , which gives some indication of its thinking for the timescale to introduce automatic transfers.
Also, Section 29 of the Pensions Act 2011, which amended the statutory definition of money-purchase benefits, did not come into force until 24 July this year. This was prompted by the case of Bridge Trustees vs Houldsworth , which confirmed that benefits to which a guaranteed return was applied could be considered ’money purchase’ even though a deficit could arise from them.
The Pensions Act revised the definition of money-purchase benefits amid intense lobbying. Schemes that fail the new definition, such as those with guaranteed underpins, now need to undertake valuations and pay PPF levies.
Labour would reverse freedoms
If the Labour party wins the 2015 general election, further changes are promised, such as the removal of higher-rate tax relief on pension contributions and the reduction of the lifetime allowance from £1.25 million to £1 million. But there is no joined-up thinking in this pledge because breaching the lifetime allowance will be immaterial when excess savings are no longer taxed so heavily.
Labour is conducting behind-closed-doors meetings to potentially reverse the new pensions freedoms if it gains power.
But it could be worse. UKIP’s erstwhile pensions spokesman, colourful former Yorkshire MP Godfrey Bloom, quit the party in October, leaving a policy vacuum for the party.
The four pensions bills
- The Finance Bill 2014 . This gave HM Revenue and Customs new powers to prevent pension liberation schemes being registered starting 20 March 2014 and made it easier to de-register such schemes if, in HMRC’s opinion, the scheme administrator is not a fit and proper person.
- Pensions Act 2014 . This received royal assent on 14 May, and sets the scene for the introduction in 2016 of a flat-rate state pension to replace the current two-component state pension (basic state pension and additional Serps/S2P element). The act brings forward the date when the state pension age (SPA) rises to 67 and sets the framework for the SPA’s review. People who have reached the SPA before 6 April 2016 will have a chance to buy class 3A voluntary contributions to build up additional benefits. Some workplace schemes face complications because their benefit formula references the state pension. The act also looks at the impact on contracting out for employer pension schemes.
- Pension Schemes Bill . Out on 26 June, this bill is designed to encourage pension scheme arrangements that offer an element of certainty or that involve pooling risk: so-called defined ambition schemes. This is ’enabling’ legislation and no further news on it is expected for some time.
- Taxation of Pensions Bill . Introduced into the House of Commons on 15 October, this bill deals with the new freedoms announced in the last Budget which, from April 2015, will allow people aged 55 to access their money-purchase pension as they want during retirement, subject to paying tax at their marginal rate. It also introduces anti-abuse legislation to limit the potential for recycling tax allowances by limiting the contributions an individual can make once they have taken their 25% cash to £10,000 per year. The bill surprised the industry by taking the new freedoms a step further by suggesting pension pots could be structured like deposit accounts, with withdrawals made at will but with tax payable on 75% of each drawdown.
Case study: Heineken – Default funds will need re-brew after Budget changes
Heineken’s defined contribution pension scheme with Standard Life was established in July 2011. It currently has about 2,000 members out of a total workforce of almost 2,100. Assets under management amount to just over £40m.
Neil Parfrey, head of pensions , says the scheme’s governance committee is currently re-examining its default funds after the chancellor’s Budget changes liberalising how members can take their pension pots.
“If some of our members are trying to target cash at retirement, then the investment strategy required will be different from the way it is structured now to take them to buying an annuity,” he says. “We are in the process of analysing this and may end up with three different vehicles: for drawdown, for an annuity and for cash.
“The trick will be in finding out what our colleagues want to do. At the moment, the switching process in the lifestyle fund starts 10 years out, so we need some change because the current model is not fit for purpose. It also raises the requirement for [employee] education.”
In line with the Association of British Insurers’ code, the scheme has a governance committee, with an independent chairman, which meets quarterly.
Parfrey adds: “We see the [governance committee] as an important part of our stewardship obligations towards our colleagues. Without the involvement of the [governance committee], colleagues would need to take a more active role in their saving options, and our experience shows this is not a particularly common behaviour.
“There is also an implicit understanding from our colleagues that the company will take an active interest in their investments, probably driven by the fact that the majority of current members came from a defined benefits scheme governed by a trustee board.”
Palfrey says there has been no real increase in transfer requests, but he does not rule out a surge when the new flexibilities become better known in the run-up to April.