Summary and implications
The unexpected announcement in the Budget allowing members full freedom over their DC pension pots from April 2015 will have consequences for the pensions industry as a whole and for the wider economy.
The Government is consulting on the detail of the changes and we may not know the results of that until much later in the year. In the meantime we have been looking at the published proposals and considering what they may mean to the various parties.
The proposals at a glance
The key proposal is for everyone to have full access to their DC pension pots from age 55.
Schemes will be required to provide "guidance" to members approaching retirement.
Most transfers out from public sector schemes will be banned. They will still be allowed where there is a bulk transfer under Fair Deal, it is to another public sector scheme under the Transfer Club arrangements or in exceptional circumstances (yet to be specified).
There is also likely to be some form of restriction on transfers from private sector DB schemes to DC arrangements to prevent a sudden outflow of funds.
DC members: more choice but danger areas
On the face of it the Budget is good news for DC members, giving them more choice over their retirement income. There is the obvious risk that the benefit will be taken in one go and spent quickly, leaving the member with only the state pension for income. Even those taking a more prudent approach might underestimate their longevity. Steve Webb's view seems to be that it doesn't matter, the state pension will be sufficient.
Taking the benefit as a lump sum may have consequences for means-tested benefits and services, including care costs. Some members may still want the certainty of an annuity but, with fewer being taken out, the risk for the insurer will increase and so therefore will the cost.
The key to the success of the new regime for members will be the quality of the guidance, the suitability of any new products which are developed and, to a certain extent, the behaviour of the member.
DC trustees: a new era of compulsion
The current pensions tax regime sets out which benefits are authorised but does not require trustees to pay any particular benefit to anyone at any specified time – this is left to individual scheme design. The Budget proposal may change this, with a suggestion that members will be able to compel trustees to pay out their pension savings on request (this is already the case for most transfer payments). It is not clear whether the intention is that members should have totally unrestricted access, so that they could call for access to any part of their funds at any time – meaning pension schemes effectively operating as instant access savings accounts – or just a one-off opportunity to access the whole benefit. Instant access to partial benefits would create administrative and record-keeping challenges for schemes.
The proposal also raises questions about lifestyling funds. The majority of DC schemes offer a lifestyling fund (and it is required for default funds in automatic enrolment schemes). Very broadly, the aim is to reduce risk in the period up to retirement and to stabilise the fund in preparation for the purchase of an annuity on a specified date. With the proposed flexibility it will be much less important to decrease risk for all members in the later stages of their investment cycle as the majority will not now be looking to purchase a one-off annuity. It may not therefore be in the best interests of the majority of members to invest in a lifestyling fund. This raises issues about fund selection by both trustees and members. It will be a challenge for trustees to select funds to match members' intentions on retirement (as these will not be known in advance by the trustees) and it will be much harder for members to make sensible fund selections. Further thinking may be required in this area, particularly on what guidance or advice could be provided to members at different stages of pension saving.
DB schemes: change of investment strategy
Allowing full flexibility in DC schemes could have a serious impact on the funding of DB schemes as well as on the investment market and wider economy. Many DB schemes invest heavily in long-term gilts and corporate bonds as they are planning to be paying benefits for the lifetimes of their beneficiaries. If this falls away and schemes pay out the majority of assets as lump sum transfers at or before retirement then the investment strategy of schemes will have to change – potentially removing £billions of investment from the long term investment market.
The government is consulting on restricting the rights of members in the private sector to transfer from DB to DC schemes. Proposals range from an almost complete ban to retaining the current transfer rights. If no major ban is introduced then schemes will have to review their investment strategies and consider whether it is appropriate to move away from looking to fund long term pension liabilities and move towards facilitating increased cash flow to fund transfer payments at or before retirement.
Schemes could also be affected by changes in the annuities market. Many DB schemes buy out pensions with annuities (either in bulk or individually) and trustees could find that this becomes even more expensive.
Trustees could find a post-Budget rush of members wanting to transfer out to a DC scheme before any new restrictions are imposed. These transfer requests should be processed in line with the current cash equivalent legislation.
Employers: risk management and workforce planning
Any restrictions on DB transfers could mean the end of enhanced transfer exercises by employers. These have been used to reduce future scheme risks by encouraging members to transfer out to DC pension arrangements. Conversely, if transfers are allowed to continue from DB to DC, employers could find that members effectively de-risk the scheme themselves by choosing to take (unenhanced) transfers in order to benefit from the new DC flexibilities.
Employers could well find situations where an employee has taken his or her benefits in lump sum form at 55, has spent that, and then wants to work on longer to rebuild a pension. We are not aware of any proposal to require an employee to actually retire from work before drawing on their DC pension pot. Individuals have been allowed to draw a pension while still in the relevant employment since April 2006 but not all schemes allow it (and many only with employer consent). If members are to be allowed to draw their pension pots as of right then the concept of moving on from work into a pension may fall away, with no "natural" time for someone to retire. This could make succession planning much more complex and uncertain for employers.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
