Lamborghini or Lada? The New Retirement Choices
By Nick Boyes
Posted: 30th May 2014 08:50As a way of drawing attention to the seismic change to the UK pensions landscape announced in the Budget speech in March 2014, admitting that you could use your pension savings to purchase a Lamborghini was inspired.
For those of us within the pensions industry this unforeseen development has caused as much excitement as the arrival of a £260k Lamborghini Aventador in the office car park. To the outside world, this might need some explanation.
Contributions to a registered pension scheme attract income tax relief, and the funds are invested virtually free of tax. This makes retirement saving particularly attractive to high rate tax payers, and makes the tax authorities very nervous about missing out on tax revenues. This had resulted in a very complex regime for limiting the amount of pension savings that individuals could make, and a bewildering set of restrictions on when and how these savings could be accessed. In simple terms the accumulated funds, after payment of a tax-free lump sum of up to 25% of the fund value, had to be used to provide an income stream in retirement. Usually this would be by the purchase of an annuity from an insurance company – a series of income payments guaranteed for life.
Although the tight grip exerted by HMRC had started to relax a little, the announcement by George Osborne that, from April 2015, that those aged 55 and over will be able to take the whole of their defined contribution pension savings as cash came as a complete surprise to the pensions industry. The immediate impact was felt by those companies that provide annuities to the market. Large insurers with a diversified offering, such as L&G and Aviva, saw share price falls in single figures, but specialist providers such as Partnership Assurance and Just Retirement saw dramatic falls of 55% and 42% respectively.
Why has the change been introduced? Will pensioners blow their savings on a world cruise or dream car? Will the burden of supporting this profligate bunch fall back on the State? Or is the Government right to assume that people can be trusted to manage their finances in old age, and that the previous restrictions were simply manifestations of the ‘nanny state’? This is difficult to call. Evidence from Australia, where this provision has been in place for some time, is that people tend to use the cash to clear debt and to invest. However, people tend to underestimate how long they are going to live. This makes it difficult to determine how quickly they should use up their pension savings. One of the measures that is to be introduced is the provision of guidance to people at retirement, to help them to make decisions that are appropriate to their circumstances and ambitions.
This is likely to add to the burden falling on those in charge of the governance of the pension scheme: the trustees. They will have to thoroughly understand the options and ensure that guidance is available at the right time.
These changes only apply to defined contribution pension schemes, also referred to as money purchase, or ‘DC’ scheme. Those lucky enough to be members of defined benefit schemes (usually referred to as ‘DB’ schemes), for example final salary schemes, will not be able to swap their entire pension for a lump sum. In order to take advantage of the relaxation of the rules that apply to DC schemes, they would have to transfer their entitlement away from their current scheme.
If they are going to do this, then they had better get a move on. The Government is not keen on a initiating a mass exodus from DB schemes, and is consulting on whether or not it should introduce legislation to ban transfers out of this type of arrangement. The consultation is expected to conclude in July.
How should trustees react to this change? For trustees of DC schemes the immediate action is to ensure that members approaching retirement are made aware of the new options that are open to them. Although the ability to take the entire fund as cash won’t be available until April 2015, the ‘triviality’ limit has been raised from £2,000 to £10,000 with effect from 27th March 2014. This means that any fund value of up to £10,000 can be taken as cash, as the pension annuity that could be purchased with it is deemed to be trivial. If the member can show that the entire value of their pension savings is below £30,000, they can take this as cash under the new provisions.
No advice has been given on the guidance that must be given to members at retirement. This is an area on which trustees must keep a watching brief; as they may be responsible for ensuring that it is available. Further details are expected from the Government.
What about the trustees of DB schemes? Should they alert their members to the possibility of taking benefits as cash, provided that they transfer to a DC scheme before the shutters are brought down? There is a danger that this information, coming from the trustees, could be seen as an endorsement of the action, and lead to some members feeling that they will lose out if they don’t act.
Pensions are confusing enough without introducing potentially panic-inducing deadlines. Any communication issued by the trustees on this topic must tread a fine line. To not raise members’ awareness may be to deny the possibility to someone for whom this would be an ideal response to their own particular circumstances. Members should be made aware, however, of the risks involved in transferring away from a DB scheme.
While the pension benefits remain in the scheme, the risk that the fund will not be sufficient to pay the promised pension benefit at retirement age falls on the sponsoring employer. If the benefits are transferred to a DC scheme, the impact of uncertain investment returns, inflation, interest rates and mortality fall entirely on the shoulders of the member.
For sponsoring employers of course, encouraging members to take on these risks could be appealing. They may want to use this development as an opportunity to reduce the liabilities of the scheme and, thereby, the associated costs and volatility. In view of the short consultation period, there may not be time to put in place an initiative to remind members of their right to seek a transfer.
Whatever the reaction of the employer or the members, the trustees will have to have their wits about them. It is not the role of the trustee to seek to encourage members to take action without fully understanding the risks that they may be taking on. Equally, the trustees should not put up barriers to prevent members from taking control of their own destiny. A deep understanding of the issues is helpful in this changing environment, and a good independent trustee can be invaluable.
This brave new world of pensions unlocking could help to encourage people to save more. Based on the current average value of the DC pots, however, members will be more likely to blowing it on a Lada rather than a Lambo.
Nick is a director of 2020 Trustees and is responsible for the continuing compliance of the pension schemes for which 2020 Trustees is trustee; establishing systems and procedures to ensure that these schemes are governed effectively and efficiently. He also represents 2020 Trustees on numerous trustee boards, usually as chairman. Nick strives to ensure that each scheme has a coherent plan, formulated with due consideration of the strength and strategic aims of the sponsoring employer. Nick has worked with The Pensions Regulator in connection with the highly praised on-line training facility, the Trustee Toolkit, and been involved in industry initiatives to raise the standard of pension scheme governance.