By Lorraine Harper, Director and Head of Governance Services, JLT Employee Benefits
As a pension specialist, I welcome the right to choose how I take my pension pot; I can tailor my pension benefits to my needs.
However, for many laypeople, freedom represents complexity and difficult decisions that will have a major impact on well-being and even, potentially, life expectancy.
The freedoms, though focused on DC scheme members, and the relatively small number of individuals with cash balance benefits, will also affect DB member choices. Those already in DC or cash balance schemes, including DB members paying Additional Voluntary Contributions (AVCs) on a DC basis, build up a pot of cash that converts to benefits at retirement. Pension
Wise applies only to members in this category.
However, DB members can seek transfers to DC arrangements in order to access the new freedoms, although doing so would expose them to significant risks. The government has therefore determined that members in this category must prove that they have sought independent financial advice and administrators must capture such evidence before releasing transfer values worth £30,000 or more. Even if advice is not to transfer, members can still insist on a transfer.
DC pension rights
The new freedoms mean that members can:
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continue to take 25% of the total value of benefits tax-free and use the remainder to buy an annuity as before;
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draw down amounts in excess of the tax-free element and pay tax on these sums. The option to buy an annuity remains open until all the funds have been used up; or
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take the whole pot as cash and potentially take a big tax hit on the excess over 25%, in one go.
Let the member beware – there are many potential unintended consequences along the path to retirement and beyond: freedom may come at a price.
Practicalities
In general, third party administrators (TPAs) run entire schemes and don’t cater on an individual basis for members, whose choices can vary greatly under the new freedoms. For most TPAs, it will be necessary to levy higher charges and make material changes to systems and practices. The majority can offer standard draw-down facilities subject to certain maxima and minima in relation to amounts, frequencies and balances. Far fewer TPAs will offer flexi draw-down, thus driving sponsors and members to transfer pension values into other vehicles such as self-invested personal pension arrangements (SIPPs).
Member pitfalls
Whilst attracted to the opportunity to take a single lump sum, members could find themselves paying unnecessarily high tax or locking themselves into low market values.
There is potential to incur tax accidentally e.g. for overstepping the annual allowance of £10,000 which applies where members take benefits flexibly and continue to make pension contributions elsewhere. Caution should also be taken not to lose the valuable protections granted on personal Lifetime Allowances.
Ultimately, the biggest risk is that members will underestimate the need for future income and could set themselves up to become paupers in later life. Such was the experience in Australia where the government is now considering a return to compulsory annuitisation.
What can trustees and sponsors do?
Pension Wise offers one free conversation at retirement for DC members or access to online guidance but it is unlikely to be enough for most people. However, sponsors and trustees can do much to help members make good decisions.
A programme of guidance starting from say, age 50, supported by good communications and modelling facilities will promote active planning for retirement. Access to pension surgeries or a help-line staffed by pensions experts will help to give members a better understanding of various factors, such a longevity and investment risks, and an appreciation of potential consequences, which in turn should result in better decisions. Specialist help-line staff can also identify those who are struggling with complex decisions and may need directing to independent regulated advice.
Transfers from DB to DC
For some DB members, transferring benefits to a DC arrangement may be the right choice. However, for a great many more members, this is likely to be a poor option as they will be giving up valuable guarantees and ancillary benefits.
Members of DB schemes currently have the right to transfer all DC AVC values independently of DB pensions but, typically, they can take only all or none of the DB benefits as a transfer value. If trustees and sponsors were to offer partial DB transfers, it would introduce a half-way house so that members could at least preserve some guaranteed benefits whilst freeing up more cash benefits. There is much for trustees to consider in moving to partial transfers including:
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amending scheme rules;
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determining the parameters to be applied on the percentages that may be converted to a transfer value or left in the scheme;
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what to do about GMPs;
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changing administration contracts and services; and
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communicating the new options successfully.
“It is by choice and not by chances that we change our circumstances” (Nadia Sahari)
Let those of us who work in pensions ensure that people make the right choices, not chance.
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