Consulting Actuaries

A gift from No.11?

Royal London Consulting Actuaries

18 December 2014

In his 2014 Budget, the Chancellor gifted considerable flexibility to defined contribution (DC) pension pots from April 2015. This was re-confirmed in the Autumn Statement.

The gift: individuals will be able to use their DC pension pots however they want, even taking it all as cash; the first 25% of which will be tax-free. There will be no requirement to purchase an annuity.

Not unreasonably, defined benefit (DB) scheme members may be wondering if, or how, they can receive a similar gift. The answer is, yes they can, but only by first transferring to a DC arrangement. At the very least, DB members, trustees and employers need to be aware of how to access the new flexibilities.

However, is the Chancellor’s gift valuable or just an empty box?

A gift for the member?

“Great…..sales, here I come!”   “Nice……but I’ve already got one just like it.” 
“OK… how does it work?”

Flexibility/Cash in hand: For some DB members, the prospect of cash in hand by transferring to a DC arrangement will be attractive. It may even be in their best interests, for instance those in poor health. We envisage DB members falling into one of three categories:

  • Small amounts of benefits worth less than £30K – Triviality may already be an option to take the entire DB pension as cash. So what’s new?
  • Large DB pensions – Cash may not be attractive, but the flexibilities may be. The member may already be using the flexibilities via income drawdown for other pension arrangements. Again, what’s new?
  • Those in between – This is potentially the group where there is most uncertainty. Is flexible access to cash or a steady guaranteed DB pension more attractive?

More choice: The flexibilities introduce more choice. Will members need an instruction manual in order to understand how it all works? They will certainly need advice.

Members who wish to transfer to a DC arrangement to take advantage of the new flexibilities, must take financial advice when the transfer value is over £30k. Evidence of having taken advice will be required. Will members be prepared to pay for this financial advice?

A gift for the trustees?

“What is it? What do I need to do?”

Trustees are required to operate their scheme in the best interests of the members. So at the very least, trustees should make members aware of the options that exist under their DB scheme and signpost the new flexibilities. The trustees must be impartial in their dealings with members, with any communications being clear, unbiased and understandable. They also need to set up appropriate procedures to deal with requests.

This is yet another layer of administrative complexity and cost. Not what trustees may have been expecting from a gift!

A gift for the employer?

“Just what I wanted……, how do I open it?”

Opportunity to reduce risk: To access the flexibilities, a member will have to switch their benefits out of the DB scheme. This will remove future inflation, investment and mortality risk.

The amount offered to a DB member at retirement will probably be less than that held for prudent funding purposes. So if a member opts to transfer, there will be a reduction in pensions risk and probably an improvement in the funding position. This may also result in reduced ongoing contribution requirements for the employer.

Will employers be able to open this gift? The need for the member to take financial advice, and the possibility that the amount offered may be reduced to reflect underfunding, may prove too difficult. Unwrapping the gift may require cash from the employer. That said, employers may see this as a reasonable price to pay to reduce their pension liabilities.

If you have any questions on these issues please contact us.