Defined contribution pension schemes: freedom, choice and flexibility

Defined contribution pension schemes: freedom, choice and flexibility

Published:

Author: Suzanne Burrell

Applies to: UK wide

In the 2014 Budget it was announced that members with defined contribution pension savings would no longer be required to buy an annuity on retirement.

A range of flexible options will from 6 April 2015 be available, including the ability to take entire pension savings as a lump sum. This is an unprecedented change in UK pension provision and potentially more far-reaching than the tax-simplification introduced in 2006.

The Taxation of Pensions Act 2014 comes into force on 6 April 2015 and implements defined contribution flexibility so that an individual's defined contributions pension savings can be accessed in one of the following ways:

  • buying a lifetime annuity
  • a scheme pension (if available from the pension scheme)
  • draw-down or short term annuity (known as flexi access drawdown)
  • withdrawing the fund in one or more cash lump sums (known as uncrystallised funds pensions lump sums)

An individual will be able to access their defined contribution pension savings at normal minimum pension age or on ill health. Normal minimum pension age is currently 55 years but this will increase to 57 years in 2028. The government will keep this under review as state pension age is reviewed.

Currently a member is entitled to take a pension commencement lump sum to the value of 25% of their pension savings. The pension commencement lump sum will continue to be available as an option where a member takes either a lifetime annuity, a scheme pension or a drawdown pension or short term annuity. For an uncrystallised funds lump sum payment, the treatment is slightly different. 25% of an uncrystallised lump sum payment will be tax free and tax payable on the rest set at the individual's marginal tax rate.

For individuals who access their money purchase benefits, a special annual allowance of £10,000 will be introduced in relation to any further money purchase benefit saving that a member enjoys. Individuals should take care to consider the tax implications of payment of an uncrystallised lump sum as there is the potential to find themselves paying a higher rate of tax.

For defined contribution pension schemes, the new flexibilities will have significant interest for members. Trustees and employers should be checking whether the scheme rules allow for any benefits other than an annuity and pension commencement lump sum. Historically, some schemes have allowed for a scheme pension but this is more unusual now that such schemes would be subject to scheme funding requirements.

Additionally, the new DC flexibility will be of interest to hybrid schemes where benefits are provided on both a defined benefit and defined contribution basis. The exact impact will depend on how the scheme is structured, as the legislation refers to the concept of a defined contribution 'arrangement'.

Additionally, in a hybrid scheme, there may be underpins which apply. Some hybrid schemes provide a defined contribution benefit on earnings in excess of a certain amount. Again, the options available may depend on what the rules say happens at retirement. The legislation refers to defined contribution arrangements, so rules should be checked, and amended where necessary to enable defined contribution arrangements to be identified.

Trustees of pension schemes set up on a defined benefit basis may be thinking that the new flexibility is not relevant for their scheme. However, where AVCs are provided on a money purchase basis then members will potentially have access to the new DC flexibility. In many cases, AVCs are applied in settlement of the member's lump sum but in some situations, the new flexibility may be attractive for members who have AVC funds which exceed the 25% limit for tax free cash but for whom an annuity is less attractive.

The legislation includes an overriding power to pay flexible benefits even if scheme rules have not been amended. This will be useful in the short term as schemes and employers may not yet have decided exactly what they want to offer and how they want to offer it. The overriding power is permissive not compulsory, so if the trustees chose not to offer the full flexibility, then the legislation does not require them to. Additionally a statutory power of amendment will be introduced so that trustees can make changes to their rules using that statutory power.

There is a possibility that a future government may look at extending the flexibilities to defined benefit pensions. In the meantime, members in such schemes may start looking at transfers out of the scheme in order to take advantage of the new flexibility.

Defined contribution guidance

As part of the introduction of the new defined contribution flexibilities, the promised guidance guarantee will be introduced. This will enable anyone with defined contribution benefits, free and impartial guidance on the range of options available at retirement.

The government response to the consultation confirms that individuals with money purchase additional voluntary contributions will be able to access the flexibilities. This means that trustees of defined benefit schemes will need to signpost any members with additional voluntary contributions to guidance providers. In practice, the options available for members with AVCs will depend on scheme rules.

Guidance will be available online via a new website Pensionswise, in person from the Citizens' Advice Bureau or by telephone from the Pensions Advisory Service. Actual options available will depend on what is available under the scheme rules in question. It is not known how far specific scheme provisions will be taken into account in the guidance provided.

The FCA has announced that pension providers will be required to ask individuals applying for flexible access to DC benefits about key aspects of circumstances relating to the choice the individual is making and give appropriate risk warnings. The DWP is looking at ways of extending the FCA requirement to trust-based schemes.

Disclaimer

This document is for informational purposes only and does not constitute legal advice. It is recommended that specific professional advice is sought before acting on any of the information given.

About the author

contact photo

Suzanne Burrell

Partner

03700 86 8902

Suzanne is an experienced pensions lawyer advising both trustees and employers. Her experience encompasses all pensions issues including: auto-enrolment, pension scheme mergers and bulk transfers, pensions regulatory change, contingent assets for pension schemes and pensions funding. She has particular experience advising both charities and co-operative sector clients.

Share this page