Pensions briefing - Six things you should know about pensions flexibilities from April 2015

Most scheme members are aware that it is possible to take their scheme benefits as cash following the Chancellor’s “freedom and choice” reforms which were implemented mainly under the Pension Schemes Act 2015. This briefing sets out the reforms in terms of the questions a member may ask – the concept is relatively straightforward, but there is obviously a great deal more detail which we cannot include here. Words in italics are defined at the end of the briefing.

An active or deferred member who is aged 55¹ or over may generally take scheme benefits as cash. For members who want to take defined benefits as cash, or whose scheme rules do not allow defined contribution accounts to be taken as cash, it can be a complicated process. Members should also be aware of any income tax payable (see 5 below).

A member may take defined contribution benefits as cash, if scheme rules allow. Most schemes will not allow members to take their defined benefits as cash, although part of them can (as before) be taken as a tax free pension commencement lump sum, or a scheme may allow (or require) a member who has trivial benefits to take them as cash.

It is also possible to drawdown cash from a defined contribution account as and when the member needs it, if scheme rules allow, although many schemes have chosen not to offer this particular flexibility (see below).

An active or deferred member generally has a right (or may be permitted by scheme rules) to transfer a defined contribution account to another scheme which allows benefits to be taken as cash either as an UFPLS or by drawdown. If a member wishes to take defined benefits as cash he will normally have to transfer them to another scheme which does allow them to be taken as cash.

There is a difference between what rights a member has under legislation, and wider options which a scheme may allow. Legislation only allows a member to transfer all his defined benefits and/or all his defined contribution benefits. If for example, a member wished to transfer his defined contribution account but leave his AVCs in the scheme, this is not a right under legislation, but may be allowed by scheme rules. If a member has defined benefits, he only has a right under legislation to transfer them out up to 12 months before his normal retirement date. Scheme rules however may allow an option or discretion to transfer at any time. If the member still has a right to accrue either defined benefits or defined contributions, then he does not have a right under legislation to transfer those benefits, but scheme rules may allow this.

Even if a scheme’s rules have not been changed to offer the new flexible options, a member can always ask the trustees to allow him to take cash. Many trustees did not feel they had sufficient time to implement processes and procedures before April 2015, but now that some time has passed, and if they receive sufficient pressure from members, they may change their policy. The legislation allows trustees to implement the new flexibilities even if their rules have not yet been changed to allow all the options. The new transfer out provisions also override more restrictive scheme rules.

A member who is taking defined contribution benefits must be advised shortly before retirement by scheme trustees to contact the Pension Wise service, for impartial information and advice. Pension Wise is a free service established by the Government, funded by the financial services industry. A member who is transferring defined benefits worth more than £30,000 to another scheme, intending to convert them to cash, must have taken appropriate independent financial advice before the scheme trustees are allowed to make the transfer, and the trustees must check that advice has been received. Appropriate independent financial advice has to be paid for by the member. His employer is not allowed to contribute directly to the cost, as this would be considered an encouragement to the member to transfer out.

Most schemes can make an administration charge in order to process paying a defined contribution account as a cash sum (either an UFPLS or drawdown). If a member has to transfer to another scheme before receiving cash, there may also be further administration charges. A member should ensure before transferring, and before taking cash, that he knows what the charges will be. A transferring member should choose a provider whose charges will fit his withdrawal pattern. Insurance companies and other providers may have very different charging structures.

In addition, the cash sum for a member who has defined benefits will be calculated by the paying scheme to be equivalent to the value of those benefits. This cash sum may or may not equal what a member would have received as a pension, depending on how long the member lives, what increases are payable, and how the cash sum could be invested.

If cash is taken as an UFPLS from a defined contribution scheme, 25 per cent will be tax free, and the balance is taxed at the member’s marginal rate. Currently HMRC is applying an emergency code to one off UFPLS cash payments from pension schemes, so the member will have to arrange any tax rebate with HMRC separately.

If the member is drawing down cash from the scheme, that cash can be used to pay a pension commencement lump sum, so effectively 25 per cent of each cash sum drawn down is tax-free, and the balance drawn down is taxed at the member’s marginal rate.

Trivial benefits are taxed in the same way, that is 25 per cent tax free, and the balance taxed at the member’s marginal rate.

No. If a pension has started, either from the scheme or from an insurance company annuity, then it cannot currently be converted to cash, or transferred to a scheme which pays cash. However, the Government has not ruled out creating a secondary annuity market in future, which would allow a member who has already purchased an annuity to sell in on to a third party for a cash sum. If a member has only taken a pension commencement lump sum, he can still transfer out the balance of benefits whether they are defined benefit or defined contribution. A defined benefit transfer will require appropriate independent financial advice as explained above.