An interesting budget for sponsors of defined benefit pension schemes

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Yesterday’s budget included a number of measures to improve the flexibility of defined contribution (DC) pensions, which will have important consequences for defined benefit (DB) arrangements. The consequences are not all good, but do present opportunities overall.

The government has announced that it will introduce legislation effective from April 2015 to allow members of DC schemes to draw from their pension funds without any limits, subject to their marginal rate of income tax. This is akin to “income drawdown” which already exists, but without the restrictions that currently prevent it from being widely accessible. In the meantime, the Government will reduce one of the barriers to entering the current form of these arrangements, by changing the “Minimum Income Requirement” (secure income from other sources) from £20,000 to £12,000 (with effect from 27 March 2014).

This has three main consequences for DB schemes:

  1. Employers wishing to close a DB scheme to accrual and offer a DC scheme instead will have an easier sell to their employees with this new DC flexibility.
  2. Some members will want to transfer their existing DB benefits to DC in order to access the flexibility. The government is consulting on whether to ban such transfers (further details below), possibly with some form of retrospective effect back to 19 March 2014. This puts employers wishing to consider any sort of transfer exercise in a difficult position.
  3. Where an option is already available at retirement to transfer to an immediate annuity, or a bulk exercise for over-age-55s is under consideration, the reduced appeal of annuities relative to the new flexibility has clear implications for the advice given to members and the likely take-up rate.

The government recognises that the new DC flexibility will encourage transfers out of DB schemes and so is consulting on whether it might be necessary to remove the option to transfer from DB to DC. The stated reasoning behind this is not member protection, though, but to ensure that investment by DB schemes in infrastructure and other areas supporting long term economic growth is not threatened. However, the Government is exploring other options including allowing the transfers subject to trustee consent or allowing the transfers but not allowing the new drawdown provisions to apply to transferred funds.

The government will introduce a duty from April 2015 on pension providers and trust based pension schemes to offer DC members free and impartial face-to-face guidance on their choices at the point of retirement. We await further detail on this especially on how the duty will be funded.

The government is also relaxing some of the small lump sum payment rules. Most notably, the trivial commutation limit will be increased from £18,000 to £30,000 and the requirement to be over age 60 will be removed. This greatly increases the scope for employers to remove small liabilities from their schemes. The maximum "small lump sum" that can be paid to extinguish a pension entitlment will also be increased from £2,000 to £10,000 and the number of small lump sums that an individual will be allowed to receive in their lifetime will be increased from two to three.

Another proposed change impacts DB schemes more directly, albeit not for some time. The Government proposes to increase the minimum pension age from 55 to 57 with effect from 2028. It will then rise in line with the State Pension Age (SPA) so that it is always 10 years below SPA. The Government is also asking respondents whether they should legislate to increase the minimum pension age further, for example so that it is five years below SPA.

The government is consulting on the changes in its document 'Freedom and choice in pensions', and has produced a short explanatory leaflet 'Budget 2014: greater choice in pensions explained' summarising the proposals that are intended to come into effect from April 2015.

The treatment of hybrid schemes and additional voluntary contributions (AVCs) within DB schemes is not yet clear and this will be considered as part of the government’s consultation.