Pension reform in the UK is set to give retirees and their employers more flexibility than ever before. But as options increase, so does complexity, and employers face some tough decisions in the months ahead. By Antony Ireland
The Freedom and Choice initiative unveiled in George Osborne’s 2014 Budget is one of the most significant changes ever made to how UK pensions operate.
Until now, retirees could access up to 25 per cent of their pension savings as cash upon retirement, but most had to then take out an annuity (guaranteed payments paid by an insurer) for the rest of their life. But the government proposes that, from 6 April 2015, people will be able to dip in and out of their defined contribution pension savings as they wish during retirement, subject to their marginal tax rate.
The new rules also provide a ‘guidance guarantee’ that every individual with a defined contribution pension will be offered free and impartial face-to-face guidance on their financial choices when they retire.
These changes drastically increase the flexibility pension-holders have with their savings at a time when poor annuity rates have put the value of pensions under scrutiny.
Some interim changes have been in place since 27 March. “At the moment the main alternative to buying an annuity at retirement is to draw down on the pension fund, and there has already been a relaxation of regulations around the amounts that can be withdrawn and some of the criteria around the flexibility of income drawdown options,” explains John Wilson, Head of Technical Services at JLT Employee Benefits, who admits hat the reforms came as a complete surprise to everyone in the pension industry.
One significant reform already in place is the increased minimum value of a pension pot that the policyholder can access as a lump sum. Individuals aged 60 and above can now access pots worth up to £10,000 as lump sums (up from £2,000), or access multiple pension pots with an aggregate value up to £30,000 (up from £18,000). “This is quite an important change that we are already seeing being utilised at both an individual level and also by some employers doing trivial commutation exercises to take small pension pots out of their schemes,” says Wilson, noting that releasing these lump sums can reduce both the administration cost and liabilities of defined benefit schemes for the employer.
These budget reforms are the latest in a raft of improvements being made in the pension industry. In addition to the Freedom and Choice reform, a charge cap of 0.75 per cent is also coming into effect on auto-enrolment schemes, while certain charging structures – such as active member discounts that increase the cost of pensions once the saver leaves employment – are being banned.
With numerous reforms underway and on the horizon, Wilson says it will be “challenging to hit the ground running” come implementation of Freedom and Choice next year. “Although we know the fundamental reforms and what the principles and objectives are, there is a lot of uncertainty,” he says. “There are still plenty of questions around how this will operate in practice, as well as what will be included in the guidance guarantee.”
Employers have a lot of work to do in a very short period of time to ensure both compliance and optimisation of their schemes, says Martin Freeman, Director of JLT Employee Benefits. “If their arrangements fall foul of any of these new regulations, they are going to have to improve their schemes or find new ones,” he warns.
However, with challenge comes opportunity.
Even those who were comfortable where they were with their pension schemes now have many options to improve member outcomes. There are so many more opportunities now than before for a company’s pension scheme to support its business goals rather than simply being something it has to provide,” Freeman says. “In the coming months they need to start thinking these issues through and working out how they are going to address them.”
Greater flexibility brings complexity
Both individuals and their employers stand to benefit from pension reform if they can successfully align the transition with their goals. However, for employers, the changes to the way schemes are accessed and regulated could prove costly – both financially and strategically – without careful consideration. “With increased flexibility in the way employees can manage their pensions comes a big increase in complexity. Both individuals and companies have a lot of choices to make,” says Freeman.
Under the reforms many retirement-aged employees may choose, for example, to reduce the hours they work and tap into part of their pension to supplement their income, effectively easing themselves into retirement rather than abruptly ending their careers.
“One of the challenges this brings employers is the effect this may have on how they manage their workforce,” says Freeman. While this arrangement could benefit certain employers by helping them retain and transition knowledge within their organisations, others may see it as a nuisance as some older employees remain in their jobs longer than they are needed. “Employers need to weigh up the risk of having to employ staff longer than they want against the risk of losing knowledge they don’t want to lose. Answering these fundamental strategic questions is the starting point before deciding which scheme is most appropriate,” Freeman says.
Helping employees make the best financial decisions for themselves may prove mutually beneficial for employers, but ultimately employers must decide how much responsibility they feel towards their employees when they retire.
“While there is a guidance guarantee in place, it is unlikely that the guidance will go far enough in helping people to actually know what they have got to do. Guidance is likely to be generic information about the type of arrangements available to them that may leave some people more confused or with more questions than they started with,” Freeman says. “An employer could decide it would like to help its employees more than that, and give them access to advice tailored to their specific circumstances as part of an employee benefits package,” he explains. After all, giving retirees proper advice at retirement should allow them to leave earlier, meaning employers may be able to manage their workforce better.
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For further information, please contact Martin Freeman, Director, Employee Benefits on +44 (0)117 927 8428