DB schemes: three ways to benefit from DC flexibility
The impact of the new pension flexibilities on members of defined contribution (DC) schemes is being much scrutinised.
Government is now publishing statistics on Pension Wise usage, and the Financial Conduct Authority is releasing quarterly bulletins on the number of members cashing in their pots. Now, new research from Barnett Waddingham shows how defined benefit (DB) schemes are reacting.
Additional Voluntary Contributions (AVCs) are usually provided on a DC basis. As such they fall within the remit of the new pension flexibility rules and there are new options available to members – if the scheme permits.
Our research reveals that 73% of members in the schemes surveyed can now take their AVC pot as a single cash sum. In many cases, it may make sense for a DB member to fund their tax-free cash entitlement from a DC pot rather than giving up part of their DB pension. However, only 18% have made changes to an existing lifestyling strategy to reflect that AVC pots are no longer likely to be used to purchase annuities.
Schemes often routinely offer commutation of small pensions to eligible members at retirement. The limits have increased so that individuals with entire pension savings of less than £30,000 or savings within a single DB scheme of less than £10,000 may take their benefits as a lump sum. Only 21% of schemes had not amended their rules to permit the new higher limits.
It is also possible to offer commutation of small pensions in payment. However, schemes and employers should note that a bulk exercise should be considered in light of the industry-wide Code of Practice on incentive exercises. A review of the Code is under way and we expect the revised version will clarify the circumstances in which the Code applies.
Our research shows that around one third of schemes have seen an increase in requests for transfer value quotations since the flexibilities were introduced in April 2015. However, this did not translate into an increase in transfer value payments.
The transfer value option can be attractive to both members wishing to access the flexibilities, and to trustees and employers wishing to de-risk their scheme.
Some schemes have taken action to help facilitate transfers for members who wish to do so:
- Where a scheme’s rules did not already permit transfers within a year of retirement age, around one third of respondents had amended their scheme rules to allow this
- 26% of schemes provide a transfer value quotation within a member’s retirement options
- 29% of schemes allow partial transfers
The advice requirement could be a limiting factor on the number of transfers going ahead. Of schemes that do offer transfer value quotations at retirement as standard, around one third of the schemes surveyed are currently therefore choosing to facilitate free access to an independent financial adviser when a member requests it.
Transfer value basis
One area where employers and trustees might like to focus more attention is the transfer value basis. Members who are likely to transfer may be in different circumstances to the average member – they may have health problems, leading to a shorter life expectancy, or they may have no dependants. Schemes will want to make sure they are paying a fair transfer value. However, less than 30% of the schemes surveyed have amended their transfer value basis since April 2015.
Impact of the new flexibilities?
Attendees at our 2015 Employer Pensions and Benefits Conference overwhelmingly (97%) voted that they would be exploring transfer value options from DB schemes in light of the new flexibilities. We are expecting partial transfers to become more popular, as they offer members the opportunity to use part of their DB benefit to take advantage of the flexibilities, whilst keeping a certain level of ‘guaranteed’ income. However, as yet, very few schemes have promoted this as an option.
Employers and trustees should properly consider the impact of the flexibilities on their DB scheme. This can help employers to formulate a benefits strategy which not only fits with its business objectives, but will provide favourable outcomes for employees and pension scheme trustees.
