Pension Schemes Bill

Lord Beecham Excerpts

Tuesday 16th December 2014 Lords Chamber

[Lord Bourne of Aberystwyth]

I am sure that we all wish him a very happy and well earned retirement, and look forward to hearing his speech today.

I turn to the Bills before us today. Together, these Bills introduce the latest radical reform of pensions. These ground-breaking pension changes were the centrepiece of the Queen’s Speech, and are about encouraging new forms of pension saving, such as shared-risk schemes and the provision of collective benefits to give greater security in retirement, and giving people freedom and choice in how and when they access their pension savings. The time is right to make these changes to private pensions legislation. The new state pension will provide a simplified foundation for those in retirement, making it easier for people to know what pension they will receive from the state. It will provide a platform on which individuals can build their own private pension savings according to their wants and needs in retirement.

The excellent early results of automatic enrolment mean that millions more savers have joined workplace pension schemes. This Government have also taken forward other changes so that the future private pension landscape delivers high-quality, value-for-money pensions for members. For example, regulations are being brought forward so that, subject to parliamentary approval, from April 2015 there will be a charge cap in the default funds of qualifying schemes—schemes used for automatic enrolment—and new requirements for independent governance committees and trustees to report on costs and charges.

The market is therefore growing, and employers and the pension industry are already thinking about future pension provision. These Bills further encourage a flourishing private pensions market that provides greater choice for business on the pensions offered and for individuals on how they access their pension savings. Taking no further action is simply not an option. Despite government action, the Department for Work and Pensions estimates that there are 11.9 million people below state pension age who are not saving enough to provide adequately for their retirement.

I turn to the Taxation of Pensions Bill. My noble friend Lord Newby is the pilot of this legislative craft, but let me say a few words by way of introduction. The Taxation of Pensions Bill contains measures to make the tax system fairer by ensuring people have more choice about how they access their savings, to prevent this new flexibility being exploited by individuals to gain unintended tax advantages and to ensure the taxation of pension savings on death remains fair and appropriate under the new system. The Bill will mean that, from April 2015, individuals from the age of 55 will be able to access their money purchase pension savings flexibly if they wish, subject to their marginal rate of income tax, rather than the current 55% tax charge. In addition to the Government’s consultation after the Budget, we also published draft legislation for technical consultation in August.

I will talk about these changes in a little more detail, starting with measures to ensure people have more choice about how to access their savings. This Bill is about ensuring that people have greater choice at the point of retirement. The current system restricts choice at the point of retirement. Those with the smallest and largest amounts of pension savings have flexibility, but those with a moderate amount of savings have very limited options. The measures in this Bill will change that by extending this flexibility, such that it applies regardless of the size of the pension pot, thereby ending the effective compulsion to annuitise.

The Bill also introduces a new method to allow people to access their pension flexibly. The “uncrystallised funds pension lump sum”, or UFPLS—the clumsiest acronym I have ever seen in my life—is a new option. This will give individuals the flexibility to take one or more lump sums from their pension fund, with 25% of each payment tax free and 75% taxed at their marginal rate, without having to enter into draw-down or take all of their tax-free lump sum in one go. The Bill also increases choice by introducing changes to encourage innovation in the retirement income market, allowing providers scope to make annuities much more flexible products in line with consumer needs.

[Lord Beecham (Lab)]

I am grateful to the noble Lord for giving way. Could he tell us how much and for how long the Treasury will gain from the changes in the Taxation of Pensions Bill as people draw down or take their pensions early?

[Lord Bourne of Aberystwyth]

The noble Lord is right if he is inferring that there is a tax saving. Estimates have been made, but of course we cannot be certain of them. I have the estimates and I will ensure that I send them to the noble Lord—I do not have them to hand —but suffice it to say that this is not the thrust of the legislation. I think we will see that it is perfect in terms of providing what pensioners want, it gives a boost to the pensions industry and it probably saves the Exchequer money, although these are only estimates. However, that is not the main intention. As I say, it is to give consumers and members, after consultation, a very fair deal.

The Bill also contains measures to ensure that the new system cannot be exploited by individuals to achieve unintended tax advantages. If the Government were to put in place no protections, an individual over the age of 55 could divert their salary each year into their pension, take it out immediately and receive 25% of it tax free, thus avoiding income tax and national insurance contributions on their employment income. This is not the intention of the reforms. However, in the context of automatic enrolment, it is also important that any solution preserves the incentive for those aged over 55 to save after accessing their pension flexibly.

As a result of extensive consultation, the Government decided that introducing a £10,000 money purchase annual allowance for those who have accessed their pension flexibly strikes the right balance. On the one hand it allows people the flexibility to withdraw or contribute to their pension as they choose from the age of 55, while on the other it ensures that individuals do not use the new flexibilities, which are intended to provide people with greater access to their retirement savings, to avoid paying tax on their current earnings. It will also avoid unnecessary complexity for both consumers and pension providers when the new system comes into places in April 2015. As stated in the Government’s response to the consultation, we will be closely monitoring behaviour under the new system and will work closely with industry to ensure that it remains fair and proportionate.

I turn now to the changes made by this Bill to the taxation of pensions at death. As set out in the original consultation document which the Government published alongside the Budget, it is likely that the 55% tax charge which currently applies to pensions on death would apply to more people under the new system. If it were retained, it could provide an incentive for individuals to remove their savings from their pension in order to avoid the 55% tax charge. Consequently, the Government have amended the Bill to ensure that taxation of pensions at death remains fair and appropriate under the new system. The changes to the Bill will allow individuals who die with pension funds remaining to pass them on to anyone they choose. These funds can be paid tax free if the individual dies before the age of 75. If the individual dies having reached the age of 75 and the funds are paid out as a pension, they will be taxed at the beneficiary’s marginal rate, or at 45% if they are paid out as a lump sum. The aim of these changes is to ensure that individuals who have made sacrifices to save over the course of their lives can pass on their pension savings without worrying about those funds bearing excessive tax charges when they die. They will also preserve the incentive for individuals to keep money in their pension without fear of their beneficiaries being hit by a 55% tax charge.

Additionally, the Chancellor announced in the Autumn Statement that these changes will extend to annuities. Death benefit payments from joint life and guaranteed-term annuities will also be tax free when the policyholder dies under the age of 75, and such death benefits will be able to be paid to any beneficiary. This will also apply when an individual uses uncrystallised or draw-down funds to buy a dependant’s annuity. These changes will be legislated for in due course, although not through this Bill. The Taxation of Pensions Bill will therefore increase choice for the 320,000 people retiring each year.

The Taxation of Pensions Bill deals with the tax changes and the Pension Schemes Bill, which I will turn to shortly, deals with changes to enable the flexibilities to work as the Government intend. There are differences in the definitions of money purchase benefit in tax legislation and in pensions legislation which we have had to address. Tax legislation provides a definition of money purchase which in essence covers all forms of accrual that result in a cash amount. The pensions legislation definition is narrower, as it focuses only on those forms of benefit in which a deficit cannot arise. This is to ensure that the correct funding and member protection regime applies. In order to ensure that the provisions of both Bills work correctly together, the Pension Schemes Bill contains a new definition of “flexible benefit” which fits within the pensions legislation context and captures the forms of benefit to which the tax flexibilities apply. We also define the term “safeguarded benefits”, which are, in the main, forms of benefit to which the flexibilities do not apply but to which other provisions do. I will explain the context in which the term is used shortly.

I turn now to the Pension Schemes Bill. This Bill will make the changes required to pension legislation as a result of the freedom and choice created by the Taxation of Pensions Bill. This will include a legislative framework for a guidance service providing individuals who benefit from the new pension flexibilities with access to free, impartial guidance so that they are clear on the range of options available to them at retirement. The Bill places a duty on the FCA to ensure that the providers it regulates make people aware of their right to guidance and signpost them to this service, and the Department for Work and Pensions will ensure that the equivalent duty is placed on pension schemes regulated by the Pensions Regulator.

It is important to note that there is a fundamental distinction between advice and guidance. Providing advice on investments, including pensions, is an activity regulated by the FCA. A financial adviser will usually make a full assessment of a consumer’s circumstances and make a specific recommendation, and may sometimes sell a product, based on what is most suitable for that person. The guidance service will not aim to replicate this. Instead, it will provide tailored information to consumers regarding the options available to them but, unlike financial advice, it will not recommend specific products or providers. The guidance is designed as a first step for consumers, to support their decision-making and to empower them to make their own choices. Having had the guidance, it is expected that many people may wish to go on to seek financial advice to help them with their decision, and the guidance will help them to access the service they need.

The Government will continue to allow members of private sector schemes offering safeguarded benefits—that is, benefits other than money purchase or cash balance benefits—the freedom to transfer to other types of scheme. However, in the vast majority of cases where a member has safeguarded benefits, it will continue to be in the best interests of the individual to remain in their scheme. Therefore, two additional safeguards will be introduced to protect individuals and schemes. First, there will be a new requirement for individuals transferring safeguarded benefits out of a scheme to take advice from a financial adviser before a transfer can be accepted. Secondly, there will be new guidance for trustees of schemes on using their existing powers to delay transfer payments and taking account of scheme funding levels when deciding transfer values.

We will also ensure that the taxpayer and Exchequer are protected. First, transfers will not, other than in very limited circumstances, be allowed from unfunded public service defined benefit schemes into schemes from which flexible benefits can be obtained. Secondly, for funded public service schemes, Ministers will have a power to reduce cash equivalent transfer values in circumstances where there is a risk to the taxpayer.

The Pension Schemes Bill also makes other changes to the transfer requirements allowing individuals to access pension savings. We will do this by extending the current transfer rights for those with flexible benefits up to and beyond their schemes’ normal retirement age, and applying statutory transfer rights at benefit category—rather than scheme—level.

We will also make three technical changes to existing pensions legislation. The first will allow pension schemes to offer the new flexibilities to their members and will ensure that these flexibilities operate as intended in relation to those with cash balance benefits. The second will allow members to take one or more lump sums from their money purchase funds after the minimum age is reached. The third will prevent the conversion or replacement of non-money purchase benefits with money purchase benefits when a scheme winds up or during a Pension Protection Fund assessment period.

As the flexibilities will come into force on 6 April next year, we are making the relevant regulatory changes that are necessary to deliver these significant reforms by that date. The Department for Work and Pensions and the Treasury are co-ordinating a structured engagement with the industry on the drafting of regulations to ensure that final decisions are informed by stakeholder views.

With these changes, the Taxation of Pensions Bill and the Pension Schemes Bill together give the individual greater choice and flexibility in how they access their pension savings. The Pension Schemes Bill also introduces legislation to enable greater risk sharing between the employer and the saver—and, indeed, third parties—and risk pooling between savers, thus encouraging greater innovation in the private pensions market.

I now turn to the measures that grant pension providers greater flexibility in the sort of pension schemes they offer. The Queen’s Speech announced a radical reshaping of pensions legislation to ensure that it remains relevant for future generations. The Pension Schemes Bill reflects, recognises and encourages innovation in response to demand. It does this by creating a clear space for shared risk or defined ambition—as they are sometimes called—pensions and enables the provision of collective benefits in the United Kingdom. Those are two quite separate concepts.

With increased participation in saving, the Government are keen to support greater innovation in the products offered to savers, based on employer and member demand. Consumer trust in the pensions industry is relatively low, and although we can protect beneficiaries against risks of high charges or poor governance, our research shows us time and again that many individuals want more stability and more certainty. They want to know something about what their savings will give them and some protection from the worst of the vagaries of the market.

Many employers have found the increasing costs of longevity—welcome though it is—and investment risk too heavy to bear in traditional final salary defined benefits schemes, but if defined contribution schemes are the only alternative, outcomes for members and savers will be less certain and more volatile than for earlier generations, making it much harder for future generations of savers to plan for later life.

Although some forms of risk sharing can already happen, the current legislation is based on a binary structure, leading to a tendency for schemes to polarise into schemes in which either the member or the employer is bearing all the risks. While both of those types of pension can be the right product for many, we do not think it is right that the only future for pensions that our legislation explicitly recognises or encourages is either where the individual member or the employer takes on the full financial risk of such long-term savings.

Therefore, the Pension Schemes Bill introduces three categories of pension scheme and enables a new type of collective benefit along with requirements to ensure that there is appropriate regulation in relation to such benefits. The scheme categories are based on the type of promise that the scheme provides to savers during the saving phase about the benefits that will be available to them at retirement. The Bill includes new definitions of defined benefits, where the member receives a full benefit and the employer takes the risk, defined contributions, where the member takes the risk, and shared risk, or defined ambition, the third category of pension scheme.

The shared risk, or defined ambition, definition describes a middle ground between the defined benefits and defined contributions definitions. It creates a distinctive space to encourage innovation in pension design that provides for more certainty for individuals than defined contributions schemes, in which there is no promise during the savings phase, by sharing risks between employers, employees and third parties.

The new scheme categories will apply to existing occupational and personal pension schemes. They do not make any additional requirements about benefit design and do not change any current legislative requirements, such as occupational scheme funding or member protections.

The definitions work at scheme level, rather than the benefit level, so the wider legislative requirements that apply to certain benefit types still apply, regardless of the scheme category. That includes, for example the new Budget flexibilities, and the collective benefit requirements, to which I shall come shortly. The definitions are formulated very specifically and, along with the regulation-making powers, they ensure that current and new scheme designs will fall into the correct categories to reflect the member experience of certainty during the savings period.

The Bill also provides for a new definition of collective benefits. These are different from shared risk schemes, although shared risk schemes may include collective benefits. The collective benefit definition enables a new form of risk pooling among scheme members that can provide greater stability in outcome for members—partly by virtue of scale. Collective pension schemes are a key part of some other countries’ pension systems—for example, the Netherlands and some of the provinces of Canada—and they are recognised internationally as being of high quality. As we aspire to develop a pension system that is rated among the world’s best—we hope the best—it is only right that the United Kingdom should also have pension schemes offering these types of benefits. We also have the advantage of providing protections at the outset which address issues that have arisen in relation to these types of schemes overseas. The regulation-making powers are key to the success of collectives, ensuring appropriate safeguards can be applied and developed in discussion with industry, employers, and members’ representatives. The Bill enables collective benefits to be part of a defined contributions scheme or a shared risk scheme. The intent is that members of schemes offering collective benefits would be able to access their collective benefits flexibly, either directly or by transferring to a money purchase scheme.

The Bill makes changes to existing legislation in order to reflect the new scheme categories and collective benefits. It also provides for additional governance protections for these new types of pensions, reflecting the new types of decisions that are being made on behalf of members. We also intend to use regulation-making powers in other legislation in respect of governance and disclosure as appropriate. We have engaged extensively with stakeholders across the pensions industry and found there is appetite for legislation that allows for greater risk sharing and risk pooling. There are employers that would welcome the greater flexibility to create pension schemes that suit the needs of their workforce. Pension providers want the flexibility to design and offer pensions that provide greater certainty and more options for sharing risk, and individuals value greater certainty than that provided by defined contributions pension schemes and the greater stability that collective benefits may provide. All these are considerable advantages.

I turn to the other changes to private pensions legislation made by the Pension Schemes Bill. These are relatively minor in terms of the main thrust of the legislation. The Bill contains two clauses from the Ministry of Justice concerning judicial pensions. One corrects the Judicial Pensions and Retirement Act 1993, regarding the funding of pensions shared on divorce, to ensure that the Act works for cases where pension sharing is activated after a person has left judicial office. The second allows a pension scheme to be established for fee-paid judges, as required by relatively recent case law. It is aimed at old and transitional cases. Pensions for fee-paid judges will in the future be governed by a new scheme under the recent public service pensions legislation.

In addition, the Bill contains a minor and technical measure on the Remploy pension scheme. The legislation will allow the Department for Work and Pensions to fund the Remploy pension scheme directly rather than via the company, should this be required in the future.

Furthermore, the Bill contains an amendment to extend a regulation-making power in the Pension Schemes Act, relating to survivors’ benefits in the case of certain gender-change cases, to Scotland. Finally, the Pension Schemes Bill contains a provision the effect of which will be to permit schemes to increase the maximum age at which a pension credit, following a pension share on divorce, must be put into payment if the highest normal pension age for benefits payable under the scheme is higher than 65.

These are very radical reforms that build on this Government’s previous changes to improve pensions in the United Kingdom. Giving people greater choice is at the heart of these reforms—greater choice for business on the pensions they offer and greater choice for individuals on how they can access their pension savings. These are important changes to allow the private pensions market to flourish too. I commend these Bills to the House. I beg to move.