Pensions freedoms – is choice a good thing?

Since April 2015 those with defined contribution pension savings have been able to access these in full once they turn 55. Buying an annuity or entering income drawdown upon retirement is no longer compulsory. This article considers the immediate aftermath of the changes and impact for the industry.

In January 2016 the Financial Conduct Authority (FCA) published Retirement Income Market Data from July to September 2015. Of the 180,000 pensions savings accessed during the period, nearly 121,000 were fully cashed out and just over 58,000 people used their pensions to take an income after receipt of the 25 per cent of savings which are tax free, suggesting that people are making use of the new freedoms.

But does the new freedom bring risk as well as opportunity?

Fraud

The new pension freedoms have played into the hands of fraudsters who continually find ever more creative ways to persuade the public to cash in their pension savings or invest in schemes which would (purportedly) increase their value.

These so-called “scam” schemes are set up seemingly as occupational pension schemes registered with HMRC. At first sight there may seem to be nothing unusual. However, the schemes charge exorbitant fees and make unauthorised payments, which result in the individual facing significant tax charges.

The prevalence of pension scams led the Pensions Regulator to embark on its “Scorpion” campaign, which alerts retirement savers and pension schemes to the risks of scams, and provides key signs to watch for. Examples include cold-calls, offering a free pension review, promised returns of over 8 per cent and a proposal to put all money into one investment.

Transfers

The Pensions Ombudsman reported that in 2015 around 19 per cent of the cases he dealt with related to pensions liberation. Many of the cases concerned whether a provider or scheme administrator could refuse a requested transfer to another scheme eg, where the provider had concerns about the legitimacy of the receiving scheme. The Ombudsman held that the answer rests on whether the member has a legal right to a transfer, which will depend upon whether the right is statutory (so certain statutory requirements are met) and the provisions of the scheme, ie, whether the scheme provisions give a discretion to refuse a transfer request. To avoid allegations of maladministration or breach of fiduciary duty, trustees, providers and scheme administrators need to ensure that they carefully consider any transfer requests and have regard to the determinations of the Pension Ombudsman and the recent High Court decision in Hughes v Royal London Personal Pension Scheme, which provides further clarity in this area.

IFAs

The requirement for IFAs to now be paid for the cost of advice given, rather than by commission from product providers, means that particularly for those with small pension pots the cost of professional advice can seem disproportionate. If press reports are to be believed then IFAs are avoiding offering advice to such clients. However, given the number of potential clients (and statistics show that most people are not saving enough towards retirement), there will also be plenty of IFAs looking for ways to offer a more cost effective solution. In principle there is nothing wrong with that, but insurers will want to know that regulatory and other duties are being met, with retainers being clearly defined in writing to avoid later disputes about the scope of the IFA’s duty.

GARs

The FCA’s report also highlighted that 68 per cent of guaranteed annuity rates (GARs) were not being used. GARs were common in the 1980s and 1990s when annuity rates were higher. A GAR effectively guarantees the level of annuity as a percentage of the fund, although availability is often subject to conditions. An individual could therefore potentially unwittingly miss out on a more valuable annuity by not taking the GAR in favour of exercising their pension freedoms. An IFA who fails to consider any applicable GARs could find themselves on the receiving end of a claim for the lost opportunity to benefit.

Looking to the future

The FCA has recently mooted a return to commission based sales. Industry comments have been far from welcoming, with criticisms raising the possibility of incentivised sales which could lead to future mis-selling scandals. IFAs need to be aware of this point, and ensure that all advice leading to either the purchase of an annuity or the exercise of pension freedoms are fully documented.

Conclusion

Increased pension freedom has transformed the pensions market and the opportunities within it. The full effect of the changes is still becoming clear, meaning a process of continued development for the pensions industry as a whole to ensure that practice suits the new landscape.

Further complicating this is the rapid rate of change affecting pensions. Further changes are anticipated in this year’s Budget regarding the taxation of pensions, and legislation has already been passed reducing annual and lifetime allowances from April and to stop members of defined benefit pension schemes from contracting out of the second state pension.

With change inevitably comes new risks and over the coming years it will be interesting to see if and how the types of claims made against those involved in the pensions industry also evolve.