Freedom from early exit charges in occupational pension schemes‚ clearer road ahead?
Pensions analysis: The government recently published their response to the consultation on capping early exit charges for members of occupational pension schemes. Kevin LeGrand, consultant at Arc Pensions Law, explains the background to the consultation and considers its outcomes.
What was the background to the consultation?
This exercise derives from the introduction, from April 2015, of the new pension freedoms under the freedom and choice regime for defined contribution (DC) pensions. This was introduced by the Taxation of Pensions Act 2014, amending the Finance Act 2004. The regime removed previous regulatory restrictions, allowing members unfettered freedom (subject to normal income tax rules) to access their pension funds through drawdown from age 55 onwards, at times and amounts of their choosing.
Although the regulatory regime was eased, it does not override the provisions of individual schemes or arrangements, and so members wishing to take advantage of the pension freedoms are still subject to any restrictions imposed through their own scheme. The government has been concerned that some individual terms may unduly restrict members’ ability to take advantage of the pension freedoms. They are particularly concerned about charges imposed under the scheme or arrangement justified on the grounds that the monies were being accessed from a date earlier than the member’s previously agreed target retirement date. These charges may be legitimate in the context of the funding of the scheme where access occurs earlier than planned, but the government was concerned some exit charges may be unwarranted and/or excessive.
In February 2016 the government responded to an earlier consultation exercise and announced that it would include in the Bank of England and Financial Services Act 2016 an amendment to the Financial Services and Markets Act 2000 giving the Financial Conduct Authority (FCA) a duty to make rules to limit early exit charges imposed in respect of personal and stakeholder pension schemes. The FCA consulted in its document ‘Capping early exit charges’ (CP/16/15) on a proposed charges cap to be effective from March 2017.
Concurrently, the government considered how to generate and implement a similar set of rules on occupational pension schemes, as it is keen to ensure that, in this area, all types of DC arrangements are subject to consistent rules. In May 2016 it published a consultation document ‘Capping early exit charges for members of occupational pension schemes’ (the May paper), leading to the publication of a further response document of the same name in November 2016 setting out the new policy. It is intending to introduce the new rules for occupational pension schemes through a provision in the Pension Schemes Bill currently going through parliament, to amend the Pensions Act 2014 (PA 2014).
What did the government propose?
The May paper proposed a charges cap for occupational schemes, subject to four principles:
- the cap should not prevent existing schemes charging early exit fees‚ the legislation should ensure that members wishing to access, convert or transfer their pension savings to a form that can be taken flexibly have an appropriate degree of protection
- the cap will only apply to charges faced by members who are eligible to use the new pension freedoms
- the cap will apply to scheme members with new and existing pensions who are eligible to access the new pension freedoms
- as far as possible, the cap for occupational and personal pension scheme members will operate in the same way
It then proposed a cap of 1% for existing personal pension contracts and 0% on new ones.
What concerns were raised by respondents to the consultation?
Respondents raised a number of technical points but were generally in favour of consistent treatment across all types of schemes.
One important concern raised by a number of respondents was that the proposals might restrict the future choice of investments in schemes, leading to a reduction in the use of longer term investments such as in infrastructure and property, where early exit charges are more prevalent. However, the government concluded on the basis of a survey by the Pensions Regulator that only 3% of all members faced such charges. In addition, its impact assessment accompanying the May paper indicated that only a minority of members currently facing early exit charges are expected to use the pension freedoms. Consequently it deemed the problem to be de minimised.
What decisions has the government made in relation to capping/banning early exit charges for members of occupational pension schemes?
A cap will be introduced. Since it is intended only to remove barriers to people accessing the pension freedoms, the cap will only apply to early exit charges for those aged between 55 and their pension age. Charges associated with accessing a decumulation product will be outside of scope as they would be incurred whether the member was accessing the product at their pension age or earlier.
The rate of the cap will be:
- 1% for existing members of occupational pension schemes
- 0% for new members of occupational pension schemes
What types of charges will be caught? Are there any exclusions?
The cap will apply to ‘early exit charges’, which are taken to mean ‘all charges imposed on members (who are eligible to access their pension savings flexibly) when seeking to access their pension early, which they would not face if they carried out the same transaction at their pension age’.
‘Pension age’ here is the age at which a scheme has agreed that a member can draw an unreduced pension, without incurring an early exit charge.
Market value adjustments (MVAs) are out of scope of the early exit charges cap, as they are not covered by the definition of an administration charge’ in PA 2014, Sch 18 (which contains the power to restrict charges). Therefore where an MVA applies, the charges cap will apply to the fund calculated after the application of the MVA. Terminal bonuses are similarly excluded as they are not a charge, and similarly not covered under PA 2014, Sch 18.
The cap will apply to any other exit charges derived from occupational pension scheme investments in such things as with-profits funds and other types of schemes that invest in property and infrastructure.
How will the cap be implemented? When will it come into force?
The implementation date in respect of occupational schemes is expected to be October 2017.
New contributions after October 2017 by an existing member of an occupational pension scheme that applies an early exit charge would not be treated as new membership and so would be subject to the 1% cap.
An occupational scheme that currently applies early exit charges to members wishing to access the pension freedoms will have to offer different charging structures or terms to new members to accommodate these new rules. Where the provisions of the existing contract between the trustees or managers of the scheme and the service provider explicitly specify that an early exit charge of below 1% will apply, the government intends to legislate to ensure that the charge cannot be increased.
In the unlikely event that early exit charges under an occupational pension scheme arise from more than one source, the cap will be applied on the member’s total fund from the scheme, to include all charges within it.
The regulations in respect of occupational pensions schemes will be enforced by the Pensions Regulator.
Are there any differences from the cap to be implemented for personal and stakeholder pensions?
The implementation date for personal and stakeholder pensions is intended to be 31 March 2017.
There are other technical differences in the specific legislative provisions to accommodate differences in the underlying base legislation being amended, but otherwise the intention is that the effect in each case is the same.
How will the imposition of the cap/ban affect the occupational pensions market and member behaviour?
The government does not expect these provisions to have any significant impact upon the types of investments held in occupational pension schemes, nor on the occupational pensions market.
Through removing one of the perceived barriers to members accessing the pension freedoms, it is thought that the numbers of people choosing to do so will increase, although there are many other factors involved in such a decision. Government predictions however are that the numbers will in any case be limited.
Interviewed by Alex Heshmaty.
This article was first publis
The views in this article are intended for general information purposes only and should not be used as a substitute for professional advice. Arc Pensions Law and the author(s) are not responsible for any direct or indirect result arising from any reliance placed on content, including any loss, and exclude liability to the full extent. Always seek appropriate legal advice from a suitably qualified lawyer before taking, or avoiding taking, any action. If you have any questions on the points raised in the above, please do not hesitate to get in touch.