Flexible retirement and recent developments

Keith Webster considers the impact of the Inland Revenue’s flexible retirement proposals and recent changes

As society becomes more affluent, more and more people want to retire early at an age when they can enjoy their retirement. However, pension benefits are often insufficient to support individuals who retire early and therefore increasing numbers of people look to supplement their retirement income by continuing to work part-time. Conversely, others desire to make use of increased life expectancy and ever improving health to remain in employment beyond their normal retirement date and therefore wish to defer receipt of some or all of their pension entitlement.

It comes as a disappointment to many people when they discover that they cannot combine retirement with gearing down their work commitments. The current occupational pensions regime does not offer the flexibility required to enable members to take their benefits whenever they wish and in the form which best suits their circumstances. However, in the face of increasing demand, the Inland Revenue have recently introduced some changes to increase the flexibility offered to members and are still looking at others.

The problems
At present, the law permits people to take their benefits from an occupational pension scheme at any time between ages 50 and 75. However, the problem arose in that members could only take a pension when they actually retired from the employment to which that pension related. This does not compare favourably with personal pension schemes where members may take their benefits any time between ages 50 and 75, whether or not they retire from their employment at the same time.

The Inland Revenue will permit a member of an occupational scheme to take benefits from one pension scheme whilst continuing to work for an unrelated employer. Yet few people change jobs in the latter years of their careers, so this flexibility is of limited use. The Revenue also looks very closely at any arrangement whereby a person purports to retire early and then remains working for the same employer but under some form of consultancy arrangement. Such arrangements will not generally be permitted where the person continues to use the same skills and experience following their “retirement”, or where the Revenue feels that there has not been a “genuine” retirement.

Furthermore, there was no option for a member to receive part of their pension benefits if they started working part-time. Subject to contracting-out requirements, a member’s entire pension benefits, must normally commence at the same time.

Some of these requirements have now been relaxed in relation to AVCs.

Inland Revenue Discussion Paper
In February 1998 the Inland Revenue published a discussion paper on increasing the flexibility in benefits available to members of occupational pension schemes. This document contained three proposals:

• the option for members to start drawing benefits relating to AVCs at a different time from their main benefits;
• the option for members to take the whole or part of their benefits at any time between ages 50 and 75, irrespective of the date of actual retirement; and
• the ability for members of money purchase schemes to defer the compulsory purchase of annuities for any period up to age 75, and to receive benefits in the meantime by drawing income directly from their fund.

The first and last of these proposals were implemented by the Inland Revenue on 30 June in Update No. 54 to their Practice Notes. These provisions come into force immediately together with some minor consequential amending regulations.

Deferred annuity purchase
This is nothing new and has been available in a limited form since 1996. It is, in reality, simply a question of investment flexibility, allowing members the choice of taking income directly from their money purchase accounts, rather than having to purchase often expensive annuities. This article does not therefore discuss it in any detail.

However, one thing that schemes should note is that the provisions of Update No. 54 allowing more extensive deferral of annuity purchase will not be available to members of schemes which are contracted-out or which do not just provide money purchase benefits. This may cause some schemes to reconsider their overall pensions package.

Flexible payment of AVC benefits
More fundamental in relation to the impact on employment expectations for the over 50s are the changes to the AVC regime.

Update No.54 permits a person’s benefits deriving from AVCs to be paid at any time between ages 50 and 75 irrespective of when any other pension benefits for that person start or whether they have left service.

The new provisions apply both to AVCs in an occupational pension scheme and to any free-standing AVC arrangements. They also extend to AVCs which have been used to purchase added years in an occupational pension scheme. Members will be able to take AVC benefits before or after their main pension benefits commence and, where they have more than one pension arrangement, they may decide to take AVC benefits from one such arrangement but not from another.

The availability of flexible AVC benefits is optional. Employers and trustees of occupational pension schemes should decide as soon as possible whether to introduce this flexibility into their schemes and there are several issues which they will need to take into account when making this decision:

• Can the scheme actually offer flexible benefits? Where AVC benefits are provided through an insured arrangement, the underlying insurance policy must be capable of providing such flexibility. The most likely problem is that the policy requires an annuity to be purchased when benefits commence. However, where AVC benefits are taken early, the Inland Revenue requires the benefits to be provided through drawing down income. It does not permit the purchase of an annuity until the remainder of the member’s benefits are taken (unless, after payment commences, there is a transfer to a scheme which does not allow early payment). Another problem is that income drawdown effectively requires the regular partial surrender of the policy. These surrenders must take place at least every 12 months and may result in penalties. Schemes will therefore need to check the terms of any policy very carefully before offering this facility.
• Once a scheme has announced that it intends to offer flexible AVC benefits the Inland Revenue requires the scheme rules to be amended within 12 months. This requirement is quite tight. The trustees must actually consider their rules before they make the announcement to members. Many schemes have rules which are drafted using generic terms such as “benefits” and “pension”. These terms would include AVC benefits and AVC funded pension. Unless the drafting is accurate, the early commencement of AVC benefits may have unintended knock-on effects on members’ other entitlements. Two obvious examples of this problem are where members may no longer contribute to the scheme when they are in receipt of “benefits”, and where members’ entitlement to death benefits depends upon whether or not they are in receipt of a “pension”.
• Whilst the benefits taken are calculated on cost-neutral terms, there will clearly be an administrative cost to the scheme in terms of both additional calculations required and of administering the payment of the AVC benefit.

Flexible pension age

The proposal to allow members to take all or part of their benefits whilst continuing to work would have had an even more far-reaching effect than the AVC proposals. However, implementation of these proposals has been delayed because of the need for amendments to existing DSS legislation. Therefore, although these proposals were included as part of the Government’s proposals for pensions reform, there is as yet no suggested date for their introduction.

In addition, although the proposed changes are to be welcomed from the members’ point of view, it is easy to overlook the massive administrative implications for pension schemes. Under the proposal, members can elect at any age after reaching 50 to take a proportion of their benefits and they can make any number of such elections up to the full value of their benefit entitlement. Every time members make an election, they are entitled to a tax-free lump sum, but they need not take a lump sum with each election. Benefits need to be re-calculated each time a member makes an election and Inland Revenue maximum benefits will need revisiting. Given the concern in the pensions industry about the administrative implications of splitting pensions on divorce, this proposal, which would essentially allow a member to split and then re-split his benefits any number of times, must be viewed with caution.

Conclusion
It is to the benefit of all members that they be given increased flexibility when considering their pension benefits. Trustees should also welcome flexibility provided they take the appropriate steps prior to its introduction. However, the Inland Revenue must not lose sight of the administrative burden that flexible benefits will place on occupational pension schemes.