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Changes in UK pensions legislation
Jon Bridger examines PSO "Update 54", concerning the flexible use of Additional Voluntary Contributions to Occupational Pension Schemes.
PSO "Update 54"
"Update 54" concerning the Flexible Use of Additional Voluntary Contributions (AVCs) has recently been issued by the Pension Schemes Office of the Inland Revenue. Whilst on the face of it the Update represents good news for members, there are a number of significant complications which trustees will need to consider carefully before deciding on any changes in their AVC procedures. There is no compulsion for schemes to offer these new facilities - it is for the trustees of each pension scheme to decide whether they believe they are appropriate.
In a nutshell the new provisions effectively end the requirement for AVC benefits to come into payment at the same time as the main scheme benefits.
Under the new provisions, AVC benefits may start at any time from age 50 (or earlier on incapacity) to age 75 regardless of whether the member retires or leaves pensionable service. There are thus two new scenarios to consider:
Scenario A - the member opts to draw his AVC benefits before his main pension.
Scenario B - the member opts to draw his AVC benefits after his main pension.
For example, under Scenario A, a member may move to part-time working in his 50's and want to receive some pension income at the same time. Therefore, he may ask to receive his AVC pension early but leave his main benefit until age 60. Under Scenario B, an example might be of a member who leaves employment at age 58 and decides to receive his main benefits at that time but prefers to allow his AVC fund to continue to accumulate for another few years before drawing on those additional benefits.
Under Scenario A, the member may continue to accrue additional main scheme benefits and also make further AVC contributions.
Scenario A
Where AVC benefits come into payment before main scheme benefits the AVC benefits must be taken as pension via the income drawdown method; they may not be taken as a lump sum or used to purchase an annuity. In our view, this presents a fundamental problem with the new flexibility provisions, given the potential pitfalls involved with income drawdown. Members would need detailed professional advice in order to understand the risks involved.
Scenario B
Under Scenario B, when the AVC pension benefits come into payment, these can be immediately secured by an annuity or, alternatively, income drawdown taken until age 75 at the latest. The trustees can choose to restrict the option to the purchase of an annuity only.
It should be noted that deferring the AVC benefits under Scenario B may reduce the maximum lump sum entitlement for a member whose lump sum is based on the formula of 2.25 times the initial amount of pension in payment.
Under each scenario there are also detailed rules regarding the timing of lump sum payments for members who commenced paying AVCs prior to March 1987. In addition to Scenarios A and B, there is also a third option which involves taking the AVC benefits at the same time as the main scheme benefits, but using income drawdown instead of annuity purchase!
General Comments
If the new provisions are adopted, there will obviously be cost implications for on-going scheme administration in order to put systems in place to monitor and record benefits taken.
The requirement under Scenario A to use income drawdown presents a major problem and so trustees need to consider the implications very carefully before offering this option. Trustees will obviously need to bear in mind the size of AVC funds likely to be available and the risks involved to members under the income drawdown route.
On the other hand, Scenario B seems to offer less problems, particularly if the trustees restrict the option purely to the purchase of an annuity.
The new provisions also apply to Free Standing AVCs. Therefore, if trustees decide on a restricted adoption of the new provisions, they will still be available to members in full via FSAVCs.
For further information, please contact Jon Bridger at the Cheltenham office.
Jon Bridger, September 1999.