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UK Pensions Speedbrief: Freedom & choice: capping exit charges for DC savers

  • United Kingdom
  • Pensions - Defined contribution

02-06-2016

The DWP and FCA have each issued proposals at the end of May to introduce a cap on early exit charges imposed by providers of money purchase pension arrangements. The capping proposals are intended to ensure that DC pension savers do not face obstacles when seeking to transfer benefits for the purpose of accessing the new flexible benefit options introduced at 6 April 2015.

Background

In the weeks immediately following the introduction of the new flexibilities at the start of the 2015-16 tax year, there were a number of reports in the media alleging that pension savers were being hampered from accessing the new benefit options. Anecdotal evidence reported was that existing providers were both refusing to offer the new options within the existing pension arrangement, whilst at the same time imposing swingeing exit charges for transfers before normal retirement age.

HM Treasury issued a consultation in July 2015 seeking views on the extent of the perceived problem and on possible options for addressing it, such as a blanket cap, a flexible cap, and relying upon the industry to address the concerns on a voluntary basis.

In its response to that consultation, HMT confirmed that some form of mandatory cap was considered to be the most appropriate way forward, but considered that the precise details of the level and scope of the cap were best left to the relevant regulators.

The FCA has therefore been given powers under the Bank of England and Financial Services Act 2016 to place a cap on charges made by personal pension providers, with the DWP being left to bring forward an equivalent cap for occupational pension schemes in the promised Pensions Bill (with input from the Pensions Regulator). The most recent consultations flesh out the details of the capping arrangements which are to be imposed.

The proposed new requirements

The two consultation papers set out essentially identical proposals, as follows:

  • The provisions will apply to members with flexible benefits (broadly, money purchase or cash balance benefits).
  • The cap will apply in respect of an “early exit charge”: ie. a charge imposed where the member opts to take benefits  (including by converting those benefits into a different form) or to transfer to another scheme after reaching normal minimum pension age but before the member’s expected retirement age under his current pension arrangement.
  • The proposed level of the cap is 1% for existing pension arrangements, and 0% - effectively, a ban – for any new pension arrangements entered into after the new provisions come into effect. The percentage rate is applied to the value of the member’s benefit at the point of exit.
  • The FCA paper confirms that where existing personal pension arrangements have exit charges which are below 1%, it will not be lawful for these to be increased to the 1% cap. Given that the DWP paper proposes mirroring the FCA arrangements, it seems likely that an equivalent provision will apply for occupational arrangements, though the point is not expressly discussed.
  • In relation to personal pension schemes, the obligation to comply with the cap is placed on the pension provider.
  • In occupational pension schemes, the obligation to comply with the cap will rest either on the scheme’s trustees / managers or on service providers, depending on whether the cap derives from the scheme’s rules or from contractual arrangements entered into with third parties.
  • Market value adjustments in a “with profits” arrangement will be excluded from the scope of the cap, subject to certain conditions; however, loss of a terminal bonus in such an arrangement will not be exempted where the member is legally entitled to receive it, or has a reasonable expectation that he is entitled to receive it.

The DWP paper also raises the issue of what it terms the “water-bed effect” – that is, the concern that other charges or fees may be increased in consequence of the cap – and warns that trustees / managers must be vigilant to ensure that excessive charges are genuinely capped, rather than simply displaced.

More generally, the DWP invites interested parties to provide further evidence on the application of exit charges in relation to occupational pension schemes, including how common such charges are, how they are calculated, and how they are imposed (ie. whether through the scheme’s trust deed and rules or via contractual arrangements).

The new caps are due to come into force from April 2017.

Comment

The introduction of exit charge caps has been on the cards for some while, but this is the first time that concrete details of the proposals have been available.

The absolute ban on exit charges for any new arrangements is not unexpected, given the direction of travel evidenced in several recently implemented policies, such as the bans on active member discounts and member-borne commission, and the introduction of the default fund charge cap of 0.75%.

As regards existing arrangements, trustees and providers will need to review their terms closely and assess what action, if any, will be required to achieve compliance. Trustees in particular will need to consider whether renegotiation of existing service contracts will be needed and, if so, will need to broach the subject with the relevant service provider in good time.

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