How DB plans with AVCs are affected by the reforms

The Pension Schemes Act 2015 sets out the framework for the government’s new Pension Wise service, designed to help people decide what to do with their money purchase benefits – now referred to as flexible benefits.

In tandem, new disclosure rules outline the responsibilities for trustees in communicating the new rules, which apply to all members with flexible benefits.

This includes DB members whose only flexible benefits are money purchase AVCs.

One of the key requirements is that trustees must tell members how to access Pension Wise as they approach retirement.

The law is quite specific on the detail that must be included. The Pensions Regulator is also publishing a guide to communicating with members about pension flexibilities.

The guide, which was still in draft at the time of writing, includes good-practice recommendations for communicating the changes to members and suggested wording for generic ‘risk warnings’.

In addition to signposting Pension Wise, there are also new requirements for information that must be included in retirement 'wake-up packs' for members with money purchase benefits, including AVCs.

From April 6 all members have a statutory right to transfer their money purchase AVCs separately from their DB pensions, and members’ attention must be drawn to this at least four months before reaching their retirement date.

Members should also be sent a copy of the Money Advice Service’s updated guide 'Your pension: it’s time to choose'.

No scheme will be forced to offer the new flexibilities, however trustees may wish to consider offering members some new choices for AVCs.

Tax-free lump sums

In practice, since 2006 most members have tended to use their AVCs to fund their tax-free pension commencement lump sums.

It is therefore unlikely that many schemes will rush to offer complex income drawdown mechanisms for AVCs.

Many trustees will be of the view that the new statutory right for members to transfer their AVCs means that if members wish to avail themselves of any of the new flexibilities they can transfer their pots elsewhere.

However, some trustees are considering allowing members to take money purchase AVCs in cash as a single 'uncrystallised funds pension lump sum'.

Broadly, an UFPLS is paid 25 per cent tax free, with the remainder subject to tax at the individual's marginal rate.

A member choosing to take their AVCs in this way would also be able to take 25 per cent of their remaining DB pension as a tax-free pension commencement lump sum.

The net result is that the member can use their AVCs to get more cash out of the scheme than they might previously have been able to – although some will be taxed – and the scheme will have a reduced liability to pay a smaller DB pension.

In the context of a scheme carrying out liability-management exercises, this option could be worth considering.

If trustees are going to allow members to take their AVCs as a UFPLS, care should be taken around communicating that option and including the appropriate risk warnings from the regulator's new draft essential guide.

The more onerous ‘second line of defence’ Financial Conduct Authority requirements – which require that contract-based providers give risk warnings specific to consumers’ personal circumstances – will not apply, although some fear that over time trustee obligations could move closer to these.

Stuart O’Brien is a partner at Sackers