Conscious uncoupling

Breaking a chain image

Martin Jones looks at how the Treasury might reconfigure the rules to break the link between tax-free cash and pension income.

Chancellor Philip Hammond delivered his Autumn budget on October 29 2018. Beforehand, the speculation had mainly focussed on tax relief and the annual allowance.

In the end, pensions got very little coverage. However, we could still see changes further down the line to the rules on tax-free cash and pension income.

Under current rules, when the (usually) 25% tax-free lump sum is paid out, the remaining 75% of funds must be designated to provide a form of income. This can be in the form of income drawdown, a lifetime annuity or a scheme pension.

However, this simultaneous approach of lump sum and income is now under the microscope, not least because of suggestions from the Financial Conduct Authority as part of the Retirement Outcomes Review.

In their June 2018 final report on the topic, the FCA suggested that consumers should have the ability to access their lump sum without committing to a form of income at the same time. Their concerns were that consumers were taking the path of least resistance thereby not shopping around or fully engaging in the process.

Designating funds into income drawdown is not an irreversible decision given that consumers are still able to annuitise further down the line. In reality, though, clients often view taking a lump sum and taking an income as separate decisions.

It’s the Treasury of course that owns the tax rules rather than the FCA. But if the Treasury were to be persuaded by this line of thinking, is a change feasible? The answer is that it may be easier to achieve than it first appears.

Firstly, the concept of funds with no lump sum entitlement already exists in the context of pension sharing orders – any part of a pension credit that is paid from drawdown funds is technically uncrystallised but cannot later be used by the ex-spouse to provide a lump sum – meaning it’s not completely alien to trustees, administrators and advisers.

Secondly, it shouldn’t take too much wrangling of the legislation. Schedule 29 of Finance Act 2004 is the bit that states a lump sum must be connected to one of the three forms of income mentioned above. It doesn’t seem overly complicated to add a new, fourth type of pension, perhaps called a ‘deferred income fund’, that would be defined as an arrangement with no lump sum entitlement and no income payable.

Given it would be a new type of pension, it would allow the FCA to put in place regulations that are appropriate to a product where no income is being paid and where no irreversible decisions have been made.

It would also seem to avoid clashes with other wrinkles – for example where members have tax-free cash entitlements of more than 25%.

It’s not always clear how much the Treasury and the regulator work together on rule changes – more’s the pity. But if it’s a change backed by the regulator and one that’s easy for the Treasury to achieve, it probably has a better-than-average chance of making it into the statute books.

Technical Team Leader

After completing his postgraduate studies at Lancaster University, Martin spent two years working for a leading insurance company before joining AJ Bell in April 2007. Martin worked initially on the AJ Bell Investcentre product before moving to a technical role in 2009. His main focus is providing technical support to the various teams and departments within the business. He is also involved in delivering training to staff on the rules and regulations that affect our customers.