Decoupling

Writing an article on ‘decoupling’ in the same month as Valentine’s feels a bit “bah humbug” – but rest assured it’s the link between taking tax-free cash and using pensions to provide an income that face the prospect of being torn apart, not any romantic relationship.

The latest report in the Work and Pension Committee (WPC)’s series on pension freedoms – this time on accessing pension savings – has made a number of suggestions. These include trialling auto-enrolment in Pension Wise appointments, changes to the Pension Advice Allowance and dropping the idea of a pension statement season.

The decoupling proposal though is the one that has caught my eye. To be clear the WPC haven’t shown a strong view one way or another, just a recommendation that a scoping exercise be carried out.

My first thoughts on decoupling are: what’s the point? What would it achieve?

Those in favour argue that under the current system people focused on taking tax-free cash may make poor use of their remaining savings, by either cashing the whole lot in, or moving the rest to a higher cost or poorer performing investment than if it was left where it was. They believe decoupling will allow the remainder to be left where it is with better outcomes.

Of course, this is exactly what happens in SIPP world already.

Under the statutory permissive override brought in with pension freedoms, any Defined Contribution (DC) pension scheme can offer flexi-access drawdown without changing the scheme rules. This means any DC scheme already can let members take tax-free cash and leave the rest invested as drawdown funds – even if they choose not to offer the option.

So you could argue decoupling is unnecessary. But more than that – it would make pensions (yet) more complicated. There would need to be a ‘third state’ of funds that are uncrystallised yet have no tax-free cash entitlement. Disqualifying uncrystallised funds anyone?? (That’s akin to a disqualifying pension credit following a pension sharing order).

There’d also be some interesting planning points around lifetime allowance (LTA) usage. If tax-free cash is taken but there is no test on any other funds, and if those funds grow at a faster rate than the LTA (not difficult considering it’s currently frozen), then the potential for LTA charges gets higher when you do want to crystallise and take an income. On the flip side you will have crystallised a larger fund than otherwise, so when it comes to the age 75 test then there will be a larger credit to offset against the crystallised fund value. More analysis of individual circumstances would be needed to work out which was the better option.

And of course we all know that tax-free cash hasn’t been called that officially since 2006. Instead it is a ‘pension commencement lump sum’ – which of course it wouldn’t be if it was decoupled from the need to commence any pension. So yet more new terminology will be required.

The Government are due to respond to the report by 18 March – let’s hope this is one relationship they don’t want to break up.

This article was previously published by Sipps Professional