Pension freedoms - the ripple effect
Over the last decade, financial advisers have had to keep on top of countless changes to the pensions rules. The constant movements in lifetime allowance, numerous forms of protection, slashing of the annual allowance and various anti-forestalling measures have all been challenging at times.
So the pond was already pretty murky. Then the pension freedoms went and dropped a massive stone in it. We all saw the splash. But it’s only now that we are seeing the ripples.
Three areas come to mind where knock-on effects are being felt, and importantly these go wider than just pensions. These are child support, bankruptcy and divorce. And all three have implications not just for clients but for their families as well.
In terms of child support, if an individual is required to pay maintenance, the Child Support Agency (CSA) has the power to issue a ‘deduction from earnings order’ (DEO). The purpose of this is to collect maintenance payments direct from the individual’s employer.
While a pension provider does not have a conventional employer-employee relationship with its members, a pension may still count as ‘earnings’ and could be subject to deductions.
These rules come from The Child Support (Collection and Enforcement) Regulations 1992. Looking at them in more detail, they simply state that a pension by way of an annuity counts as earnings. But what about other types of benefits?
It’s reasonable to infer that a regular income from drawdown is likely to be viewed in the same way as an annuity. Tax-free cash, on the other hand, is not. And there are question marks over infrequent drawdown payments and Uncrystallised Funds Pension Lump Sums (UFPLS).
Given that these regulations pre-date by some way the rise of SIPPs and pensions simplification (let alone the recent pension freedoms), applying them to modern scenarios often feels like trying to write an email on a typewriter.
But whether you are advising the party paying the maintenance or the party receiving it, these are wrinkles that you may be required to iron out at some stage.
We are also seeing uncertainty in the context of bankruptcy where several court cases have addressed the issue of how the bankruptcy rules work in the post-freedoms landscape. The most important of these is Horton v Henry. This has been sent to the Court of Appeal, and we are currently awaiting the ruling.
This imminent judicial treatment, however, did not prevent the Insolvency Service updating their guidance last year, such that individuals over 55 with undrawn pensions may not even be able to apply for bankruptcy in the first place.
Then there is divorce. The pension sharing mechanism was introduced 17 years ago, and it is a blunt instrument that sometimes struggles with the nuances of modern retirement products. In a worst-case scenario, the party paying the pension debit could use the post-freedoms flexibility to whip out their whole fund before the pension provider is even aware that a court order exists.
Of course, as with all recent news stories, Brexit is adding another twist, and this is no different. In a period where the executive and legislative agenda will be driven for the foreseeable future by other concerns, it’s unlikely there will be much time to bring the legislation up-to-date in areas like child maintenance, bankruptcy and divorce.
So while pension freedoms have led to progressive outcomes for savers, the ripples may lead to regressive outcomes elsewhere. And until such time as there is clarity, advisers will need to continue thinking outside the box when advising clients with challenges in these areas.