It has been confirmed that the Code of Practice on Incentive Exercises will apply to any exercises regarding commutation of trivial and small pensions. We explore the purpose of the Code, look further into Incentive Exercises, and consider what this means for trustees.
The last budget heralded an increase in the limits below which members with small pensions are able to take their entire benefit as a taxed cash lump sum, known as trivial commutation. With effect from 27 March 2014, the amount which can be taken as a lump sum on trivial commutation increased from £18,000 to £30,000 (under the all schemes trivial commutation regime) and from £2000 to £10,000 (under the scheme specific small lump sum commutation regime).
This means that more members reaching retirement will be able to trivially commute their pensions for cash sums. In December 2014, the Incentive Exercise Monitoring Board Technical Group (the Group) published a note confirming that the Code of Practice on Incentive Exercises (the Code) applies to one-off trivial and small pension commutation.
The Code of Practice on Incentive Exercises
The Code was introduced by the Industry Working Group in response to concerns about the conduct of Incentive Exercises. The purpose of the Code is to help ensure that all Incentive Exercises enable members to make informed decisions and better choices. The Code sets out that Incentive Exercises should:
- Be carried out fairly and transparently.
- Communicated in a balanced way and in terms that members can understand.
- Be available with appropriate financial advice that is paid for by the party initiating the exercise.
- Be able to achieve high levels of engagement.
- Provide access to an independent complaints and compensation process.
For the purposes of the Code, an Incentive Exercise is an invitation or inducement provided to members to change the form of their accrued Defined Benefit (DB) rights in a UK registered pension scheme which meets both of the following tests:
- One objective of providing the invitation or inducement is to reduce risk or costs for the pension scheme.
- The invitation or inducement is not ordinarily available to members of the pension scheme.
In their note published in December 2014, the Group stated that they would generally expect one off trivial commutation / small pot lump sum exercises to existing pensioners and dependents to meet these tests.
Types of Incentive Exercises
A key part of the Code is to consider whether an offer is a Transfer or a Modification. This distinction is important as it impacts on the level of information the party making the offer needs to provide to scheme members.
- Transfer Exercise – for example, involving transferring out of a DB scheme on an enhanced basis or in return for some other inducement.
- Modification Exercise - for example, a pension increase exchange exercise involving an enhancement to pension income, in return for surrendering all or part of future pension increases.
The Group considers that a one-off trivial commutation exercise / small pot lump sum exercise would constitute a Modification Exercise.
The consequences of applying the Code and treating the exercise as a Modification Exercise include:
- Offering financial advice that should include a final, tailored written recommendation.
- Meeting the so called Value Requirement and providing financial guidance to members.
- Complying with the Code’s requirements on vulnerable customers.
Implementing the Code
The party initiating the Incentive Exercise is responsible for following the Code and seeking to ensure that all parties comply. The Code indicates that trustees should start from the presumption that Incentive Exercises are not in most members’ interests. Applying the code will assist Trustees in discharging their duties and responsibilities but the Code is voluntary, and so whilst advisable is not currently obligatory.
The Group recognise that the 2014 Budget announcements are likely to have a significant impact on Incentive Exercises and are planning a major review of the Code in 2015 once government policy, legislation and market developments have become clearer.
Author: Mikela RochfordThis information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.