On 26 May 2016, the DWP published a consultation on capping early exit charges for members of occupational pension schemes (the “Consultation”) that contain ‘flexible benefits’ (broadly, defined contribution and cash balance benefits) in existing and new schemes. The consultation is expected to run until 16 August 2016. We take a look at how the cap may be implemented.
Since the introduction of the pension freedoms in April 2015, the Government has become aware that individuals may face a range of potential barriers when seeking to access their savings under the pensions freedoms, which includes incurring early exit charges. With effect from 2017, the Government intends to introduce a cap on early exit charges imposed by trustees, managers and / or providers of occupational and personal pension schemes when a member leaves the scheme early in order to access their benefits flexibly.
The Government has considered the most effective means of capping early exit charges that pension scheme members may incur and has developed four key principles of how it will implement the cap.
The four key principles are:
- The legislation implementing the cap is not intended to prevent scheme trustees, administrators and third parties from charging early exit fees in existing schemes. The legislation should ensure that consumers wishing to access, convert or transfer their pension savings to a form that can be taken flexibly have an appropriate degree of protection.
- The cap will only apply to charges faced by scheme members who are eligible to access the pension freedoms.
- The cap will apply to scheme members with new and existing pensions who are eligible to access the freedoms.
- As far as possible, the cap for occupational and personal pension scheme members will operate in the same way.
The consultation defines exit charges as “those fees and charges incurred when a customer transfers out of their pension into another fund or scheme, or otherwise accesses their pension flexibly before a date specified in the personal pension contract or, in the case of an occupational scheme, the scheme rules.” Such charges are assumed generally only to apply on early exits and so individuals will still be able to access the new flexibilities without paying an exit charge by waiting until their agreed retirement date. On this basis, the consultation assumes that to be caught by an early exit charge, an individual must satisfy three conditions:
- They wish to transfer out, or otherwise access, their pension;
- They wish to do this before their scheme’s agreed retirement date; and
- Their scheme applies a penalty for early exits.
The consultation provides that market value adjustments (MVAs) will be excluded from the cap if they satisfy certain conditions, which includes reflecting the difference between an indicative value given to a member and the eventual market value of their share of scheme assets on exit. It is proposed that regulations will make clear that adjustments made to the value of the benefits a member is entitled to receive by way of a terminal bonus (whether as a result of an express entitlement or as a reasonable expectation arising under the scheme) are not classified as MVAs. The rationale is that an MVA is a change to the nominal value of a member's benefits to reflect the underlying market value of the assets as opposed to a genuine charge for services. However, a terminal bonus under a with-profits policy will not count as an MVA if the member has a reasonable expectation they are entitled to it.
The primary duty to comply with the early exit charge cap will be placed upon the party who actually applies the charge in practice. This could be a service provider or the trustees of an occupational pension scheme. The Government considers that this will provide a firm basis for trustees to renegotiate existing contracts with service providers where necessary. In respect of future contracts, trustees should ensure that no new arrangements in excess of the cap are entered into.
If you have any questions or would like more information, please contact a member of our pensions team.This 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.