This is a guest post by Nick Lord. It argues that the new pension rules are a game-changer for debt advisers and that debt advice agencies need to put measures in place to ensure that their advisers can provide best advice post April 2015. Nick is a consultant on money advice and personal finance issues working with Government departments, regulators and firms.
Debt Advice and the Proposed Changes to Pension Legislation
The Chancellor’s March 2014 budget announced changes to pension legislation. The changes present a major challenge in the provision of financial advice to those who have defined contributions pensions.
Historically debt advisers have paid little attention to their clients’ pension savings. Either the client is well below pension age and so any future entitlement is irrelevant, or the exercising of any current or near-future pension option would make little if any difference to the range of advice options. The only time when a future pension entitlement is generally questioned is if the client is considering bankruptcy, with the possibility of any pension lump sum vesting in the bankruptcy trustee. But the changes introduced by section 11 of the Welfare Reform and Pension Act 1999 provided assurance that all approved pensions are excluded from the bankruptcy estate.
The proposed pension rules require a change to this historic approach. From April 2015, debt advisers will always need to consider the implication of their client having savings within a defined contribution pension, even where the client is a long way from retirement age.
The Proposed Changes
The Government proposes that, after April 2015, all those over 55 who have saved into a defined contribution pension scheme will be able to access their savings as they wish. There are further immediate changes for those with small defined contribution pension pots.
A defined contribution pension is one where the individual saves money into a pension investment. The savings are increased through tax relief and may also be topped up by employer contributions. The individual can choose where to invest their pension savings; the investment choice may be very limited or it may be very wide. But either way, the idea is that the combination of on-going contributions and investment growth increases the value of the pension saving over time to provide retirement income for the individual and any family.
Historic rules which apply to most savers means that the pension pot is not available as a lump sum and at least 75% of the savings has to be converted into an annuity. That is, at least 75% of the savings pot is given to an insurance company in exchange for a guaranteed lifetime income. A combination of low contributions coupled with greatly reduced annuity rates has discouraged many from saving for their retirement. For example, consider a 60 year old man with what he thinks is a handsome £50,000 saved in his pension pot. He is likely to be hugely disappointed to hear that if he wants inflation proofed retirement income and a 50% pension for his wife after his death, he will receive an annuity of just £100 per month in exchange for his £50,000. He may well conclude that he would have done better saving outside a pension where he may have had a smaller pot of money that he could have withdrawn as and when he wanted.
This is worrying news given the need to encourage people to save more for their pension and particularly given the Government’s flagship scheme that automatically enrolls eligible employees into a defined contribution pension scheme. The DWP states that about 4.7 million people have so far been auto-enrolled.
The Government proposals mean that those aged over 55 with defined contribution pensions will be able to take money from their pension pot without the obligation to take an annuity. Further, those over 60 with pension savings of less than £30,000 or with individual pension pots valued at less than £10,000 can now immediately take their savings without waiting until April 2015. In all cases the first 25% of money taken will be tax-free with the balance attracting Income Tax.
This major change in the rules is causing much debate amongst financial advisers, with many worried about the impact on consumers and the wider process of financial advice. Part of this concern centres on the possibility (probability?) that advice to those with relatively small pension saving to take lumps sums from a pension pot turns out to be sub-optimal and subject to a future complaint because of subsequent life events.
The pension changes should arguably be of just as much concern to debt advisers and their managers. The ability for eligible clients to repay debt by taking lump sums will have to become part of the landscape for debt advice. But the impact is not only on this client group. Advisers must also consider the impact on younger clients. In general, advisers must now pay close attention to all situations where clients have existing savings in a defined contribution pension scheme and:
- are already over the age of 55; or
- are approaching the age at which they can opt to take their defined contribution pension benefits ( so, say, all situations where the client is 52 or older); or
- are advised to consider a debt management plan or IVA which will likely extend beyond the age of 55.
However, the implications of the pension changes for debt advice go further than this. The continued roll-out of auto-enrollment together with the incentive of the new rules will mean that younger clients will be encouraged to save into a defined contribution pension scheme. This may be an appropriate long term plan, particularly given the employer contribution and tax relief. But it will also mean that the client has less money available to repay debt. Advisers must be able to discuss the advantages, disadvantages, and implications of existing and new clients starting or continuing to save into a pension scheme whilst also struggling with a debt problem.
In summary, in order to offer best advice, debt advisers must be able to explain:
- whether clients can, either immediately or in the future, access their pension saving to repay debt and the advantages, disadvantages, and implications should clients pursue this option. This requires consideration of a potentially complex set of issues including tax, benefit, and family issues;
- the options for creditors to seek repayment of debt through realising a debtor’s pension savings;
- how pension savings will be addressed in bankruptcy; and
- explain the advantages, disadvantages, and implications of debt clients paying into a defined contributions pension scheme (including through auto-enrollment) at the same time as repaying debt.
The Impact on Creditors
The new pension rules offer a potential new way for creditors to recover debt. Currently, the requirement that defined contribution pensions are mainly accessed through annuity income means that pension pots are not seen as a major asset. Even if there was a way for the creditor to force the debtor to access their pension, the lump sum and annuity income is relatively unattractive as additional repayment to the creditor.
But the post April 2015 environment is potentially very different. If a creditor is owed £20,000 and the debtor has a pension pot worth, say, £25,000, the creditor will see the attraction in encouraging the debtor to realise the pension or considering whether legal action would force the pension into payment.
Bankruptcy or the threat of bankruptcy would be one obvious way to attack the pension pot. Whilst the Welfare Reform and Pension Act 1999 was meant to ring fence pensions out of bankruptcy the Raithatha v Williamson case has muddied the waters such that debt advisers can no longer confidently say that pensions are not part of the bankruptcy estate. But at present, the Trustee could only potentially lay claim to the maximum 25% lump sum and subsequent annuity income. Going forward, the debt advice will need to consider that the bankruptcy trustee may be able to claim the entire pension. If this turns out to be the reality, then bankruptcy becomes a more powerful tool in debt recovery.
[Update: the October 2016 Appeal Court decision in Horton means that pensions are now protected in bankruptcy.]
The Regulatory Problem
There are clear challenges in debt advisers discussing the issues outlined above. Additional training will be urgently needed and agencies also need to think through the impact on the time needed to provide debt advice. But there is a further regulatory issue.
Advising whether an individual should cash in or vary a specific pension product falls within FCA regulation. This requires that the adviser meets minimum training, competence and other standards. Overstepping this regulatory boundary will mean that the adviser and/or debt advice agency, at least theoretically, risk enforcement action by the FCA. More pragmatically, it seems highly probable that the debt advice agency’s professional indemnity insurers would be concerned if debt advisers offer advice in an area which the regulator has decided needs experienced and qualified financial advisers. As highlighted above, qualified financial advisers are already indicating their reluctance to take the risk in advising where clients have small pension pots. In this context, ‘small’ has been reported as below £200,000.
It is possible that those in the not for profit debt advice sector could try to avoid this problem by arguing that advising on pensions as an ancillary to debt advice is not within their ‘course of business’ and therefore outside the FCA remit. However, following a change in legislation the FCA Perimeter Guidance Manual provides that debt counselling provided by a not for profit body is to be regarded as a business activity (PERG 220.127.116.11B). If the Government and regulator deem it appropriate to protect consumers by bringing not for profit debt advice agencies within regulation for debt counselling, it seems obvious that advice on pensions should be caught in the same way.
But the reality is that very few debt advisers are qualified to the minimum level required by the FCA to give more general financial advice. So we are left with an unsatisfactory situation that a very basic principle of debt counselling – advice on whether a debtor should use savings to repay debt – may cause a regulatory breach. This is an area which clearly would benefit from guidance from the regulator and where the debt advice sector urgently needs to determine a forward policy.
Some examples of the future environment for debt advice
Simon is aged 55. He has credit card debt of £30,000 and is unable to maintain payments because of reduced income. Simon also has a money purchase pension which is currently valued at £30,000. Simon asks whether he should cash-in his pension to partly repay his debt.
The debt advice must consider that, until April 2015, Simon’s usual option for accessing his pension is to take a maximum of 25% of his fund as a tax free lump sum with the balance being converted to an annuity to provide a pension income. The option of a £7,500 lump sum and a small additional income would not normally be considered as part of the debt advice process.
However, from April 2014, Simon has the option of taking his entire pension fund as a lump sum under the ‘triviality’ arrangements.25% of his pot will be tax free and he will pay income tax on the balance. His likely lump sum payment from his pension is £25,500. He could offer some or all this in full settlement of his credit card debt.
Carole is 53. She seeks debt advice because of financial problems following separation from her husband. She has debts of £25,000 and no assets of her own. However, her solicitor advises that she can make a claim on her husband’s large pension with a view to a part transfer to Carole. Carole is thinking of petitioning for bankruptcy and asks whether any financial settlement with her husband would impact on her debt situation.
The debt advice must take account of the fact that Carole may accrue a significant asset which, depending on how she takes an interest in her husband’s pension, could be used to repay her debt or which creditors could attack as a means to repay debt. The timing of the transfer of any pension would be critical as would the decision on whether to seek a transfer from her ex-husband or an ‘earmarking’ of his pension.
Peter is 31. He is on a debt management plan paying £105 pcm. His employer has advised that Peter will be auto enrolled into a defined contributions scheme from next month. This means his income will reduce by £12.15 per month and this will increase in stages to £60.76 per month from 2018. Peter asks whether he should opt out of his auto-enrollment pension
The debt advice must consider whether the potential advantage to Peter in repaying his debt more quickly is more than offset by him not paying into the auto-enrolled pension, including missing out on the additional contributions paid by his employer.
Nick Lord DipPFS