Freedom and Choice was designed to give savers more options at retirement, but some face a hard decision in order to take advantage. James Phillips explores the difficulties
When former chancellor George Osborne introduced Freedom and Choice, savers found themselves able to enjoy a wider range of in-retirement products.
However, for one group the freedoms have come at a cost. Savers with enhanced protections allowing them to take more than 25% of their cash tax-free cannot take advantage of the freedoms without losing their extra tax-free allowance.
Many old-style schemes with enhanced protections for tax-free lump sums also state in the rules they must buy an annuity with the provider.
Yet, while the freedom rules allow savers to transfer their savings to a provider that allows lump-sum payments or drawdown, doing so would void the tax-free status of their savings.
The government did grant a small interim period for such savers to transfer their pots with no consequence. But this expired only a few months after the freedoms legislation came into force on 6 April 2015, with savers having to take their tax-free lump sum by 6 October.
Anyone who did not take advantage of the period is now stuck between a rock and a hard place. Hargreaves Lansdown senior pensions analyst Nathan Long says retirees are forced to make a difficult decision.
He says: "We've got an issue where people who want to take advantage of the pension freedoms are being restricted.
"You've got a slight problem as the rules of this protection say you can keep the tax-free lump sum as long as you stay within the pension plan. But as soon as you transfer it away, you lose that protection and drop down to 25%.
"This means most people have a decision of whether they want the bigger lump sum, so have to buy an annuity, or transfer out and have a lower entitlement to have drawdown."
Taylor Wessing partner Mark Smith adds some members may not even be aware they could be giving up their protections.
He says: "The protections for those rights came subject to certain conditions, meaning you could lose them inadvertently or knowingly in certain circumstances, one of which is by transferring unless you transfer in a particular way."
Smith is alluding to a means of escape where members may be able to retain their enhanced rights when partaking in a block transfer.
Where at least two members want to transfer out of the same scheme to the same separate provider, they can do so without losing their tax-free allowance, as long as they transfer at the same time.
Long explains: "The one quirk that allows you to keep the tax-free lump sum – and this shows how old and bizarre this legislation is – is you can transfer it with someone else within the plan to the same alternative pension scheme.
"As long as you move at the same time to the same provider, that's fine. But you have to find someone to do that. It's all a bit messy and archaic."
The reason this approach can be successful is because HM Revenue and Custom's (HMRC) definition of block transfers includes where two members move from an occupational scheme into personal plans, even though this is technically into two separate products.
"In reality, you are transferring from an old-style occupational scheme to a personal pension scheme, which is by definition a one-member scheme," Smith explains. "You can't fit two into one.
"However, HMRC has said as far as the receiving schemes are concerned, they will accept a block transfer can be made into a personal pension scheme so long as the other conditions are satisfied."
Trapped retirees may only find solace through two courses of action. Either the scheme changes its rules or the government reinstates the rules of the interim period.
Smith says the block transfer approach has a higher likelihood of success the larger the scheme is, simply due to there being more fish in the pond to transfer with. Members of small schemes might find it hard to leave, and remain stuck with a difficult decision.
He says: "The only options for members of small schemes who can't find someone to transfer with are to either transfer anyway in the knowledge you are giving up part of your tax-free lump sum, thus being able to access more flexible rights, or alternatively decide your tax-free enhanced position is more valuable to you and stay where you are and don't get the greater freedoms.
"Otherwise, try and persuade your scheme employer and trustees to amend the existing scheme to provide greater flexibilities."
However, it may sometimes be a futile effort to press providers to relax their rules, leaving members at a disadvantage.
Long explains that providers are unlikely to change these historic contracts.
He argues: "A lot of these pensions are housed either with old insurance company contracts, who probably won't change them in respect to the pension freedoms, or they're in occupational schemes still with an employer they don't work for anymore.
"It's quite easy for legislation to change but it's not high up on the agenda at the moment."
Freedom and Choice may not be straightforward for every saver. For those with guaranteed tax-free savings, their choice is between tax-free savings and an annuity, or an alternative product at a reduced tax-free allowance.
Yet HMRC may not be willing to give ground on the issue, so savers may simply make do with the options they have.
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