How does pension liberation work?
In order for a pension to be ‘liberated’, it first has to be transferred out of the pension scheme that currently holds it.
Pension transfers are undertaken on the transferor’s understanding that the transfer value (money representing the member's pension rights) will be used only to provide the member with pension benefits in retirement (for example, providing a tax free lump sum and a regular income or annuity).
However, in ‘pension liberation’ transfers, money is transferred to a new scheme, and then made available (wholly or partly) as a cash payment back to the member, either directly or indirectly. As noted below, these payments are sometimes structured as loans or other arrangements under which the member is notionally required to repay the funds which have been advanced.
Pension loan websites
The Pensions Regulator has encountered websites which offer to arrange loans to members of pension schemes.
These loans are offered on the basis that the member transfers to a new specified pension arrangement and then receives a loan (either directly from that new arrangement or by an indirect route). The loans are given without the need for credit checks or security.
Members of pension schemes should be aware that such pension loan arrangements may result in significant tax consequences, even though members may be told otherwise by the loan organisers.
What is the catch?
Converting a pension into cash might sound very attractive to people who urgently need money. However, if something sounds too good to be true, it invariably is.
- A member may be poorer in retirement. A member can only use their pension fund once. If they liberate their pension, there will be much less (or no) income from it when they retire.
- A member may be hit by unexpectedly high fees. As part of the liberation transaction, a member will probably have to pay the organisers a ‘commission’ or ‘arrangement fee’ and may have a number of ‘deductions’ made from the transfer value before they get it. They might be told these deductions are from a number of different things but, typically, the member may get around 70% to 80% of their transfer value once the organisers have taken their cut (deductions will vary).
- A member may be hit with significant charges by HMRC. If a member has liberated their pension, they need to tell HMRC and will have to pay tax. If they fail to tell HMRC and HMRC contacts the member first, they may be charged penalties and interest in addition to the tax.
Example: The implications of the charges a member will face if they liberate their pension
You are a member of a pension scheme run by a previous employer. The transfer value of the pension is £20,000. You decide to liberate the pension after being approached by the organiser of a pension liberation scheme who assures you there is a loophole enabling you to release your pension and turning it into cash.
You are told by the organisers that 20% of your pension transfer (£4,000) has to be deducted as commission. You receive a loan for £16,000, after deductions.
You are contacted by HMRC about an unauthorised payments charge due on your liberated pension. The rate is 40% and you will be liable to an additional 15% unauthorised payments surcharge. This means you would be charged £11,000 on the full £20,000 liberated.
You are required to pay £11,000 from the £16,000 you have received, leaving only £5,000. In addition you may also be liable to penalties and interest on the unauthorised payments.
Is pension liberation the same as 'pension unlocking'?
No. Pension liberation should not be confused with ‘pension unlocking’. With pension unlocking, a person aged 55 or over can release up to 25% of their total pension as a tax free lump sum.
The Financial Services Authority (FSA) warn that unlocking a pension will almost certainly mean a member will have less income in retirement and, as a result, unlocking is only suitable for a very limited number of people and circumstances. Information on pension unlocking can be found on the FSA website.
What to look out for
Operators and members of occupational and personal pension schemes should be wary of websites offering immediate cash sums following a transfer. The release of benefits as an immediate cash sum is likely to have implications for both members and scheme administrators relating to charges imposed by HMRC.
Members should ensure that they take appropriate financial advice before using such websites and be aware of the potential for charges being imposed by HMRC. Some of the people promoting these schemes may be authorised as financial advisers, so ask your adviser to explain the full consequences to you.
If administrators or trustees encounter any requests for transfers via websites offering immediate cash on transfers, they should ensure that appropriate due diligence checks are carried out.
What action is The Pensions Regulator taking to tackle pension liberation?
The Pensions Regulator expects the trustees of occupational pension schemes to comply with legislation and act in accordance with their fiduciary duties and in members’ best interests. If trustees fail to adhere to these requirements we will take action where appropriate.
The regulator’s powers to ensure that members are protected include the:
- suspension and/or prohibition of trustees
- appointment of new trustees to schemes
- issuing of financial penalties.
The regulator continues to investigate new reports of liberation and will continue to co-operate with the pensions industry, other government agencies and law enforcement agencies to ensure liberation is prevented, deterred and disrupted.
Who to contact
If you are concerned or are approached and offered the services we have described above, you should contact either of the organisations below. Please provide as much infirmation as you can about the services and the firms involved, including their contact details and 'firm reference number' (FRN) if they claim to be authorised by the Financial Services Authority (FSA).
The FSA's consumer helpline on: 0845 606 1234
HMRC's Pensions Anti Fraud Unit on: 0115 974 2147
The Pensions Regulator on: 0845 600 0707
You can also check the FSA's register which lists all authorised financial services firms.