Pensions redress newsletter October 2024 – How might the Budget affect redress payments?

Ahead of this month’s Budget, I’m going to summarise the tax adjustments made in pension redress calculations and discuss the potential impact of any changes announced by Rachel Reeves.

When we calculate redress for a consumer who has received unsuitable financial advice to transfer their pension to an alternative arrangement, we compare:

• The value of the transfer proceeds (i.e. the current value of their defined contribution pension pot)

with:

• The value of their pension had they not received the unsuitable advice

This comparison is normally carried out gross of tax. In other words, the calculation tells us how much would need to be paid into the current pension pot to provide the pension that they would have received had they not transferred out.

Although the redress rules do allow for redress payments to be paid into the current pension pot in this way (subject to annual allowance restrictions), it’s rare for this to happen in practice.

This is because:

1. Consumers tend to prefer to receive a cash-in-hand payment
2. The advising firm finds it easier to make the redress payment directly to the individual than to pay money into a personal pension arrangement.

Pensions in payment are subject to income tax, whereas cash-in-hand redress payments do not normally attract tax charges. So if the consumer were to receive the gross redress as a lump-sum payment, they'd be overcompensated.

This is where tax adjustments come in.

For someone who has yet to retire, the general rule for adjusting gross redress to calculate an appropriate cash-in-hand redress payment is to reduce it by:

• 15%, for someone who is expected to be a basic-rate taxpayer in retirement
• 30%, for someone who is expected to be a higher-rate taxpayer in retirement.?

You'll see these percentages on letters from the Financial Ombudsman Service.

The adjustments are based on the premise that:

• One-quarter of the loss in the value of the pension (this being the gross redress) could have been taken tax-free as a pension commencement lump sum
• The rest would have attracted tax at the consumer’s marginal rate of income tax.

The 15% reduction therefore comes from (0.75 x 20%) and the 30% comes from (0.75 x 40%).

From this you can quite easily see that if the tax rules change so that less pension commencement lump sum can be taken tax-free, then the 15% (or 30%) adjustment will become inappropriate.

For example, if the consumer has no remaining tax-free cash allowance, then we would need to apply a bigger reduction, reflecting the increased tax paid by the consumer on their ‘lost pension’. And that would mean lower redress payments.

There would be a similar fall in redress if income tax rates rose.

Of course, there are plenty of other complexities that could arise.

Let’s take the example of a consumer who transferred from a defined benefit pension scheme to a defined contribution scheme, and has yet to reach retirement age in the defined benefit scheme. If they have already taken their maximum cash lump sum, then they may have benefited from an advantageous tax position compared to taking the cash at retirement age in the defined benefit scheme.

I'd argue that this should be reflected in the redress calculation.

Latest First Actuarial Redress Index update

We’ve updated our First Actuarial Redress Index to show movements in typical redress over Q3 2024.

Our modelling shows that for a ‘typical case’ – where the transfer took place after the introduction of pensions freedoms and the consumer is currently aged 50 – we’d expect a redress calculation carried out at 1 October 2024 to show that the consumer hasn’t suffered a loss.

It’s important to note that redress is highly sensitive to the specific circumstances of each case, and firms should not assume that all complaints would result in a no-loss outcome.

How can First Actuarial help me?

Learn more about First Actuarial’s pension transfer redress services here – Pension transfer redress services - First Actuarial.

Or get in touch with me, Sarah Abraham, at [email protected] to discuss your redress needs.

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