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There was a significant improvement in the members pension
rights for private sector companies with the introduction
of the Social Security Act 1973 (SSA
73). Prior to this Act members had no statutory rights
to any benefits accrued in an occupational pension scheme
for early leavers.
When the Act was introduced on 6 April 1975 it allowed
for the preservation of a members pension rights, known
as preserved benefits, after 5 years of service and would
include both employee and employer contributions. For
less than 5 years service the scheme member was entitled
to a refund of their contributions. Preserved
benefits in a previous employers pension scheme can
be left to accrue until the normal pension age (NPA) of
the scheme member.
As a result of Social Security Act 1986 the members pension
rights can be left as a deferred
pension if the individual leaves with 2 or more years
of pensionable service or, if less than 2 years of service,
receive a refund
of contributions. For a final salary pension the members
deferred pension could be granted discretionary benefits
by the scheme trustees and could be entitled to other
benefits such as a widows pension.
An individual may wish to have a more flexible income
at retirement and opt for, from their employer
pensions, a pension transfer to a money purchase scheme
where they could take pension
withdrawals rather than a compulsory purchase annuity.
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Indexing benefits
Since the Social Security Act 1990 all occupational pension
schemes must incorporate indexation of accrued benefits in line
with the retail price index (RPI) to retirement age. Since 6
April 1997, limited
price indexation (LPI) has applied to approved schemes and
exempt approved schemes for indexation of pension income after
retirement age, including deferred pensions.
In a final salary pension, deferral may result in the member
benefiting from any surplus realised in the scheme. For money
purchase such as an additional voluntary contribution (AVC)
scheme or group
personal pension (GPP) indexation does not apply on deferral
but the pension fund value will increase by the investment
return on the underlying assets.
Members that leave a final
salary pension before their normal retirement age with
2 or more year's service can have their benefits held in the
scheme until the stated retirement age. The benefits will
be index linked at the rate of inflation or 5.0% whichever
is the lower. A refund of pension contributions is available
for scheme members with less than 2 years service in a final
salary scheme. Tax and a contribution to purchase membership
of state pensions
will be deducted from the refund before payment. Scheme members
with over 2 years membership of a final salary scheme are
not eligible for a refund.
Since the Pension Schemes Act 1993 (PSA
93) the guaranteed minimum pension (GMP) part of a contracted
out schemes preserved benefits, has been subject to a minimum
level of revaluation
that applies to both public services schemes and private sector
employers. GMP accrued from 6 April 1993 up to 5 April 1997
of preserved benefits must have a revaluation equal to the
average earnings
index (AEI) of 7.0% and from 6 April 1997 this is reduced
to the RPI or a maximum of 5.0% a year.
For a scheme member nearing retirement, the definition of
final remuneration for the member can take into account increases
in pensionable earnings that have not kept up with the RPI
and this is known as dynamisation.
Any use of dynamisation will still be subject to the earnings
cap.
The earnings of the member during the definition years, say
the best three years except the final year preceding the retirement
age, will be averaged and revalued in line with the increase
in the RPI to give the final
remuneration. Dynamisation will usually increase the retirement
benefits in the form of a pension income and any commutation
to a tax free lump sum for the scheme member.
Pension transfers
Where a scheme member wishes to change from an existing pension
scheme to a new pension scheme, a pension transfer of member
rights will facilitate this move. During the early 1990s pension
transfers became controversial as regulation became more effective
and the Financial Services Authority (FSA)
revealed in the pensions
review that a substantial number of individuals were advised
to transfer their pension rights from final salary occupational
pension schemes to money purchase pensions and a buyout
policy commonly known as section 32 policies.
Poor advice was given because clients did not understand
the implications of a pension transfer or the advice given
was wrong and the client suffered financial loss. To give
advice on pension transfers from occupational pension schemes
independent financial advisers (IFA)
must be authorised by the FSA and hold a recognised qualification
such as G60 Pensions or equivalent, as specified by the permitted
activity 13 rule.
On divorce,
there must be advice given by an IFA even if the pension transfer
is as a result of a pension
sharing order granted by the court and where the scheme
rules do not permit dual membership. This means that an internal
transfer is allowed and the pension
credit to the former spouse
must then be applied as an external transfer to another pension
arrangement.
The amount of cash accumulated in a pension that can be transferred
from a previous employment to a new pension is called a transfer
value. The value is calculated by an actuary
in the case of an occupational defined benefit scheme or reflected
in the value of the pension fund in the case of a defined
contribution scheme such as a personal pension and stakeholder
pensions or money purchase scheme. It will normally be transferred
to a new scheme by section 32 policies or a personal pension
transfer plan.
When transferring retirement benefits from an occupational
pension scheme to a personal pension or similar plan, the
Inland Revenue apply actuarial
guidance note 11 (GN11) as a measure to prevent the scheme
member transferring the fund value and in the process produce
benfits at retirement age that are greater than the maximum
Inland Revenue benefits allowable under the occupational pension
scheme.
The transfer
value analysis system (TVAS) was introduced from 1 July
1994 and is a method specified by LAUTRO on the 1 January
1995, then the Personal Investment Authority (PIA) and now
the Financial Services Authority. The TVAS is applied to all
transfers from a final salary occupational scheme. The critical
yield calculated by the TVAS is required from a receiving
personal pension or section
32 policies to match at retirement age the benefits provided
by a final salary occupational pension scheme. For the purpose
of valuing the TVAS and future pension payments, a rate of
interest based on the annuity
interest rate (AIR) is used.
The AIR reflects the yield to redemption on high coupon medium
and long term gilt edge securities and is reviewed quarterly
by the FSA. The AIR will have an impact on the critical yield
such that a higher annuity interest rate would reduce the
critical
yield, discounting future pension payments at a higher
rate and result in a lower capitalised fund value needed to
provide a given pension income at the retirement age for the
scheme member.
At retirement it is possible for individuals of occupational
or personal pension schemes to exercise an open
market option to find the highest pension income. This
income can be paid as a level
annuity or can have added features such as a guaranteed
period, varying levels of survivors
pension or with RPI or fixed rate escalation.
Alternatively, the member may wish to increase flexibility
with pension
drawdown where the pension fund is greater than £100,000
and the member is not dependent wholly on this money to provide
an income in retirement.
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