RPSM03110090 - Technical Pages: Protecting pension rights from tax charges: Retained benefit practice before 6 April 2006: September 1991

IR12 Practice Notes September 1991 version

7.4

Benefits greater than 1/60th of final remuneration for each year of service may be given up to a maximum of 1/30th of final remuneration for each year of service (up to 20 years) provided that the aggregate of the benefits in respect of service with the current employer together with any retained benefits does not exceed 2/3rds of final remuneration (but see paragraph 7.7 in relation to controlling directors and paragraphs 7.14 and 7.15 in relation to aggregation of benefits).

Easement

For members whose earnings for the first year’s employment following entry to the scheme (if a member of more than one scheme of the employer, the test is applied following entry to the first scheme) do not exceed 1/4 of the permitted maximum (determined at its level on entry) and who are not, and have not been within 10 years prior to joining the scheme, controlling directors in respect of the employment being pensioned, the maximum benefit is a pension of 1/30th of final remuneration for each year of service (up to 20 years) without reference to retained benefits. Except where it is clear from the outset that earnings exceed the threshold, the test will need to take place 12 months or so after the member joins the scheme. Schemes providing benefits on the basis of this paragraph may therefore wish to qualify any benefit promises given on joining.

7.5

The limit in paragraph 7.4 is qualified in respect of a money purchase scheme. Benefits payable from such a scheme prior to normal retirement date cannot be restricted in accordance with that limit as a result of preservation legislation (Social Security Act 1973). In these circumstances the limit is the greater of

1. 1/60th Final remuneration for each year of service (up to 40) increased by 57 per annum compound or a greater percentage provided this does not exceed the increase in the retail prices index during the deferment period and
2. the total benefits the individual could have expected to receive at normal retirement date calculated on the same basis that applies for incapacity together with any statutory increases required by the relevant DWP legislation

except that in relation to b there is substituted the actuarial equivalent of the total benefit the member could have expected to receive at normal retirement date.

Controlling directors with continued rights

Lump Sum retained Benefits

8.26

For controlling directors entitled to continued rights, the lump sum benefits payable from the relevant personal pension schemes and retirement annuity contracts (viz lump sums from all such schemes and contracts, not just those arising from premiums or contributions paid in respect of relevant earnings from that employer) are to be taken into account as retained benefits when calculating maximum benefits to ensure that the aggregate of lump sum scheme benefits and retained benefits does not exceed 1.5 times final remuneration.

16.20

For individuals accruing benefits faster than 1/60th for each year of service with an employer or 3/80ths for each year of service for lump sums retained benefits must be taken into account when calculating Inland Revenue limits.

A value will be given to such retained benefit.

1. when a member’s entitlement under the scheme is first determined on entry,
2. if a member’s entitlement is revised, and
3. when a member’s benefits crystallise on leaving pensionable service, or when they become payable (subject to paragraphs 16.22 and 16.28 as appropriate).

The valuation of a retained benefit may not be straightforward if it comes into payment other than at the date that benefit entitlement vests under the current employer’s scheme. The following paragraphs give guidance on acceptable methods of valuation and the circumstances in which a subsequent revision of that valuation will be necessary.

16.21

Pensions already in payment, although they have an enhanced value by reason of earlier payment, may nevertheless be taken at their current amount (but see paragraph [16.23] if subject to revaluation). Similarly lump sum benefits already paid are taken at their actual amount and their pension equivalents calculated as if received (or to be received) concurrently with scheme benefits.

16.22

Pensions which will not come into payment until after normal retirement date or the actual date of retirement or leaving pensionable service under the current employer’s scheme should be taken into account on the basis of their actuarial equivalent (viz the actual amount of benefit that could be secured or provided) at that date or, alternatively, brought into account once they begin to be paid. where the former basis is applied, the value of the retained benefit is the amount of pension benefit that could be secured or provided at normal retirement date but if the valuation is occasioned by the member leaving pensionable service or retiring before normal retirement date, the retained benefit should be brought into account on the basis of the actuarial amount of benefit that could be secured or provided at the date of leaving pensionable service or early retirement as appropriate. Where the retained benefit is the benefit that can be purchased from a cash fund (as in paragraph 16.25), the amount that could be secured or provided at that the relevant date under the current employer scheme is calculated by applying an appropriate annuity rate to the fund after allowing for prospective revaluation in accordance with paragraph 16.23 and for any other benefits prospectively payable such as an own right spouse’s pension. Lump sums which will not come into payment until after the date on which a member’s entitlement vests under the current employer’s scheme may be appropriately discounted in valuing them as retained benefits for the purpose of any necessary restriction of the lump sum payable from the current employer’s scheme.

16.23

A retained benefit may be subject to a provision for increase by reference to the rise in the cost of living, either fully or up to some stated percentage, during the period before benefit entitlement vests under the current employer’s scheme.

Increases for the period before the valuation date should be taken into account or valued on the basis of the appropriate scheme rules subject to the requirements of the Social Security Act 1990. Notional increases should also be taken into account – in some schemes cost of living increases do not come into payment before age 55. Future increases should be assumed at 5% per annum compound or by reference to the stated percentage if less.

A pension subject to automatic increases at a fixed rate regardless of the rise in the cost of living should be valued by reference to that fixed rate.

16.24

A benefit may be secured by a with-profits or investment-linked insurance policy which will continue to increase in value during deferment. Its value as a retained benefit should be calculated on the assumption of a reasonable return (consistent with current and future expectations) on the paid-up value. The Inland Revenue consider that it is reasonable to assume that the policy value for both types of contract will increase at not less than 9% per annum unless the maturity date is less than 5 years ahead. In that circumstance it should be valued by reference to the current bonus rate or an estimate more closely aligned to yields currently obtainable.

16.25

Where benefits are expressed in terms of a lump sum to be applied on maturity to secure the benefits payable the value of those benefits should be calculated in two stages. The emerging lump sum should first be estimated on the basis set out in paragraph [16.24]. An appropriate annuity rate should then be used to convert that figure into its annuity equivalent. The annuity rate should take account of the employee’s normal retirement age under the current employer’s scheme and the funding assumptions set out in paragraph 13.10(b) and (c). If the calculation is being made at, or shortly before, the annuity commencement date, the life office’s current annuity rates should be used.

16.26

The value of a retained benefit in the form of a paid-up retirement annuity contract, or under a personal pension scheme should be taken as the notional value of the annuity assuming it will come into payment at the normal retirement date under the current employer’s scheme. the same assumptions and annuity rates should be used as under paragraphs [16.24 and 16.25]. Where such a retained benefit comes into payment either before or after the vesting date (as defined in paragraph 16.20) under the current employer’s scheme, paragraphs 16.21 and 16.22 apply as appropriate.

16.27

Some retained benefits, such as those under some buy-out policies or personal pension schemes, offer a choice at maturity as to the form (within certain parameters) of the emerging benefits. In such cases the scheme should take a conservative view (i.e. in order to avoid overfunding, assume that the member will opt for the maximum permissible personal pension) as to what options the member will select at retirement. The basis explained in this paragraph should be used by all schemes irrespective of their date of exempt approval in respect of members joining after 31 July 1994.

16.28

A retained benefit valued on entry to the scheme will not be required to be revalued unless:

1. further improvements are made to the member’s prospective benefits from the current employer’s scheme,
2. the deferred pension (not being one from the Armed Forces Pension Scheme) qualifies for a full cost of living increase and exceeded £10,000 per annum at the time the new arrangement was set up. In this case its current value should be taken into account at retirement (or normal retirement date, if earlier, for a member with continued rights),

the member exercises an option which produces larger initial benefits than had been assumed under paragraph [16.27] above.

16.29

Benefits from the Armed Forces Pension Scheme do not fall within the general pattern of occupational pension scheme benefits and the terms used to describe the benefits require some explanation: