RPSM03110120 - Technical Pages: Protecting pension rights from tax charges: Retained benefit practice before 6 April 2006: July 1997 version

July 1997 version

16.34

In addition to the specific duties placed on the administrator by tax legislation there is a general duty to administer the scheme in accordance with the terms of it trust deed and rules: approval is conditional upon the provisions included in those terms being complied with. Thus, amongst other things, the administrator has a duty to ensure that Inland Revenue limits on benefits are properly applied. Failure to comply with the terms of the trust deed and rules can result in the scheme’s approval being withdrawn .

16.35

Retained benefits may need to be valued:

1. when a member’s entitlement under the scheme is first determined on entry,
2. if a member’s entitlement is revised, and

when a member’s benefits crystallise on leaving pensionable service, or when they become payable (subject to paragraphs 16.38 and 16.47 as appropriate).

In addition retained benefits may have to be valued at the date of assessment when determining the maximum funding rate permissible for fully insured money purchase schemes.

16.36

The valuation of retained benefits 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

16.37

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 16.42 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.

16.38

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. The latter alternative is not available to a member with pre 1 June 1989 continued rights or a member not entitled to continued rights whose lump sum retirement benefit is calculated by reference to the scheme pension payable (see paragraphs 8.6 and 8.25). where the former basis is applied, the value of the retained benefit is:-

1. Where the valuation is at normal retirement date, the amount of pension benefit that could be secured or provided at that date,
2. Where the valuation is occasioned by the member retiring or leaving pensionable service before normal retirement date, the actuarial amount of pension benefit that could be secured or provided at the date of early retirement or leaving pensionable service as the case may be.

In assessing the annuity equivalent to the retained benefit in a and b above the calculation should assume that the retained benefits will take the same form as the benefits payable under the current employer’s scheme in terms of own right spouses’/dependants pension, post retirement increases, guarantees etc.

16.39

Where the retained benefit is the benefit that can be purchased from a cash fund (as in paragraph 16.44), the amount that could be secured or provided at the relevant date under the current employer's scheme in a) or b) of paragraph 16.38 above is calculated by applying an appropriate deferred annuity rate to the fund. In the case of a member retiring before normal retirement date, appropriate deferred annuity rate means the amount of pension the cash fund would buy at the date of early retirement, assuming that the retained benefits will take the same form as the benefits being provided under the current employer's scheme as explained above. In the case of a member leaving pensionable service before normal retirement date in circumstances not giving rise to the immediate payment of relevant benefits, appropriate deferred annuity rate means the amount of pension the cash fund would buy at the date of leaving pensionable service, again assuming the retained benefits will take the same form as the benefits being provided under the current employer's scheme, but taking account of revaluation during the period of deferment.

Example

Data:

Member leaves pensionable service of current employer at age 50 - normal retirement date 65.

Value of retained benefit cash fund at age 50 = £10,000.

Retained benefit subject to revaluation at fixed 5% pa during deferment.

Calculation:

The annuity value of the retained benefit at age 65 is, say, 11.62.

Allowing for increases at 5% pa for 15 years and discounting at 8½% pa, the deferred annuity factor at age 50 is 7.11. Therefore, the retained benefit should be taken as a pension of £1,406 (£1 0,000 ÷ 7.11).

16.40

Where in the case of a member leaving pensionable service before normal retirement date and not taking immediate benefits, the current employer's scheme is a money purchase scheme offering the member a choice at maturity as to the form of benefits, the principle in paragraph 16.46 should be followed.

16.41

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.

16.42

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 relevant Department of Social Security pensions legislation. 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.

16.43

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.

16.44

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 16.43. 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 published practice. If the calculation is being made at, or c-shortly before, the annuity commencement date, the life office's current annuity rates should be used.

16.45

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 1 6.43 and 16.44. Where such a retained benefit comes into payment either before or after the vesting date (as defined in paragraph 16.35) under the current employer's scheme, paragraphs 16.37 and 16.38 apply as appropriate.

16.46

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

A retained benefit valued on entry to the scheme will not be required to be re-valued 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); or

the member exercises an option which produces larger initial benefits than had been assumed under paragraph 16.46 above.

Retained benefits from this source should be quantified in accordance with the chart set out in paragraph 16.49.

16.49

16.50

Guidance is often sought as to whether retained benefits from earlier employments/occupations should be apportioned when later employments are concurrent.

16.51

when calculating benefits from concurrent employments the treatment of retained benefits from earlier employments or occupations will vary depending on whether or not the employments are associated or the relevant schemes are connected. Where the employments are not associated and the schemes are not connected any such retained benefits should be apportioned by reference to the initial remuneration where the concurrent employments commence simultaneously and each amount treated as a separate retained benefit. Where the concurrent employments do not commence simultaneously, the retained benefits should either be set fully against the earliest employment and ignored for subsequent employments, or be set fully against the earliest employment and then re-apportioned (on a remuneration basis) when the subsequent employments commence.

16.52

Where the concurrent employments are associated or the schemes are connected, the retained benefit in full is set against benefits from the employment which vests first and any unexhausted balance (see paragraph 16.53) is set against the benefits from the other employments successively as they vest. If all the benefits vest together the same principle applies but the sequence is immaterial. In this context the vesting date is defined in paragraph 16.35.