RPSM03301028 - Scheme Administrator Pages: Protecting pension rights from tax charges: Valuing pension rights: Arrangement types

The four types of pension arrangement

The classification of a pension arrangement is dependent on the type of benefits being provided by the arrangement. So an arrangement providing defined benefits will be a defined benefits arrangement. With the exception of a hybrid arrangement an arrangement can only provide one potential type of benefit. So a pension scheme providing main benefits as defined benefits and top up benefits as money purchase benefits will contain at least two arrangements – a defined benefits arrangement and an other money purchase arrangement.

Other money purchase arrangements

This is a money purchase arrangement that does not providing cash balance benefits. The amount of benefits provided is wholly dependent on the amount of payments made to the arrangement by or on behalf of the member.

Former personal pension schemes, most retirement annuity contracts (see RPSM03101091) and most small self administered pension schemes will fall into the other money purchase arrangement category.

Cash balance arrangements

The amount of benefits provided is dependent on the amount that has been promised will be made available to provide those benefits. However unlike an other money purchase arrangement the amount available to provide benefits is not dependent on the payments that have been made by or in respect of the member of the arrangement.

For example a member is promised that £3 million will be made available to provide pension benefits. The member does not know exactly how much pension and lump sum they will receive, just that it will cost £3 million to provide those benefits. Benefits worth £3 million will be provided regardless of the money that is in the arrangement at any point in time. If there is more than £3 million in the member’s arrangement only £3 million can be provided. Similarly if there is less than £3 million in the arrangement, benefits worth £3 million must still paid. Further funds will need to be put into the arrangement by, for example, the employer so that the promised benefits can be paid.

Defined benefits arrangements

The amount of benefits provided is not dependent on the amount that will be made available to provide benefits. An example of a defined benefit is the provision of a pension of 1/60th of salary for each year of service with an employer.

Hybrid arrangements

A hybrid arrangement is an arrangement where more than one type of benefit is potentially payable. But when benefits crystallise the amount and type of benefit will be set and the hybrid arrangement will turn into one of the arrangements listed above. An example of a hybrid arrangement is where a member’s benefits is being provided with money purchase benefits with a final salary underpin of 1/100th salary for each year of service. If the benefits from the money purchase funds are greater than the final salary underpin the member will be given benefits on a money purchase basis and the arrangement will become an other money purchase arrangement. However if the final salary benefits are greater in value these will be paid and the arrangement will become a defined benefits arrangement.