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Limits on pension scheme transfers
Caroline Harrington looks at the recently issued draft regulations covering transfers between occupational schemes and personal pension plans which could limit transfer options. This article first appeared in the October 2000 issue of Pensions Management magazine. For more details contact Caroline Harrington in the Amersham office.
The Inland Revenue recently issued draft regulations covering transfers between occupational schemes and personal pension plans. The need is to ensure that surpluses are not passed from an occupational scheme, where pensions are limited, to a personal pension plan, where pensions are unlimited. Existing legislation requires a member's fund to be checked against a maximum limit (often known as a "GN11" test - referring to the Institute of Actuaries Guidance Note). The proposed changes are more dramatic than many realised.
This test will be more common in future, since it will now apply to all those earning over half the salary cap, (i.e. more than £45,900).
Current Position
Current legislation specifies how the paid-up pension should be calculated, and how this may be escalated at 5% a year before retirement, and 3% a year once in payment. A distinct advantage of the current legislation is that account can be taken of market rates for annuities - this has been important recently as the cost of annuities has risen. The current legislation also allows the actuary to take account of underlying interest rates and mortality rates at the time of the transfer. One problem of the current legislation is the allowance for fixed increases of pensions in payment of 3% per annum, which is now clearly out of date.
Proposed basis
Inland Revenue are suggesting a radical change away from the current market-related basis to a fixed basis. This proposed basis specifies an interest rate of 8.5%, and a price inflation assumption of 5.3% for a pension in payment. Mortality table PA(90) must be used, and can be rated down one year. These assumptions bear no resemblance to a current market rates of interest and mortality. If the Scheme member took a maximum transfer value on the proposed basis they would not be able to secure their paid-up pension in the market. This seems ludicrous!
Mortality table PA(90), which must be used, is also out of date. Last year, the Continuous Mortality Investigation Bureau published their latest mortality tables, the PA92 series. These tables reflect recent dramatic improvements in longevity, and are particularly relevant for young members transferring who can expect further improved longevity by the time they retire.
Minimum Funding Requirement (MFR)
The Pensions Act 1995 introduced
MFR, as a minimum level for transfer values. This was to ensure that a Scheme was likely to have sufficient monies to buy the accrued pensions. The proposed regulations, in setting an upper limit on transfer values, in some cases produces transfer limits lower than the
MFR minimum. The graph below illustrates this for a male with a paid-up pension of £10,000 per annum. It shows that the proposed basis would give a transfer of less than the
MFR for anyone aged over 50! Furthermore, the
MFR figures in the table use current market rates. If market rates rise then the
MFR figures would increase and the age at which the
MFR basis exceeds the proposed transfer limit would be even lower.
There are a host of other inconsistencies in the proposed legislation:
- Why calculate Post '89 benefits using the N/NS formula applicable for Pre '87 members? This contradicts the legislation for calculating paid-up benefits for these members.
- Peculiarly, the proposed legislation includes an assumption for future salary growth (6.9%). The graph below allows for this. Had the graph allowed for increases in deferment at only 5.3% then the MFR transfer values would be higher than the "maximum" transfer for all people over the age of 39!
The proposed move away from market-related transfer values will restrict the options for those preferring a personal pension plan environment. Such restrictions negate the new retirement flexibility sought by all. It is to be hoped that the Revenue listen to the many objections to their proposals and reconsider.
Caroline Harrington, October 2000.