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Maximum transfer value regulations
Caroline Harrington from Barnett Waddingham's Amersham office reviews the new transfer regulations which came into force on 6 April 2001.
This article appeared in the March 2001 edition of Pensions Management magazine.
Transfers from occupational schemes have been commonplace for many years. But it wasn't always so. Before "preservation" arrived in the 1970s, transfers were rare. No one doubts now that preservation was a good change: why should someone leaving pensionable employment before retirement lose their pension benefit? So leavers became entitled to a "preserved pension", and quite right too.
These preserved pensions were popularly called frozen pensions, but after revaluation was introduced that became a misnomer. Pension scheme members became much better off. But if preservation was good, what about transfers?
Perhaps - with hindsight - many recent pension problems would never have happened if members had kept their preserved pensions. No pensions mis-selling scandal. But it is not reasonable to expect pension transfers to be uninvented - although there are fewer than there once were.
In recent times, as final salary schemes have become threatened, fewer employers are willing to offer "added years" in return for transfers received. Contracted out schemes have become reluctant to accept transfers - worried less they then become liable for the cost of retrospective GMP equalisation costs. And now new regulations bring new difficulties for high earners trying to transfer their pension benefits.
From 6 April 2001 transfers from occupation schemes to personal pensions are subject to new legislation. My
article in Pensions Management in October 2000 described what were then draft proposals for new transfer value limits. Many individuals and pensions bodies complained about the Treasury proposals - but to little avail. In spite of obvious flaws in the new limits, the actual Regulations issued on 11 January were largely unchanged (Statutory Instrument 2001/119). Some changes did help - as in all these things there was good and bad news.
Good news: wider exemptions
The new regulations only apply to "controlling directors" (essentially those owning or controlling 20% or more of the company's shares), and anyone over age 45 whose remuneration has exceeded the earnings cap. This is a more generous definition than originally proposed, and is welcomed.
Good news: MFR transfers can always be paid
Since April 1997, there has been a statutory minimum on transfers from occupational schemes - the Minimum Funding Requirement (MFR) reserve. It is quite possible for the MFR transfer to exceed the new minimum laid down in the transfer regulations and the Treasury's draft proposals would have prevented schemes complying with the Pensions Act 1995.
Sensibly the Inland Revenue will now permit members of final salary schemes to an MFR transfer as a minimum. Welcome though this is, it is odd that the new limit on the maximum a member can transfer to a Personal Pension Plan is fighting MFR, which was introduced as a minimum.
Anyway this will not help money purchase schemes where there is no MFR transfer. I wonder if some money purchase schemes with a transfer limit problem might convert to a defined benefit promise immediately before the transfer to allow an MFR reserve to be transferred as a minimum?
Now the bad news
The cost of pensions varies according to financial markets. And pension schemes are invested in stocks and shares whose values change from day to day.
Last year when the draft proposals suggested a new fixed transfer test, regardless of markets, our complaints fell on deaf ears. It is disappointing that the Pension Schemes Office (PSO) introduced such a fixed basis.
We had been hoping that the transfer value would include some market-related adjustment. The Revenue said this was unnecessary - it could vary the limits from time to time to reflect changing markets.
Fine if we could rely on them to do so but their record suggests they will not. For example, for several years now the reserve permitted in a director's pension scheme has been less than the market cost of buying a two-thirds salary pension in the market. Schemes showing a surplus on the Revenue's basis cannot actually afford to buy the maximum permitted benefit.
Given the timescales needed to introduce the new legislation we cannot rely on the PSO being quick to react to a fall in annuity rates.
More bad news: less choice
Successive governments have encouraged the "ownership" concept in pensions. First personal pensions and now stakeholder pensions.
People like the new flexibilities, particularly at the time of retirement. More and better information is available about the value of their pension benefits and they like to be able to choose the most appropriate pensions vehicle for their circumstances.
This is particularly true now that "drawdown" retirement funds can remain invested into retirement - not without investment risk - but in the right circumstances the ability to draw a variable income and defer the insured annuity purchase to age 75 can be attractive.
These new limits are affecting just those higher earners best suited to take advantage of drawdown. These individuals do not need the guarantees that fixed pensions bring.
Often emotion affects their transfer decision - if they have left service with the Company they can feel more comfortable taking their benefits out of the company scheme. If these people's funds are higher than this new maximum test then they may not be permitted to transfer their benefits out of the scheme to a personal pension.
Death benefits constrained
For no good reason the Inland Revenue has created differences between company schemes and personal pensions. For example, personal pensions may normally allow a member's family to withdraw the full value of their pension fund less 35% tax in the event of death during drawdown.
Company schemes cannot offer this benefit, which is an attractive feature for single members, or those in bad health. Harsh indeed to deny this simple feature to those caught by the new transfer limits.
As mentioned previously, preservation legislation was introduced to protect members, and was a good thing. But preservation can work against members of a generous money purchase scheme.
If they leave service before normal retirement date then they are entitled to the whole of their benefits.
But if their maximum transfer value was just slightly less than their fund share in the scheme they are not allowed to forgo that small difference: preservation legislation means that a transfer to a personal pension cannot proceed.
Silly transfer restrictions remain
Paragraph 10.22 of the practice notes does not permit transfers at all if a member is already in receipt of his pension, or if he has already reached normal retirement date.
In fact the PSO has partly relaxed their rules, but they haven't told many people. The Association of Pensioneer Trustees were authorised in 1998 by the PSO to tell its members that transfers could be made after retirement age if benefits had not started and the member was still in service (why on earth this second restriction - where is the scope for tax abuse here?) There is therefore still some confusion throughout the industry as to how and when these rules apply.
Convert to a personal pension?
The Revenue also recently opened the door to convert a company pension scheme member's benefits into a personal pension still inside the company scheme. This is a new option for small self administered schemes (SSASs) (Statutory Instrument SI 2001/118).
This is only permitted after 6 April 2001, and although there will be no actual transfer, the new transfer value test limits do still apply. As long as the Pensioneer Trustee remains then this should be sufficient for the conversion to go ahead. The switch need not apply to all the members of the SSAS - individual members can pick whether they live by company scheme rules or personal pension rules. This would mean that those members coming up to pension age could choose to be subject to the personal pension plan rules, while leaving other members of the SSAS under the existing SSAS rules. They could in turn convert their share of the funds if this suits them. And furthermore SSAS members already on pension can switch to Personal Pension rules.
There is increasing pressure for pension simplicity. And we are led to believe the message had reached the Revenue. But these new restrictions show that nothing has changed. It is a shame that the PSO did not take the opportunity in the new regulations to make our life and theirs simpler.
This article appeared in the March 2001 edition of Pensions Management magazine.
For further information, see Caroline's
October 2000 and
November 2000 articles on the same topic.
Caroline Harrington, May 2001.