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What is a GMP?
Pensions Beginners Page
Welcome to the second in a series of articles designed to introduce readers to some pensions' related topics.
What is a GMP?
Guaranteed Minimum Pensions (GMPs) apply to members of Contracted Out Salary Related Pension Schemes (COSRS) who were contracted out of the State Earnings Related Pension Scheme (SERPS) prior to 6 April 1997. SERPS is now known as the State Second Pension (S2P).
The concept is that the occupational pension scheme will provide members (and widows/ers) with pensions at least equivalent to what they would have earned under SERPS - effectively privatising part of the State pension.
SERPS started in April 1978. Pension schemes that provided the minimum level of benefits (GMPs) could apply to contract out of SERPS. In return, the employer and members were allowed to pay lower rates of National Insurance. The discount given in respect of reduced National Insurance contributions is known as the "rebate".
This all sounds fine in principle, but as might be expected there is a good deal of administrative work that goes with contracting out, involving the employer, pension administrators and the National Insurance Contributions Office (NICO) of the Inland Revenue.
Leaving the Scheme
When a member leaves a COSRS, whether due to retirement, death or leaving service, the GMP needs to be calculated. The GMP calculation is complex and is most efficiently calculated by computer systems. The GMP has to be verified by NICO. The calculation is based on contracted out earnings (also known as band earnings) for each year of contracted out service. This is equivalent to the members earnings that are assessable to national insurance ie. earnings between the lower and upper earnings limits. When a member leaves a scheme the GMP is calculated as a weekly amount. This amount is then revalued to protect it against inflation to age 65 (men) or 60 (women).
Revaluation
There are various methods of revaluing GMPs. One way uses an index based on National Average Earnings, however many schemes adopted the 'fixed rate' method so that the amount payable at retirement is known when a member leaves the scheme. The amount of fixed rate revaluation depends on the date the member left the scheme and has reduced considerably over the years. In 1978 it was 8.5% per annum for each complete tax year between the date of leaving and State Pension Age. This rate has reduced at various intervals and is currently 4.5% per annum for new leavers.
Death
Provision of GMP includes a spouse's pension of one half the GMP, although for female members this only applies to GMP earned after 6 April 1988. This is payable on death of the member.
Transfers
A GMP liability can be transferred to another COSR, or a suitable Personal Pension or Contracted Out Money Purchase Scheme (COMP). In the latter case the GMP would be converted into Protected Rights (see below).
Changes over the years
There have been two significant changes to GMPs. The first came into effect on 6 April 1988. For GMPs earned before 6 April 1988 the State is responsible for paying annual increases on the GMP once it comes into payment. The increase is based on price inflation. For GMPs earned after 6 April 1988, the Scheme is responsible for inflation up to a maximum of 3% each year, with the State paying the balance of price inflation, if any.
Since 1988 some other types of scheme can be used for contracting out; Contracted Out Money Purchase Schemes (COMPS) and Personal/Stakeholder Pensions. These schemes do not have to give GMPs; instead, the benefit in lieu of S2P is simply whatever can be secured from the result of investing the National Insurance Rebate.
The next big change came in April 1997. Contracted Out Salary Related Schemes stopped needing to provide GMP in respect of contracted out service after that date. A much simpler test applicable to the whole scheme was introduced to evaluate the overall level of benefits being provided by the scheme rather than an individual guarantee for each member.
Conclusion
So that's GMPs, well at least an introduction! You will have gathered that administering them is complicated. The concept of contracting out remains for the time being, however, the number of COSRS in particular is in decline. Pensions Simplification is tackling the complexities of benefit and contribution limits, and many commentators now question the value of contracting out.
Nuala Hedges and Richard Young
Barnett Waddingham LLP, August 2005