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Revaluation for Early Leavers
Pensions Beginners Page
Welcome to the fifth in a series of articles designed to introduce readers to some pensions' related topics.
Revaluation for Early Leavers
Introduction
When a member of a final salary pension scheme leaves having completed at least 2 years service, they become entitled to a preserved pension in respect of the benefits (excluding lump sum death in service benefits) that have accrued during their membership of the scheme. The preserved benefit remains in the scheme until the member retires or decides to transfer the benefit elsewhere.
Preservation Legislation
Preservation was introduced by the Social Security Act 1973 and came into effect on 6 April 1975. At that time to qualify for a preserved pension you had to be over age 26 and have at least 5 years qualifying service. Prior to that most leavers lost their pension rights, just getting a taxable refund of their contributions instead.
To prevent the value of a preserved benefit diminishing over time through the effect of inflation, preservation legislation was extended by the Social Security Act 1985. This introduced the requirement to increase (or "revalue") in deferment (i.e. the period between leaving service and retirement) that part of a preserved pension, in excess of the Guaranteed Minimum Pension (GMP), which related to service completed on or after 1 January 1985. It applied to members who leave service on or after 1 January 1986. For further information on GMPs please follow this link to our earlier article "What is a GMP?"
Subsequent legislation removed the age qualification and reduced the qualifying service requirement from 5 years to 2 years.
The Social Security Act 1990 further extended the revaluation requirements to cover the whole of the member's pension, in excess of the GMP, for members leaving pensionable service on or after 1 January 1991.
Revaluation of benefits in excess of GMP
This is where it gets complicated!
Preserved benefits in excess of GMP must be increased for each complete year in the period of deferment. The minimum increase that must be applied is notified each year when the Secretary of State makes an Occupation Pensions (Revaluation) Order (known as "Section 52a orders") which gives the revaluation percentage to apply for periods of deferment ending in the year that the Order comes into force.
The increase factors are based upon the rise in the Retail Prices Index over the period, but limited to 5% per annum over the whole period.
For ease of use most reference tables show the factors tabulated by year of retirement and years of deferment, however this is not the format used in the Orders.
Section 52a orders have a list of revaluation periods and their associated factors. Each revaluation period begins on a 1 January and ends on the 31 December prior to the order coming into effect.
For example the 2003 Order (effective from 1 January 2004) has revaluation periods of:-
| 1 January 1986 to 31 December 2003 |
| 1 January 1987 to 31 December 2003 |
| 1 January 1988 to 31 December 2003, and so on down to |
| 1 January 2003 to 31 December 2003. |
The factor to apply for a preserved member retiring in 2004 will be that for which the revaluation period contains the same number of complete years as the period of deferment.
Thus a member who left the scheme on 1 July 1996 and retired on 1 August 2004 will have been deferred for eight complete years, making 1 January 1996 to 31 December 2003 the relevant revaluation period.
If the same member retired on 1 June 2004 there would be seven complete years of deferment which would make 1 January 1997 to 31 December 2003 the relevant revaluation period.
GMP revaluation
AnyGMP element of a preserved pension must also be revalued, from the date a member ceases to be contracted-out of the State Scheme until their State Pension Age, but the method is different to revaluing excess benefits. Currently, trustees have the choice of two different methods of revaluing GMPs: Full Rate increases or Fixed Rate increases.
Schemes which opt for increases at Full Rate increase their GMPs annually in line with Section 148 Orders (previously known as Section 21 Orders). Section 148 Orders are based on the increase in the National Average Earnings Index each year.
Fixed Rate revaluation increases are determined by the date of termination of pensionable service. The annual percentage increase is fixed and depends on the date of leaving as follows:
| Leavers between 6 April 1978 and 5 April 1988: |
8.5% |
| Leavers between 6 April 1988 and 5 April 1993: |
7.5% |
| Leavers between 6 April 1993 and 5 April 1997: |
7.0% |
| Leavers between 6 April 1997 and 5 April 2002: |
6.25% |
| Leavers after 6 April 2002: |
4.5% |
The revaluation period for GMPs is the number of complete tax years between a member's date of leaving and their 65th birthday, or 60th if female.
Money Purchase Schemes
Statutory revaluation does not apply to Money Purchase arrangements. Instead, any investment returns earned by a member's money purchase fund after they have left the scheme must be used to provide additional benefits for the member. Administration expenses can be deducted but these must not be greater than the expenses that would have applied if the member had remained in service.
Sue Manning & Chris Elliott, December 2005.