Chapter 5 - Defined Benefits Flashcards
Defined cash schemes
These were schemes that generally limited the benefit provided so that it fell within the pre- A-Day HMRC limits for tax-free cash alone. Thus, prior to the introduction of the PCLS from 6 April 2006, schemes had generally tended to provide a lump sum of 3/80ths of final pay for each year of scheme membership. These schemes still exist, but are only 100% cash for transitionally protected pre-A-Day benefits.
Setting up the scheme
A defined benefit scheme is governed by a trust. Under this trust, the trustees hold the scheme’s property for the benefit of the members of the scheme. The scheme must also have its own set of rules. The trustees must administer the trust in accordance with trust law and the requirements of the Pensions Act 1995 and the Pensions Act 2004.
Accrual of benefits
Example 5.3
Mark started working for his company on 1 May 2011 and he joined the defined benefit scheme after a one-year waiting period. He reached the scheme’s normal pension age on 1 May 2022. The scheme has an accrual rate of 1/60th for each year of pensionable service. Mark’s basic salary was £39,000 and he had a company car with a taxable value of £6,000. The scheme’s definition of pensionable salary is basic salary.
Based on Mark’s final pensionable remuneration, the defined benefit scheme provided a pension of:
10/60ths × £39,000 = £6,500.
Mark’s pensionable service is less than his service with the company, but the shorter period of service is used because this is the definition of service stated in the rules of the scheme. Similarly, his pension is based on £39,000 rather than his total remuneration of £45,000, because the scheme’s definition of pensionable salary is basic salary.
Employer’s contribution
The employer usually contributes into the scheme on an annual basis. The scheme’s actuary will calculate the level of contribution required on a regular basis, which must be at least every three years. This is known as the funding rate.
cost depends on a number of factors, such as:
* the level of the members’ final pensionable remuneration in future;
* the investment returns achieved by the underlying pension fund;
* the annuity rates available when a member comes to retirement, unless the pension income comes directly from the scheme’s assets, in which case annuity rates are not an issue;
* the cost of providing guaranteed benefits to members who leave the scheme before the scheme’s normal pension age;
* the number of members who die before the scheme’s normal pension age; and
* the profile of the scheme membership, e.g. the age and marital status of the members, which determines the period over which the contributions will be made and the level of spouse’s benefits that may need to be provided.
Statutory escalation of benefits in payment: member reached SPA before 6 April 2016
Pre-1988 GMP
- The scheme does not have to provide any escalation. The State is responsible for paying the increases to the GMP, which will be fully in line with the increases in CPI, and will pay these along with the member’s other State Pensions.
GMP accrued between 1988 and 1997
- The scheme is responsible for paying increases to the GMP in line with increases in the CPI to a maximum of 3% p.a. Where CPI exceeds 3% in any year the additional escalation up to full CPI escalation is paid by the State.
Non-GMP accrual prior to 6 April 1997
- No requirement for any statutory increases.
Pension for service after 5 April 1997 but before 6 April 2005
- Must escalate in payment in line with CPI to a maximum of 5% p.a.
Pension for service after 5 April 2005
- Must escalate in payment in line with CPI to a maximum of 2.5% p.a.
Statutory escalation of benefits in payment: member reaches SPA on or after 6 April 2016
Pre-1988 GMP
The scheme does not have to provide any escalation.
GMP accrued between 1988 and 1997
- The scheme is responsible for paying increases to the GMP in line with increases in the CPI to a maximum of 3% p.a.
Non-GMP accrual prior to 6 April 1997
No requirement for any statutory increases.
Pension for service after 5 April 1997 but before 6 April 2005
-Must escalate in payment in line with CPI to a maximum of 5% p.a.
Pension for service after 5 April 2005
-Must escalate in payment in line with CPI to a maximum of 2.5% p.a.
Pension increase exchange
Many defined benefit schemes now offer a pension increase exchange where the member is offered the option of giving up future guaranteed increases to their pension in return for a higher initial pension with no future increases other than statutory increases
