The following sets out in detail the rules applying to the GMP that apply to members with pre 6 April 1997 service in a defined benefit contracted-out scheme.
Many clients will have part of their overall pension rights held in final salary (defined benefit schemes). Many of these schemes were, and are, contracted out of the second tier of State Pension provision.
Whether a client wishes to know the transfer value of these benefits or understand what their eventual pension entitlement might be, it is important to understand how the pre April 1997 contracted-out element of the preserved benefit entitlement works.
What is contracting out?
If a scheme contracted out of the State Earnings-Related Pension Scheme (SERPS) prior to 6 April 1997, the members were forgoing the guaranteed earnings related pension provided by the government, on the basis that minimum pension benefits were to be provided within a COSR or money purchase scheme. This removed the responsibilities from the state to provide the client with a SERPS supplemental pension for the time that the member participated in the pension scheme.
To be contracted out an individual had to be earning at least the amount of the lower earnings level and paying or treated as paying standard rate Class 1 national insurance contributions on those earnings.
This means that only employed persons could accrue a GMP entitlement.
Did contracting out affect basic state pension?
No. The basic state pension and SERPS are two separate pension arrangements.
What is GMP?
The benefits accrued within the COSR or certain money purchase occupational pension schemes are known as GMP.
The majority of contracted-out money purchase schemes chose to offer protected rights instead, as these did not require the same level of guarantee that GMPs place on the scheme, but instead depend on investment returns within the money purchase structure.
GMP benefits intend to provide a pension broadly equivalent to the pension an individual would have earned had they remained in SERPS. It is the minimum pension which an occupational pension scheme must provide as one of the conditions of contracting out.
Once a member has left a pension scheme it is the scheme's responsibility to maintain the level of the member's GMP and increase it in deferment by a prescribed rate of revaluation. Legislation dictates certain types of revaluation to be applied.
The pension after state pension age must not be less than the revalued GMP entitlement.
How do the revaluation methods work?
Once an active member of the pension scheme has left service the scheme trustees are obliged to revalue the GMP element of the pension from the date they left the scheme to the date of retirement.
There are three ways of applying the revaluation to the GMP in deferment. They are:
Section 148 orders
Section148 orders revalue the guaranteed minimum pensions broadly in line with the National Average Earnings. A different rate of revaluation will therefore be applied for each complete tax year between leaving and GMP age (65 males, 60 females).
Limited revaluation is revaluation in line with Section 148 orders, limited to a maximum of 5% per annum.
When a scheme applied limited revaluation a ‘Limited Revaluation Premium’ (known as a LRP) was paid to the Department of Social Security by the scheme when a member left service. This covered the estimated cost of the state providing any increases above 5%, up to full revaluation under Section 148 orders.
Limited revaluation was abolished for leavers on or after 6 April 1997. However, it is still possible for preserved pension accrued before 6 April 1997 to have limited revaluation applied to the GMP element.
When applying a fixed rate GMP revaluation the rates are provided by the Government Actuary and are intended to be equivalent to the future increases in Section 148 orders. The rates are adjusted every few years* to reflect changing economic conditions. The revised rate applies to all leavers after that date of change and the GMP will be revalued over the number of complete tax years between the member's date of leaving and state pension age.
If National Average Earnings exceeds the fixed rate of revaluation applicable to the leaver, the government will make up the difference.
*See following table:
Date of leaving
Revaluation rate % per annum, compound
6/4/2007 – 5/4/2012
6/4/2002 – 5/4/2007
6/4/1997 – 5/4/2002
6/4/1993 – 5/4/1997
6/4/1988 – 5/4/1993
6/4/1978 – 5/4/1988
In general, Statutory Style Schemes (eg Local Government Pension Scheme or NHS etc) will revalue their members' GMP by Section 148 orders and escalate it in payment by statutory minimum. This method is not often used in private sector schemes as the liability to the trustees would be unknown and unlimited.
As a result, most private sector schemes will revalue GMPs by the fixed rate in deferment and statutory minimum in payment.
Historically, some schemes may have offset statutory revaluation on the GMP against other scheme benefits rather than add them to the member's deferred entitlement. This meant the total was lower as the statutory increases were incorporated into the other benefits as a replacement for part of them, rather than being added on top. This practice was known as full franking, and was forbidden for leavers on or after 1 January 1985.
In some cases, partial franking may be applied by the scheme. The most common occurrence is when the scheme retirement age is before GMP age, and the increases granted under the scheme to a pension in payment are offset against the GMP revaluation between retirement and GMP age.
What are the GMP escalation requirements?
GMP rights earned before 6 April 1988 will be increased in line with RPI and paid by the state by adding it to the basic state retirement pension. The same applies to any excess of RPI over 3% for rights built up since 6 April 1988.
Schemes must provide for increases of GMP in payment in line with RPI (up to 3%) for rights built up between 6 April 1988 and 5 April 1997.
Please note the state increases will not be awarded if the GMP (including increases before and after payment commences) is higher than the additional state pension that would have been received by the member had they not been contracted out.
A transfer of GMP to protected rights or scheme rights from 6 April 2005 does not qualify for increases to the additional state pension.
When can benefits be taken?
In normal circumstance, the earliest age is 65 for a man and 60 for a woman. There is no requirement to have retired before taking benefits.
GMP can be commuted on the grounds of triviality, but not before age 65 for men and 60 for women or earlier only on the grounds of serious ill health.
It is possible to defer taking GMP benefits to a later date. The scheme must increase the GMP by a set rate during deferment. If retirement is postponed for seven complete weeks or more beyond state pension age, GMP must be increased by at least 1/7% for each complete week.
For the post 88 portion of the GMP the increase would be applied after providing the escalation rate of RPI/3% per annum.
Widow's GMP is half the GMP to which the member was entitled (or prospectively entitled if benefits have not yet been taken) at the date of his death, including:
a) any increase due to postponement after state pension age, and
b) any increases to the GMP from state pension age.
Widower/Civil Partner's GMP is half that part of the GMP, to which the member was entitled (or prospectively entitled if benefits have not yet been taken) at date of the member's death, attributable to the tax year 1988/89 and subsequent tax years.
Scheme rules may provide for it to cease on remarriage before state pension age, or in other circumstances
The entitlement to a widow's/widower's/civil partner’s GMP cannot be reallocated by an unmarried member to enhance their own GMP.
Can GMP transfer to other registered pension schemes?
Yes, if the recipient scheme is willing to accept them. This could be another occupational scheme, a Section 32 policy (‘buy out bond’) or a personal pension. However, the ceding scheme must ensure that the full GMP liability can be met first. Scheme rules may prevent the transfer if the fund is insufficient to cover the GMP entitlement.
Transfers of GMP rights to COSR, money purchase scheme on a GMP basis and Section 32 policies must remain as GMP benefits. The GMP requirements that applied in the original scheme equally apply in the new scheme, ie providing spouses/civil partner’s pensions, revaluation of the entitlement etc.
On transfer to a money purchase scheme (non-GMP basis) or a personal pension, the GMP will be converted to scheme rights.
Please note a transfer of GMP to protected rights or scheme rights from 6 April 2005 does not qualify for increases to the additional state pension.
Accrued GMP rights may be transferred overseas to a qualifying recognised overseas pension scheme (QROPS), subject to certain requirements.
The Pensions Act 2007 provided a facility to allow contracted-out occupational pension schemes to convert members’ GMP to ordinary scheme benefits.
The DWP suggest that schemes may utilise this option in order to simplify their benefit structures, making the administration of the scheme easier. It also believes that members will be able to understand their pension rights more easily.
With effect from 6 April 2009, trustees of contracted-out defined benefit pension schemes can decide whether or not to convert GMP benefits. Before conversion can commence, trustees must gain formal consent of the employer and have taken reasonable steps to consult affected members.
The legislation requires the conversion to be made by means of actuarial equivalence. This is to ensure that the actuarial value of a member's rights before and after a proposed change, are compared to ensure that they do not fall in value as a result of conversion.
Converted GMP benefits still have to provide a spouse’s/civil partner’s pension for retirement and death benefits, although pension commencement lump sums are permitted to be taken and there are no restrictions on subsequent transfers out to other registered pension schemes for post conversion benefits.
For further information please contact your Old Mutual Wealth Business Consultant. Full details of Old Mutual Wealth Pension products can be found in the appropriate Member’s/Trustees' Guide, available from your consultant or Adviser Direct.