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What are the defined benefit Scheme features?

“Under DB schemes, the employer takes the investment risk. Employer and, if applicable, member contributions are set at a level determined by the actuary. They are then invested by the scheme trustees in order to meet the scheme’s ‘technical provisions’, i.e. the amount of assets required to cover the scheme’s future liabilities as they fall due.”

“An employee’s final salary DB pension will depend on whether they draw their pension at ’normal’ pension age, alongside the following three factors:

Pensionable service: this is usually the employee’s period of membership in the scheme.
Pensionable remuneration: this is the definition of earnings that is used to calculate the member’s benefits.
The accrual rate: the rules of the scheme will determine the rate at which benefits accrue, e.g. 1/60th of pensionable remuneration for each year of pensionable service.”

“Benefits in a career average scheme are calculated based on pension accrual on a year by year basis as follows:

each member accrues a proportion of their pensionable salary for each year of pensionable service e.g. 1/56th per year;
for active members of the scheme the amount accrued in each year will be based on the member’s salary for the year in question; and
each year’s accrual will then be revalued to retirement in line with the scheme rules; this could be in line with inflation (e.g. with increases in CPI) or by a fixed amount each year.”

“Another variation on a defined benefit scheme is the integrated scheme. With this type of DB scheme, the benefit provided at retirement age is reduced in some way to take into account the member’s Basic State Pension”


What is the difference between Flexible and Safeguarded benefits?

“Flexible benefits =

money purchase benefits, cash balance benefits and any benefit that is calculated by reference to a fund.”

“Safeguarded benefits =

benefits that are neither money purchase nor cash balance.”


What falls into the definition of safeguarded benefits according to the FCA?

“In Policy Statement 15/12 published in June 2015, the FCA confirmed that the following would fall within the definition of safeguarded benefits:

Policies with a guaranteed annuity rate (GAR). These are included because with GARs the benefits are calculated by reference to the guarantee and not just the plan value. The FCA, however, went on to add that in its view the factors to be considered in giving up a GAR are less complex than the range of benefits to be assessed under a defined benefit scheme and do not require a transfer value analysis.

The suitability assessment must, however, consider the value of the GAR that would be lost and the firm would still require the appropriate FCA permission.

Contracted-out DB schemes containing guaranteed minimum pension (GMP) are also regarded as containing safeguarded benefits as the DB scheme must guarantee to provide benefits at least equivalent to the GMP at the member’s State pension age.

Deferred annuities, also known as section 32 (S32) policies, that contain GMP are also safeguarded benefits. S32 policies are so named after the provision in s. 32 of the Finance Act 1981, which relates to deferred annuity contracts. They are known as deferred annuities as they will provide an annuity at some point in the future.


Who is eligible to join a DB Scheme and when?

“The rules of the scheme define who is eligible to join the scheme and when. Typical rules include the following:

a minimum entry age, e.g. 18 or 21;
a probationary or ‘waiting’ period before an employee may join the scheme – typically set up to one year, though it may be longer for those below a certain age;
differentiation between categories of employee, e.g. a scheme may differentiate between management, staff and workers; and
a different level of benefits offered to each category, e.g. more generous benefits are provided to the management category.
The employer cannot make membership of the scheme compulsory, although if the scheme is being used as a qualifying pension scheme, under the Pensions Act 2007, all eligible jobholders must be automatically enrolled into the scheme.”


What are the Employer contributions into a DB Scheme dependent on?

“the cost depends on several factors, such as the:

level of the members’ final pensionable remuneration in the future;

investment returns achieved by the underlying pension fund;

longevity assumptions within the pool of members and the associated costs of meeting the promised pension commitments – this is in effect similar to the way a life office calculates an annuity rate;

value of scheme assets, including member contributions paid;

cost of providing promised benefits to members who leave the scheme before the scheme’s normal pension age;

number of members who die before the scheme’s normal pension age;

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.

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.


What about the Employee contributions into a DB Scheme?

“As the costs of providing the promised level of benefits are unknown, most employers insist, as a condition of membership, that the employee pays a certain amount of these costs.”


Guaranteed Minimum Pension:

“Prior to 6 April 2016 the majority of DB schemes were contracted out. In a contracted-out scheme the member did not accrue any entitlement to Additional State Pension benefits, such as the State Earnings Related Pension Scheme (SERPS) or, since April 2002, the State Second Pension (S2P) for their period of pensionable service. Instead the scheme had to provide a certain minimum level of benefits to replace the Additional State Pension benefits given up. Members who were contracted out between 6 April 1978 and 5 April 1997 built up an entitlement to a guaranteed minimum pension (GMP), which was broadly the same amount as the pension they would have earned under SERPS. Contracting-out was not possible prior to the introduction of SERPS on 6 April 1978.

Contracting-out was abolished from 6 April 2016, but those who were members of a defined benefit scheme for any period between 6 April 1978 and 5 April 1997 will still have some GMP entitlement within the scheme.”


GMP where Member reaches State Pension Age before 6 April 2016

“Statutory escalation requires schemes to pay increases to GMP in payment of:

Pre-88 GMP – the scheme does not have to provide any escalation.
Post-88 GMP – 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 the member is in receipt of benefits from a GMP they will receive additional payments from the State to make up the difference between the increases that the scheme is required by law to pay on the GMP and the rate of increase in CPI.”


GMP where Member reaches SPA after 6th April 2016

“These members are entitled to the new State Pension. Those who had not reached their SPA by this date will have had a starting amount – known as a foundation amount – calculated. This will ensure the individual is not disadvantaged by the new rules. Where the individual was contracted out before 6 April 2016, a deduction, called the rebate-derived amount, will have been applied to the new valuation”

“once their new State Pension comes into payment it will increase each year without reference to how much GMP they are receiving. In other words, unlike the pre-April 2016 rules, no ongoing allowance will be made to account for any CPI increases paid by the scheme in respect of post-88 GMP.”

“Guaranteed minimum pensions will lose value under the new State Pension rules, however those with longer to go to SPA will build up higher amounts of State Pensions under the new rules. The impact of these reforms will be worse for individuals who, having spent long periods in contracted out pension schemes, are now close to retirement. This is because they will not have the opportunity to build up additional entitlement to the new State Pension to compensate for the loss of increase to GMP accrued”


Statutory increases to Pensions in Payment to individuals attaining SPA before April 2016.

“The following table summarises the statutory minimum increases for individuals attaining SPA before 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 in payment and will pay it 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. (known as limited price indexation (LPI)).

Pension for service after
5 April 2005

Must escalate in payment in line with CPI to a maximum of 2.5% p.a.”

“Prior to 2011, statutory increases were based on inflation as measured by RPI and this was changed by the then Government to the CPI from 2011 onwards. However, some schemes still use RPI to calculate increases to pensions in payment rather than CPI.”


Statutory increases to pensions in payment to individuals reaching SPA after 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. The State does not have to provide any escalation.

Non-GMP accrual prior to
6 April 1997

No requirement for any statutory increases. The State does not have to provide any escalation.

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. (known as limited price indexation (LPI)).

Pension for service after
5 April 2005

Must escalate in payment in line with CPI to a maximum of 2.5% p.a.”

“You should note that in the second table there is no longer any reference to GMP escalating fully in line with CPI. This is because for individuals who reach their SPA on or after 6 April 2016, there is no longer any increase made via the State Pension to reflect CPI increases on any GMP that the member may have. The only increases in payment to GMP for these individuals will be in respect of post-88 GMP where the scheme pays CPI increases up to a maximum of 3%. Otherwise, GMP will be paid on a level basis. Of course, the new State Pension that the individual receives will be index-linked.”



“Some schemes accrue the pension and PCLS separately, (known as ‘in addition’), e.g. the member may be entitled to 1/80th final pensionable remuneration for each year of service as a pension plus 3/80ths of final pensionable remuneration as a PCLS.


However, it is now more usual in DB schemes for the pension to be commuted to provide the PCLS, as follows:

the annual pension is reduced (commuted) on a pre-determined basis for every £1 of PCLS that is taken; and
the rules of the scheme will specify the commutation factor that will be used to reduce the pension, e.g. a commutation factor of 12:1 means that for every £12 of PCLS the pension will be reduced by £1.
Scheme commutation factors rarely reflect the full market value of the pension foregone. Research shows that there has been an increase in commutation factors, with the typical figure now being 15:1, although there are wide variances. However, for a member aged 65, a commutation factor based on market RPI annuity rates would be around 31:1. On these figures, in purely actuarial terms, higher rate, additional rate and basic rate taxpayers all lose out by drawing cash.

Excerpt From: Neil Dickey BSc (Hons) Chartered Financial Planner FPFS. “AF7: 2018-19 Study text.” The Chartered Insurance Institute, 2018-07. iBooks.
This material may be protected by copyright.


PCLS contd. :

“A scheme that was contracted out prior to 6 April 2016, cannot allow any part of any GMP to be exchanged for PCLS”

“Under the simplified regime, the maximum PCLS is calculated as follows:

PCLS = (PCLS + (20 × residual pension)) × 25%.
The residual pension = pre-commutation pension – (PCLS/C), where C is the commutation factor used by the scheme.
This leads to a complex scenario because it is not possible to calculate the member’s residual pension until the PCLS has been calculated – and it is not possible to calculate the PCLS until the residual pension has been calculated.

The Pensions Tax Manual (PTM) lays out a formula that must be used to calculate the maximum PCLS payable by a DB scheme.

This formula is:”


Bridging Pensions:

Some defined benefit schemes pay a bridging pension, usually where the scheme’s normal pension age is lower than State pension age (SPA). When the member reaches their normal pension age a higher pension is paid until SPA is reached, at which time it reduces to reflect the commencement of the member’s State Pension. The effect of the reduction could be to reduce the scheme pension back to its normal level or to a lower level to compensate for the period of time that it was paid at a higher level, with the approach taken depending on the scheme rules. This can also be referred to as a State pension deduction.

Be aware
Not all schemes will reduce the pension after SPA if a bridging pension is in place prior to the SPA.

This is permitted under the Finance Act 2004 and the Finance Act 2013,”


Early retirement DB Scheme:

“James is a member of his company’s DB pension scheme, which provides a pension of 1/60th of final pensionable remuneration for each year of service. James is about to take early retirement on his 62nd birthday after completing 25 years’ service in the scheme. The scheme’s normal pension age is 65. James’ final pensionable remuneration will be £30,000 and the scheme applies an early retirement factor of 0.5% for each month that the member retires before the scheme’s normal pension age.
We can calculate James’ early retirement pension as follows:

James has accrued a pension of 25/60ths × £30,000 = £12,500.
James is retiring three years early, so the early retirement factor will be 3 × 12 × 0.5% = 18%.
His pension will therefore be reduced by 18% × £12,500 = £2,250 p.a.
His early retirement pension will therefore be £12,500 less £2,250 = £10,250 p.a.”


ill health early retirement:

“The scheme rules may also permit early retirement in the event of ill-health, even if this occurs before the current normal pension age of 55.


The rules of the scheme define how to calculate the pension on ill-health early retirement. This may be:

based on service to the date of ill-health early retirement and salary at the date of ill-health early retirement, but without any early retirement factor;
based on prospective service to the scheme’s normal pension age and the salary at the date of ill-health early retirement, again without any early retirement factor; or
somewhere between these two levels.
It is important to note that the payment without any early retirement factor will normally only apply for a member who is still in service. For a deferred member, if the scheme rules do allow ill-health early retirement, there will almost certainly be an actuarial reduction applied. The member receiving the pension would have the option to take PCLS in the normal way.”


Serious ill health:

“If the member is in serious ill-health so that their expectation of life is less than a year, the whole pension may be commuted for a cash lump sum known as a serious ill-health commutation lump sum. The capital value of the pension that may be paid as a cash lump sum is calculated using a commutation factor selected by the scheme administrator.”

“The payment of a serious ill-health commutation lump sum before age 75 is a benefit crystallisation event (BCE) (BCE 6: Relevant lump sums). The commuted lump sum is tax-free if the value of the benefits provided does not exceed the member’s remaining lifetime allowance (LTA). Any excess lump sum over the member’s remaining lifetime allowance would be taxed at 55%.

It is worth noting that while serious ill-health commutation is an option permitted by HMRC, most DB scheme will not actually allow this commutation. Where they do, it is only the member’s benefits that can be commutated and on the member’s the dependant’s pension is still payable.”

“A serious ill-health commutation lump sum can also be paid after the age of 75, provided the member had some lifetime allowance remaining when benefits were tested against the LTA at age 75. Any serious ill-health commutation lump sum benefit paid after the age of 75 is taxable as the recipient’s income via PAYE.”


Death Benefits:

“The scheme (or a separate insured arrangement) can pay lump-sum death benefits to a member’s beneficiaries in the event of death in service; this is called a defined benefits lump sum death benefit. The maximum lump-sum death benefit is unlimited, although in the event of the member’s death before age 75, any lump-sum death benefit in excess of the member’s remaining lifetime allowance is subject to a lifetime allowance excess tax charge of 55%.”

“If a deferred member dies before taking the preserved benefits, a death-in-service lump sum is not usually paid. In some schemes, however, circumstances the member’s contributions are returned (with or without interest added), and other schemes will offer a lump sum equal to 5 years’ annual pension, where a member dies with no dependants. The member’s beneficiaries are usually just entitled to a percentage of the member’s preserved pension, revalued to the date of death.

It is important to clarify the scheme rules in relation to the payment of death benefits as there is a great deal of variety in the definitions used by schemes to determine who will benefit in the event of death.”


Scheme pensions for Spouse/Civil partner:

“Since 5 December 2005, it has been possible for same-sex couples to enter into civil partnerships. The first marriages for same-sex couples took place on 29 March 2014. Due to an exemption in the Equality Act 2010 (known as the EA10 exemption), occupational pension schemes were not required to provide the same survivors’ benefits to civil partners/same-sex spouses as they would to opposite sex spouses, with civil partners / same-sex spouses only being entitled to contracted-out survivors’ benefits relating to service on or after 6 April 1988 (the date on which contracted-out benefits for widowers were introduced) and all other survivors’ benefits relating to service on and from 5 December 2005.”

“Some schemes will include restrictions on payment of benefits to legal spouses or civil partners, in the following circumstances:

Where the marriage is recent, i.e. in the last six months.
Where the spouse at the date of death is not the same as the spouse at the time of retirement.
Where the spouse or civil partner is more than ten years younger than the member.
For same sex marriage and civil partners spouse benefits may only be payable from the date the legislation changed.
The trustees may reserve the right to reduce or even cease payments where a surviving spouse remarries or even co-habits in the future.”


Dependant's Pension:

“Where there is no legal spouse or civil partner, the trustees may consider paying a pension to a financial dependant. This could be on the same terms as a spouse pension, but not necessarily so. Some schemes will set out the eligibility criteria and this will usually include some proof of financial interdependency such as living together, sharing bills, shared children etc.
These benefits are payable at the discretion of the trustees and will generally be subject to similar terms as described above for spouse’s benefits.”


Children's Pension:

“Again, there is great variation in the payment of these benefits from scheme to scheme.
Children’s pensions are generally paid as a percentage of the spouse’s pension.
Usually there will be a cap on the maximum that will be paid in children’s pensions in total, with the overall amount apportioned equally between the eligible children.
This will normally only be paid until the child’s 18th birthday.
It could be extended to 23 years of age if the child is in full-time education or vocational training.
The definition of eligible child will change from scheme to scheme. Some will include all dependent children, including step and adopted children, whereas others are more restrictive.

Where a member has a child with disabilities who will remain financially dependant on the parent throughout their life, some schemes may consider an adult dependant’s pension. However, this is generally only where no spouse or other dependant’s pension is payable, and would be subject to the same ongoing reviews.”


Trivial Lump Sum:

“A member of a DB scheme may commute one or more pension arrangements if they comply with the following:

1. They are age 55 or over (reduced from age 60 from 6 April 2015, are retiring due to ill-health or have a protected pension age).

2. The lump sum extinguishes the member’s entitlement to defined benefits under the registered pension scheme making the payment.

3. All commutations must take place within a twelve-month period from the date of the first trivial commutation payment. Any commuted lump sum paid after the twelve-month period has ended will not qualify as a trivial commutation lump sum.

4. The value of all members’ rights (both defined benefit and money purchase, whether uncrystallised or crystallised) should not exceed £30,000 on the nominated date (the nominated date can be any date within three months of the start of the commutation period).

5. The member has not been paid a trivial commutation lump sum previously (from any registered pension scheme), except any earlier payment within the commutation period (a trivial commutation that occurred before 6 April 2006 does not count).

6. The lump sum is paid when the member has LTA available, although it is not tested against the member's LTA.


Early Leavers (Refund of employee contributions)

“An employee who leaves the scheme after less than two years may be entitled to a return of their own personal contributions – known as the short service refund. This is not obligatory as the scheme may instead offer a preserved pension for those leaving with between three months to two years of pensionable service. If the member has completed at least three months’ service in the scheme, they must also be given the option of a cash equivalent transfer value (CETV).

If a refund of member’s contributions is awarded, the tax treatment is:

the first £20,000 of any refund is taxed at 20%; and
any excess is taxed at 50%.
The tax liability falls on the scheme administrator, who can deduct the tax from the member’s refund.”

“Be aware
Short service refunds where a member leaves a money purchase occupational pension scheme having completed less than two years’ pensionable service have been abolished. They are now only available for members who leave with no more than 30 days’ pensionable service in the scheme.
You should note that the rules for short service refunds from DB schemes remain unchanged.”


Early Leavers (Preserved Pension):

“Where the member has between three months to two years of pensionable service, they are entitled to a preserved pension instead of a refund of contributions if the rules of the scheme allow, or if they have completed more than two years’ service. The scheme will determine which approach it offers its members. Members who leave pensionable service under an occupational defined benefit pension scheme with at least two years’ qualifying service as an option are entitled to a minimum level of preserved pension.

The preserved pension at the date of exit is calculated in the usual way, based on the scheme’s accrual rate and the member’s pensionable service and pensionable remuneration.

A member of a defined benefit scheme with a preserved pension is usually known as a deferred member or a deferred pensioner.”


Not contracted out prior to 6 April 2016:

“The rate by which the preserved pension is revalued in deferment depends upon the date the member left the scheme and the period of benefit accrual within the scheme.”


Contracted out prior to 6thApril 2016:

“Guaranteed minimum pension
Up until 6 April 1997, part of a member’s accrued pension under a contracted-out scheme was the guaranteed minimum pension (GMP). The underlying principle is that the GMP must hold its value against rising earnings rather than prices.
GMP can be revalued in deferment in three different ways.

In line with the increase in the average earnings index, commonly referred to as S148 orders (previously known as S21”

“orders). This is the approach to revaluation taken by public sector schemes, and former public service schemes such as the British Steel Pension Scheme (BSPS).
At a fixed rate, which is the most common method by which GMP is revalued by private sector defined benefit schemes. The fixed rate depends on the date the member left pensionable service”

“For leavers before 6 April 1997, it was possible to limit the revaluation to 5% a year in return for paying the Department for Work and Pensions (DWP) a ‘limited revaluation premium’. The DWP then made up any difference to the full rate of s.148 order increases. If increases in line with S148 orders turn out to be less than 5%, the lower rate applies.”


Benefits in excess of GMP:

“Pre-6 April 1997 benefits in excess of GMP and all benefits accrued on or after 6 April 1997 (known as ‘post-1997 benefits’) are revalued in the same way as for schemes that were not contracted out, based on the member’s date of exit and the period over which benefits are accrued in the scheme.

For pre-6 April 1997 benefits in excess of GMP and post-1997 benefits, the index used to calculate the statutory rate of revaluation prior to 2011 was the RPI. Revaluation awarded prior to 2011 is still based on the RPI, with only revaluation from 2011 being based on the CPI.”


Revaluation of Preserved Benefits within a DB Scheme:

Revaluation of preserved benefits within a defined benefit scheme


S148 orders or fixed-rate. (Limited revaluation was an option for early leavers before 6 April 1997.)

Non-GMP benefits

Date of exit before 1 January 1986

No compulsory revaluation.

Date of exit between 1 January 1986 and 31 December 1990

In line with increases in CPI to a maximum of 5% p.a. in respect of benefits (in excess of GMP) accrued from 1 January 1985.”

“Date of exit between 1 January 1991 and 5 April 2009

In line with increases in CPI to a maximum of 5% p.a. in respect of all benefits (in excess of GMP).

Date of exit after 5 April 2009

In line with increases in CPI to a maximum of 5% p.a. in respect of all benefits (in excess of GMP) accrued to 5 April 2009. In line with CPI to a maximum of 2.5% p.a. in respect of accrual after 5 April 2009.”


Transferring Out:

“Those who left the scheme with more than 3 months’ pensionable service on or after
1 January 1986 have a legal right to transfer from the scheme as an alternative to a preserved pension.”

“A transfer value must be offered to an early leaver who has completed at least three months’ service in the scheme. The transfer value provided must be the cash equivalent of the promised benefits being given up


Pension Transfer Rules:

“Members who are more than one year away from the scheme’s normal pension age have the statutory right to transfer their safeguarded benefits. However, they are required to obtain appropriate ‘independent’ advice where the CETV is in excess of £30,000 (on a scheme-specific basis) and they wish to transfer to a different scheme or to a different section of their existing scheme to acquire flexible benefits.

The requirement for advice arises because the conversion of safeguarded benefits into flexible benefits is a regulated activity. The advice is regulated advice where:

the individual receiving the advice is a member of the pension scheme or a survivor of a member of the pension scheme;
they have rights in respect of safeguarded benefits; and
the advice concerns converting safeguarded benefits into flexible benefits within the same scheme, transferring safeguarded benefits to a new scheme to:
access flexible benefits, or
receive an uncrystallised funds pension lump sum (UFPLS).”

“The law states that ‘appropriate independent advice’ is advice that is given by an ‘authorised independent adviser’:


means that the advice must be provided by an adviser who is independent of the employer or trustees/manager of a scheme. However, it can be provided by an adviser who operates on either an independent or restricted advice basis.


means that the adviser (or the person checking the advice) must have the necessary permissions to carry on a regulated activity. In this case, it means that this individual must be a pension transfer specialist, i.e. have the appropriate qualifications (e.g. AF3 Pension planning).”

“A transfer value analysis (TVA) is required when assessing a possible transfer from a defined benefit scheme. A TVA will not be required if the benefits are being crystallised at the DB scheme’s normal pension age, but will still be required if the benefits are being crystallised before then.”

“Where a scheme’s trustees receive a request from a member to transfer safeguarded benefits with a CETV of more than £30,000, they must see evidence that the member has received appropriate independent advice.

Members will be expected to meet the cost of the advice, except where the transfer is employer-instigated”