GMP revaluation - Pension schemes containing GMPs should take action to avoid what could be a costly hangover from contracting-out
Pension schemes containing GMPs should take action to avoid what could be a costly hangover from contracting-out, where pension scheme rules have not kept up-to-date with the law.
One of the key features of the pension landscape came to an end on 6 April when contracting-out was finally abolished. The regime delivered part of the state pension via private sector pension schemes. The hangover from the contracting-out regime will continue for some time to come because some pension scheme members will continue to have rights which relate to contracting-out – in particular, the guaranteed minimum pension or GMP, where a scheme was contracted-out on a salary related basis before 6 April 1997.
The GMP is what is says on the tin. It is a guarantee that a pension scheme member is paid a minimum amount of pension. One part of calculating the GMP is that its minimum amount must reflect inflation between when the member earns it (i.e. when he was employed) and retirement. This increase is known as revaluation.
Before 6 April 2016, a member would cease to be contracted-out when he or she left employment and left the pension scheme. At that point, the law gave the pension scheme a choice between two main methods of revaluing the GMP. The methods are known as fixed rate revaluation and section 148 revaluation.
On 6 April 2016, some pension scheme members ceased to be contracted-out as a result of the abolition of contracting-out. However, such members may continue in employment and to build up benefits in their pension scheme. The law has changed for such members insofar as the point at which a pension scheme has the revaluation choice now arises when employment ends and they cease earning benefits in their pension scheme - i.e. a date in the future, and not on the date that contracting-out was abolished on 6 April 2016.
Understandably, some pension scheme rules make the choice to use fixed rate revaluation from when contracting-out ends. The potential difficulty with this is that some members will have continued in employment after 6 April 2016 and will have continued to build up benefits in their pension scheme. In relation to such members, pension scheme provisions may not have not kept up-to-date with the law. At the same time, the law requires a pension scheme to use section 148 revaluation until employment ends.
In other words, some pension scheme rules require fixed rate revaluation from 6 April 2016, but the law requires section 148 revaluation until employment ends. Where members are still in employment and still in a pension scheme, this can create a cross-over period in which a pension scheme has to use the better of fixed rate revaluation and section 148 revaluation for a GMP. This could be quite costly for an employer as well as administratively complex.
The law deals with this by giving trustees an option of passing a resolution to update their rules in line with the law. This will give trustees the ability to only use section 148 revaluation until employment ends and avoid the cost of a cross-over period. However, the option is only available until 5 April 2017.
Trustees should review their rules and current arrangements for GMP revaluation in the coming months. Some pension scheme rules will need updating in line with the new law.