What happens to the benefits of leavers who remain in the pension scheme?
In this section we will look at leavers who benefits remain in the pension scheme when they leave (deferred members). This generally applies to:
DB schemes – Members with more than 2 years’ pensionable service
DC schemes – Members who joined the scheme before 1 October 2015 and left with more than 2 years’ pensionable service, or, members who joined the scheme on or after 1 October 2015 and left with more than 30 days’ pensionable service.
The deferred benefits are calculated at date of leaving, they may also be referred to as preserved or paid-up benefits.
The benefits will increase from date of leaving to retirement date in different ways depending on the benefits basis and the scheme rules.
Benefits at date of leaving
For a member of a DB scheme the pension calculated at date of leaving is based on three things defined in the scheme rules:
1. Pensionable Service
2. Final Pensionable Salary
3. Scheme Accrual RateSet out below is a basic calculation based on the following:
DB Pension per annum: 20 x 1/60th x £60,000 = £20,000
For a member of a DC scheme the pension cannot be calculated at date of leaving because a pension can only be purchased when the member actually retires. At date of leaving the only benefit that can be calculated is the value of the member’s investments. In the case of unitised funds this would be:
Set out below is a basic example of a unitised fund calculation at date of leaving based on the following:
DC fund value: 15,000 units x £1.65 = £24,750
Due to the different forms in which the benefits are provided, it is often difficult to compare the benefits provided by the two different types of schemes.
DB benefits are generally regarded as more valuable, but for an accurate analysis, members can speak to an Independent Financial Advisor to get an idea of how the two compare. It is now a legal requirement for a member to obtain independent financial advice if they wish to transfer from a DB scheme to a DC scheme if the transfer value is over £30,000.
The member may have transferred-in benefits and they must be included. The form of benefits provided by the transfer-in will depend on how the receiving scheme treats transfers-in.
If the receiving scheme provided DB benefits in exchange for the transfer value, then the member would usually be granted additional pensionable service, or they may be granted a fixed pension which is payable at Normal Retirement Date.
If the receiving scheme provided DC benefits in exchange for the transfer value, then the additional benefits would be in the form of additional DC funds.
The member will receive a statement of benefits at date of leaving. Some schemes may also show estimated benefits at retirement by applying notional increases to either the pension or the fund value however, these are for illustration purposes only and cannot be guaranteed.
Increases to benefits after leaving a defined benefit scheme
When a member leaves a DB scheme the pension will increase from the date of leaving to retirement date.
Care!
It is important to determine when a member left a scheme as different increase rates apply. Also some schemes may apply different rates for different periods.
The pension is generally calculated into two elements and each one is treated differently.
1. Guaranteed Minimum Pension (GMP)
This applies to members in contracted-out service in schemes between 6 April 1978 and 5 April 1997. The scheme rules will state whether the GMP increases annually either:
The rate of increase applies to all leavers, it is not something a member can choose.
The increase is applied for each complete tax year from date of leaving to age 60 for females and age 65 for males.
There is also an additional increase for females who retirement date is between age 60 and age 65.
2. Excess Pension
This is the amount of pension earned in excess of the GMP. If a scheme is not contracted-out, or a member has no GMP because they did not accrue any benefits in the scheme before 1997, then the whole pension is treated as excess pension.
The excess pension is divided into two further elements:
The increase applies to each complete year from date of leaving to the scheme’s Normal Retirement Age.
If a member left the scheme before 1 January 1991, then some of their pension may not be guaranteed to increase in deferment.
The member’s leaving service statement will show each part of the benefit and how it will increase. There is no obligation on trustees to provide deferred members with regular updates of their pension entitlement, the member may of course request an update.
It is important for members to notify the scheme if they change their name or address so that they can be contacted when they approach retirement, this will normally be done 3 months before their retirement date.
However, if a DB member also has DC benefits they would be contacted between 4-6 months before their retirement date.
Increases to benefits after leaving a defined contribution scheme
When a member leaves a DC scheme their fund will remain in the existing investment. If the investment is in unitised funds, the number of units remains fixed.
No guarantees apply to the value of the investment which will fluctuate up to the time benefits are taken. For example, the fund could be performing well but on the day the units are disinvested, the stock market could crash and the value would then plummet. This is why a member in the traditional lifestyle strategy will find that their funds have been placed into safer investments 5 to 10 years before retirement.
However, with the introduction of the new flexibility for DC members, lifestyle strategies are being revised to reflect the fact that members may not buy annuities.
Legislation states that leaving service statements just have to show the member’s rights and options (if any) however, most schemes will provide more information such as the number of units in each investment fund. Each year the member will receive a Statutory Money Purchase Illustration (SMPI) Statement showing the current value of their funds and an estimate of the projected benefits at Normal Retirement Age and the assumptions used.
This is for illustration purposes only and cannot be guaranteed but it will give the member an idea of the amount of pension the fund may purchase.
It is important for members to notify the scheme if they change their name or address so that they can be contacted when they approach retirement. They will be provided with an estimated quotation of benefits 4-6 months before they are due to retire.
Death after leaving a scheme
When a member leaves a scheme and then dies before the benefits come into payment the benefits normally paid out are shown below. However, remember the scheme rules may differ.
DB scheme member
DC scheme member
Death benefits are discussed more fully in the module "Pension Scheme Death Benefits”.
Additional Voluntary Contributions (AVCs)
If a member pays AVCs they can be left in the scheme and taken with the main scheme benefits. Alternatively they can be transferred leaving the main scheme benefits behind.
The provider will issue a statement each year showing the current value of the AVCs.
