Retirements Fact Finding (final Salary)


Salary Related Schemes

In a salary related scheme, often referred to as a defined benefit scheme, the scheme rules will describe how a member's benefits should be calculated on leaving service, retirement or death. This element of the resource material will concentrate on the calculation and communication of retirement benefits for a salary related scheme.

The case studies that you will study in the examinations will include two (2) salary related schemes, one of which is a CARE (Career Average Revalued Earnings) scheme:

  • The RST Pension Scheme (which is not contracted out)
  • The XYZ Pension and Life Assurance Scheme (which was contracted out for Category A members until 5 April 2016 but was never contracted out for Category B members)

There are four (4) distinct retirement calculations and candidates will be tested on each of these in the examinations:

  1. Normal retirement (for members who are "active" or “preserved” and who retire at normal pension date)
  2. Early retirement (for members who are “active” or "preserved" and who retire before normal pension date)
  3. Ill-health retirement (for members who are “active” or “preserved” and retire before normal pension date due to ill-health)
  4. Late retirement (for members who are "active" or “preserved” and who retire after normal pension date)


Fact Finding

1. How are normal retirement benefits calculated?

A normal retirement pension for a salary related scheme is typically based on the rate of pension accrual, the member`s period of pensionable service and the member`s final pensionable salary at normal pension date.

The links below provide further information on some of the terms:

Under the XYZ Pension and Life Assurance Scheme for a Category A member, a normal retirement pension is based on a default pension accrual rate of 70ths (although members can vary their contribution rate in exchange for an accrual rate of 60ths or 80ths), the member`s period of pensionable service (measured in years and days) and the member`s final pensionable salary (best pensionable salary in the last 5 years) at normal pension date.

Under the XYZ Pension and Life Assurance Scheme for a Category B member, a normal retirement pension  is based on a pension accrual rate of 60ths, the member`s period of pensionable service up to 3 July 2011 (measured in years and days) and the member`s final pensionable salary (either best pensionable salary in the last 5 years or, if greater, final pensionable salary at 3 July 2011 increased by RPI).

Under the RST Pension Scheme a normal retirement pension is based on a member’s CARE pension calculated up to 5 April prior to normal pension date plus a proportionate amount from 6 April up to normal pension date. A year-to-date pro-rata CPI factor is additionally applied to the member`s CARE pension accrued to the previous 5 April.

The CARE pension is then compared to an `underpin` pension based on 1/100 x pensionable service (measured in years and complete months) x final pensionable salary (based on contractual salary). If this results in a higher figure, then the `underpin` pension rather that the CARE pension is payable.

Benefits under the RST Pension Scheme must be split pre 6 April 2006 and post 5 April 2006 due to the different rates at which these elements of pension increase in payment.

The links below provide in depth information on further items and considerations which are relevant to the calculation and treatment of retirement benefits:

2. How are early retirement benefits calculated?

An early retirement pension is generally calculated in the same way as a normal retirement pension except an actuarial reduction is typically applied to the accrued pension.

An early retirement pensions is generally reduced by an actuarial factor to reflect the fact that the pension is coming into payment earlier than expected and, consequently, is likely to be payable for a longer period than expected. The factor will typically be a fixed percentage for each complete year that the member retires early (pro-rated for each complete month early). This is the case for the XYZ Pension and Life Assurance Scheme and the RST Pension Scheme.

It is not uncommon for schemes with a normal pension age of 65 to offer retirement from age 60 with no actuarial adjustment. This is particularly likely when equalisation considerations apply.

TIP: With effect from the 6th April 2010, the earliest that a member can generally retire from an occupational pension scheme is age 55.  This is expected to rise to age 57 in 2028 in line with rises to the State Pension Age.

As with normal retirement, members can commute part of their pension for a tax-free cash sum and take a reduced pension – (see ‘Tax free lump sum’ link in previous section).

TIP: Under the RST Pension Scheme, the post 5 April 2006 pension should be commuted first with the balance, if any, being commuted from the pre 6 April 2006 pension.

If a scheme was contracted out prior to 6 April 2016, similar checks to those required for normal retirement apply on early retirement. The pension accrued for the period 6 April 1978 to 5 April 1997 must be at least equal to the GMP. In addition, if the member takes the tax-free cash sum option, the scheme should ensure that the residual pension (when revalued to ‘GMP due date`) covers the GMP at ‘GMP due date`. If it does not, the scheme must, as a minimum, uplift the residual pension to the GMP once the member reaches GMP due date`.

Should early retirement occur after ‘GMP due date` then the residual pension, after taking the tax-free cash sum option, must cover the GMP – (see ‘Contracting out’ link in previous section).

TIP: GMP due date is the date at which the GMP becomes payable and is age 65 for males and age 60 for females. It is not, as is often believed, the same as State Pension Age.

3. How are ill-health retirement benefits calculated?

An ill-health retirement pension can be based on actual pensionable service and final pensionable salary at the date of retirement (with or without an actuarial reduction being applied) or, if the scheme rules permit, it can be based on prospective pensionable service to normal pension date and final pensionable salary at the date of retirement.

In the event of ill-health retirement, it is possible for members to receive their pension prior to age 55. In cases of serious ill-health the scheme rules may additionally permit the pension to be fully commuted.

Where ill-health benefits are not fully commuted and the pension is based on pensionable service to normal pension date, careful consideration needs to be given to Annual Allowance limits.

  • Tax-free cash sum option - Please refer to earlier sections where this is discussed or where there is a ‘Tax free cash sum’ link.
  • Contracting out - Please refer to earlier sections where this is discussed or where there is a ‘Contracting out’ link.

4. How are late retirement benefits calculated?

A late retirement pension is generally calculated using the pension accrued at normal pension date with an actuarial increase being applied (as in the XYZ Pension and Life Assurance Scheme) or by accruing extra pensionable service until late retirement date with no actuarial increase being applied (as in the RST Pension Scheme).

A late retirement pension is generally increased by an actuarial factor to reflect the fact that the pension is coming into payment later than expected and, consequently, is likely to be payable for a shorter period than expected. The factor will typically be a fixed percentage for each complete year that the member retires late (pro-rated for each complete month late). This is the case for the XYZ Pension and Life Assurance Scheme.

  • Tax-free cash sum option - Please refer to earlier sections where this is discussed or where there is a ‘Tax free cash sum’ link.
  • Contracting out - Please refer to earlier sections where this is discussed or where there is a ‘Contracting out’ link.

5. How are retirements from preserved status handled?

Preserved benefits (often called deferred benefits) belong to members who have left the pension scheme and who have chosen to leave their benefits in the scheme to be taken when they reach retirement. For the purposes of the examinations, a preserved member will always have a date of leaving and a date of retirement.

For a salary related scheme, leaving service entitlements will normally be quoted at the member's date of leaving and will then need to be indexed up to the member's actual retirement date (with actuarially adjusted factors being applied on early or late retirement to cater for a longer or shorter period of payment, respectively).

Under the XYZ Pension and Life Assurance Scheme, the GMP will need to be increased during the period of deferment using the fixed rate revaluation method. Schemes may also adopt the full rate revaluation method whereby the GMP is increased fully in line with the increase in average earnings (Section 148 orders).

For the fixed rate method of revaluation the percentage rate to be applied depends on the date the member left the scheme (see table below). The number of years of revaluation at this percentage rate will be based on the number of complete tax years between the date of leaving and `GMP due date` (or earlier date of retirement). Further statutory increases will apply in the event of retirement occurring after `GMP due date` (age 65 for male members and age 60 for female members).

For the fixed rate method of revaluation the percentage rate to be applied depends on the date the member left the scheme (see table below). The number of years of revaluation at this percentage rate will be based on the number of complete tax years between the date of leaving and `GMP due date` (or earlier date of retirement). Further statutory increases will apply in the event of retirement occurring after `GMP due date` (age 65 for males and age 60 for females).


6 April 2017 onwards

3.5%

6 April 2012 to 5 April 2017

4.75%

6 April 2007 to 5 April 2012

4.0%

6 April 2002 to 5 April 2007

4.5%

6 April 1997 to 5 April 2002

6.25%

6 April 1993 to 5 April 1997

7.0%

6 April 1988 to 5 April 1993

7.5%

6 April 1978 to 5 April 1988

8.5%


Under the XYZ Pension and Life Assurance Scheme, the whole of the pension in excess of the GMP at the date of leaving is increased by RPI subject to a maximum of 5% for each complete year from date of leaving to date of retirement.

Under the RST Pension Scheme, the whole of the pension is increased by CPI subject to a maximum of 5% for each complete year from date of leaving to date of retirement.

6. How are communications with the member / trustees made?

Once the benefits have been calculated they need to be communicated to the member and / or trustees of the scheme in the form of a letter. The examinations will expect learners to write letters to include all the facts and figures that are required to be communicated.

For retirement case studies from the RST Pension Scheme and XYZ Pension and Life Assurance Scheme all letters should include the following (where applicable):

1. Member’s date of retirement

2. Member’s options:

  1. Full pension (stating actual values for pension splits [pre-1988 GMP, post-1988 GMP and excess elements for XYZ Pension and Life Assurance Scheme; and pre-2006 and post-2006 elements for RST Pension Scheme])
  2. Tax-free lump sum and residual pension (stating actual values for pension splits [pre-1988 GMP, post-1988 GMP and excess elements for XYZ Pension and Life Assurance Scheme; and pre- 2006 and post-2006 elements for RST Pension Scheme])

3. Pension details:

  1. Commencement date
  2. Frequency of payment
  3. Pension increase rates (stating actual rates for pension splits [pre-1988 GMP, post-1988 GMP and excess elements for XYZ Pension and Life Assurance Scheme; and pre-2006 and post-2006 elements for RST Pension Scheme])

4. Spouse’s pension

5. Death in retirements benefits

6. LTA percentage used (stating percentage for each of the member’s options)

7. Requirements for payment:

  1. Choice of option
  2. Member’s birth certificate
  3. Bank details

The list is not definitive and all letters must, for example, refer to any special circumstances and additional information contained in the case study.