Early leavers and transfer options

Leaving Service

What options are open if you leave the employer before pension age?

• You may take early retirement. This is normally available from age 50 onwards, but earlier retirement may be allowed on ill health grounds, or for certain employments.
• If you have had less than two years’ pensionable service, you may take a refund of your contributions – but this is subject to a 20% tax charge.
• If you are a member of a Final Salary Scheme, you may preserve your benefits within the scheme. This means that your pension at the normal retirement age will be calculated according to the years of service at the time you leave.
• If you are a member of a Money Purchase Scheme you may leave your funds fully invested in the scheme. You can then take the benefits at the normal retirement age.
• You may be able to transfer the capital value.

Transfer of Occupational Schemes

Occupational Schemes may be transferred to:

• section 32 policies,
• another employer’s occupational scheme,
• Personal Pension Plans, or
• Stakeholder Pensions.

Section 32 Policies

This type of scheme gets its name from Section 32 of the 1981 Finance Act, which enabled these policies.

These policies are designed to take transfers from Occupational Pension Schemes. They may not take transfers from any other type of pension scheme. Once the transfer has been made, no further contributions may be made. The transfers may be made from Occupational Schemes which were contracted out of SERPS via the Guaranteed Minimum Pension (GMP) test. This meant that the Guaranteed Minimum Pension would at least equal the provision of a pension under SERPS.

A Section 32 Policy means that the company taking on the scheme must guarantee to pay at least the GMP at retirement.

Section 32 Policies	Personal Pension Plans or Stakeholder Pensions
Guarantee to pay the GMP at retirement date, with possibility of additional benefits.	No guarantee – the benefits depend on the performance of the investments in the fund.
No additional contributions allowed.	Further contributions allowed -see the limits.
Benefits may be taken between the ages of 50 and 75 without the member retiring – but the funds must be sufficient to provide the GMP from the State Pension age.	Benefits may be taken between the ages of 50 and 75 without the member retiring.
Tax-free lump sum limited by Inland Revenue Rules.	Maximum tax-free lump sum of 25% of the value of the fund. However, it may be lower if it was limited at the time of transfer from the Occupational Scheme.
Inland Revenue rules may limit the pension at retirement.	No limits on the pension at retirement.
Any surplus returned to the employer or retained by the insurer.	There can be no surplus – all the funds are used to provide the benefits.
Any GMP transferred is retained as a GMP.	Any GMP transferred is not guaranteed.
Benefits in respect of contracted-out rights after April 1997 are not guaranteed but may be taken from age 50.	Benefits in respect of contracted-out rights after April 1997 are not guaranteed and are not available until age 60.
Funds may be transferred to Occupational Schemes, Personal Pension Plans, Stakeholder Pensions or another Section 32 Scheme.	Funds may be transferred to Occupational Schemes, Personal Pensions, or Stakeholder Pensions, but not to Section 32 Schemes.

The pension could also be more than the GMP. If the funds exceed the requirement to pay the GMP, the company operating the scheme may use the excess to either:

• pay a tax-free lump sum, or
• buy an additional annuity.

A Section 32 Scheme may also transfer the fund to:

• a Personal Pension Plan, or
• a Stakeholder Pension, or
• an Occupational Scheme.

If you are thinking about transferring an Occupational Scheme, the table overleaf gives a comparison of the options.

Surpluses

The scheme’s funds are subject to statutory valuations, which compare the funds held with the scheme’s liabilities to present and future pensioners. If there is a surplus of funds, and the surplus is more than 5% of the liabilities, the trustees must provide the Inland Revenue with their plans to reduce the surplus.

In calculating the liabilities, limited price indexation (LPI) may be applied. LPI allows the benefits to pensioners to have a limited increase in benefits each year – the lower of 5%, or the increase in the retail price index (RPI).

Plans to reduce the surplus may include:

• Providing new and improved benefits.

• Contribution holiday for members.
• Contribution reduction for members.
• Refund to the employer. (This refund is subject to a 40% tax charge and must be approved by the Inland Revenue first.)

Legal basis of Occupational Schemes

Occupational Schemes are run by a board of trustees, and overall supervision is exercised by the Occupational Pensions Regulatory Authority (OPRA). The Pensions Act 1995 is the overall governing statutory law.

Trustees

All trustees are subject to regulation by OPRA and, if they are in breach of their duties, OPRA has the power to impose fines of up to £50,000 for each breach. OPRA may also suspend, prohibit or disqualify trustees, and even prosecute if they are found to be guilty of a criminal act.

Members of a scheme have the right to elect one third of the scheme’s trustees. However, the following schemes are exempt from this provision:

• Schemes with only one member.
• SSASs.
• Public Sector schemes.

Rules

Schemes may adopt the ‘prescribed rules’, which are a set of standard rules and procedures for election of trustees.

Alternative rules may be adopted if approved by the members of the scheme.

Investments

There must be a written statement of the scheme’s investment policy, unless the scheme’s investments are wholly in insurance policies. No more than 5% of the scheme’s funds may be invested in the sponsoring employer’s business. Trustees are not allowed to make loans from the scheme’s funds.

Professional advisors

Professional auditors and actuaries must be appointed by the trustees. These professional advisors must be suitably qualified, and the auditor must not be connected to the scheme (as a member), or to the employer.

Professional advisors have a duty to report to OPRA any failures of the trustees to meet the requirements of the Pensions Act 1995. This is known as whistleblowing, and failure to do this can result in the advisor being reported to his or her professional body.

The scheme actuary must produce a Minimum Funding Requirement (MFR) certificate for Final Salary Schemes. If the scheme is not sufficiently funded, it must make good the shortfall within certain time limits as follows:

• If the scheme is between 90% and 100% funded, the time limit is 10 years.
• If the scheme is less than 90% funded, the time limit is three years to reach 90%, then a further 10 years to make it up to 100%.

Annual Report

The scheme must produce an annual report, unless it is exempt. Exemptions include:

• Schemes with only one member.
• Public Sector Schemes.
• Unapproved Schemes.
• SSASs.
• Earmarked Schemes.

The report must include the auditor’s report, the annual audited accounts, and the latest actuarial valuation certificate.

Executive Pension Plans (EPPs)

In essence, these are Money Purchase Occupational Pension Schemes designed for company directors (who are of course employees) and/or other key personnel. They generally allow much more flexibility, and the employer company may make generous contributions. They are also sometimes referred to as ‘Top Hat’ schemes.

Great flexibility can be exercised in respect of the contributions to these schemes. Contributions must be paid by the employer and additional contributions may be made by the employee. The employee contributions can be made by regular payments or by special one-off payments. The tax relief and contribution limits for employees are the same as for ordinary occupational pension schemes.

Advantages

A particular advantage is that the employer can make contributions to this plan, and these contributions save the company the National Insurance liability, currently 12.2%. The combination of tax relief and the relief on National Insurance contributions makes this a very attractive alternative for owner-directors.

If the fund exceeds or looks likely to exceed the normal Inland Revenue limits, contributions may have to be stopped or restricted.

Employer contributions escape any tax liability on either the employer company or the employee. Thus, an employer company can invest profits tax free, and the directors (or other beneficiaries) can receive part of the accumulated fund as a tax-free lump sum when they retire.

The employer may make single contributions to make up for missed contributions in earlier years of service. There is full tax relief up to £500,000 in a tax year. Above this level, tax relief is spread over a number of tax years. Details are the same as those given in Chapter 6, relating to SSASs.

The fact that contributions and benefits such as death benefits and the tax free cash lump sum are related to the salary of the director (or other executive) involved means that this type of plan can be very flexible for a small, director-controlled company. To a large extent, the salary of the controlling director can be set at will. Thus, for example, the maximum tax-free lump sum allowed of 150% of final salary can be determined by voting a high salary. The final salary is actually based on the average of the highest three years’ salary within 10 years of actual retirement.

The maximum lump sum can be paid, and it is then valid for only the balance to be used to provide a pension. This provides a way to achieve a large cash sum. The death in service benefits can also be very generous – up to four times salary plus refund of the member’s contributions plus interest. This means that, with tax relief on the contributions, it can be a cheap and tax efficient way of providing valuable life assurance.

Most major insurance companies have off the shelf packages for EPPs so they can be set up relatively cheaply and quickly. Many companies also limit their charges to 1% (if the invested funds are their own) to compete with Stakeholder Pensions.

Who pays the premium?

Many companies have been formed from businesses previously run by a proprietor as a self employed sole trader, or in partnership. When they were working as self employed, they sensibly started paying premiums to a Personal Pension Plan, or a Stakeholder Scheme. After the change in status of the business to a limited company, they continue paying the premiums privately. At first sight, this seems reasonable, since they continue to get tax relief at their highest marginal rate of tax. The individual pays pension contributions net of basic rate tax (at present 22%), and must claim any additional relief for higher rates. The company, if it pays the contribution, must pay it gross, and claim it as a business expense, against which it gets Corporation Tax relief.

But could there perhaps be any saving if the company made the contribution?

The first thing to do is to look at the rate of Corporation Tax paid by the company. At present rates, this could be 0%, 19%, 23.75%, 30%, or 32.75%. The next thing is to look at the rate of tax paid by the individual. This could be 22% or 40%. By comparing the actual effective rate paid in each case, there could be advantages either way.

However, even this analysis does not take into account the whole cost involved. The director must have the salary to pay the pension contributions. In order to pay the salary from the company to the director there is a National Insurance cost of 23.8% – 11% employee’s cost, and 12.8% employer’s cost. Furthermore, paying a pension contribution does not reduce the employee’s National Insurance liability. Therefore, to calculate the true cost, National Insurance must be taken into account.

There could therefore be a considerable saving if the contributions were made by the company instead of by the director. The big difference is, of course, the cost of the National Insurance contributions. However, the calculation must be made according to each individual circumstance. The relative rates of Income Tax paid by the director, and Corporation Tax paid by the company are also a key factor.

In essence this is a ‘salary sacrifice’ arrangement which benefits from saving the National Insurance cost. Because there is a sacrifice of salary, this will only work in a Money Purchase Scheme, not a Final Salary Scheme. There could also be tax benefits in sacrifice arrangements relating to bonuses or dividends.