Transfer Test Failure?...This Could Be The Answer
The content of this page is based on our understanding of how pensions worked before A-Day, the 6 April 2006, and is provided for reference only.
The Personal Pension transfer regulations which came into force on 6 April 2001 mean that certain members must pass a ‘valuation test’ before a transfer can proceed from an occupational pension scheme or s32 to a Personal Pension plan.
(A full explanation of the regulations can be found in our factsheet entitled Personal Pension Transfer Regulations)
At first, it seemed that those members who fail the test would be trapped in the occupational pensions regime and wouldn't be able to enjoy the potential benefits of transferring to a personal pension plan, e.g. phased, self-investment. But by looking at the regulations in more detail, it can be seen that members who previously failed the valuation test may still be able to transfer by using one of the following options:
1. Wait until the test no longer applies
The test only applies to those, in respect of the transfer payment:
- who are, or were in the last ten years, controlling directors, and
- who are age 45 or over and are, or were in the last 6 years, earning more than the current earnings cap.
If a member no longer falls into either category in respect of the employment to which the transfer relates, they can transfer without the need for a test.
For example, if a 40 year old controlling director of company A used to be a controlling director of company B 10 years ago, a transfer of the pension from company B to a Personal Pension is allowed. No test is required as he is no longer treated as a controlling director in company B for the purposes of the test.
This similarly applies to the high earner rule so that a member who earned more than the current earnings cap 6 years ago can transfer without the need for a test.
Note however that for ‘s32s’ set up prior to 6 April 2001, the old earnings cap rule applies so that a member would have to wait 10 years instead of 6.
If there is no scope to wait until the test can be passed (e.g. the scheme is winding up) or if the member does not wish to leave their benefits within the scheme (e.g. falling fund values), one option is to transfer the benefits to a ‘s32’ buy out policy whilst waiting for the relevant time period to expire. On subsequent transfer to a personal pension plan from the ‘s32’, a test will not be required.
2. Wait until fund values fall
Whilst the transfer value calculated by the test is essentially fixed, fund values can and do fluctuate. Investment market conditions could mean that the value of a member’s fund has decreased since the last test.
3. Wait until the client leaves service
For post ‘89 members only (generally, someone who joined their current scheme on or after 1 June 1989), whether the member has actually left service or not can drastically affect the test. It is invariably better to wait until a member leaves service before transferring since if they do this, potential service remaining to normal retirement date need not be taken into account, e.g. for an unmarried member with a final salary at date of leaving of £65,000, a normal retirement date of 65, no retained benefits and a fund value of £175,000:
Member does not leave service
Member leaves service
Max transfer value based on N/NS x P, where
Max transfer value based on P, where
† This calculation is defined in Appendix XI and is basically the maximum pension calculation at date of leaving.
4. Transfer to another scheme
As mentioned above, by transferring to a ‘s32’ buy out policy and then transferring to a personal pension plan at a future date, members may be able to transfer without restriction if they fall outwith the categories where a test is required.
If however the member is due to retire before the expiry of the 10 or 6 year period, this route is no longer possible as a test will still be required all the way up to retirement.
By taking advantage of the retained benefits concession however, a member can transfer benefits which have previously failed the valuation test to a personal pension plan, e.g.
Step 1 - Member leaves service with current employer and joins a scheme of a new employer. The benefits provided by the new scheme must be no more than 1/60th for each year of service in order to satisfy the retained benefits condition.
Step 2 - Transfer previous benefits to new scheme. No valuation test is required.
Step 3 - At a future date, transfer to a personal pension plan. Although the valuation test may still be required, the test will be based on service with the new employer only, without reference to the retained benefits. As long as this test is passed, the transfer of the new benefits PLUS the old retained benefit may proceed.
With this option, care must be taken to ensure that the new scheme satisfies HM Revenue & Customs ‘sole purpose test’ – which says a scheme should only provide relevant benefits for its members. If a transfer is made to a new scheme and then this is transferred to a personal pension shortly afterwards, HM Revenue & Customs may well view this as failing the ‘sole purpose test’ and could withdraw approval from the scheme. On the other hand, if the transfer is made to an existing scheme with several members and members remain in the scheme after the transfer to the personal pension plan, this would not normally be a problem.
5. Reduce the member’s fund by reallocation
At the time the transfer regulations were drafted, it was thought that DWP legislation would not allow a member to reduce their fund value so that the transfer to a personal pension plan could proceed.
Following representations by the pensions industry, HM Revenue & Customs consulted the DWP and have now confirmed that such a reduction can indeed be achieved within the legislation, subject to certain conditions. Because this method of reducing a member’s fund could potentially breach DWP legislation, we would always strongly recommend that the Trustees seek legal advice before proceeding to ensure all the relevant legislative conditions are met.
Here’s how it could work:
Member's fund value
Maximum transferable fund
transfer cannot proceed
Trustees reduce member's fund by
Member's fund value after reduction
Maximum transferable fund
transfer can proceed
The main condition that must be met in order for the reduction to proceed is that it must not breach either DWP legislation or HM Revenue & Customs tax approval conditions. In addition:
- the scheme rules must allow or be changed to allow the reduction prior to transfer and the rule change must
- be approved by HM Revenue & Customs prior to transfer
- be made separately to the transfer
- apply to all of the scheme members at any time
- be agreed by all the scheme members (including deferred/pensioner members)
- the scheme Trustees must be satisfied that the rule change and reduction exercise do not contravene DWP legislation or HM Revenue & Customs tax approval requirements.
Note that it is not permissible to use this method for s32 plans.
Once the fund reduction has been done, the remaining surplus must be dealt with in line with the scheme rules and HM Revenue & Customs practice, e.g.
- by reallocation to other scheme member(s) to increase benefits (subject to HM Revenue & Customs maxima)
- by a refund to the employer less a 35% tax charge.
Due to the reporting/approval and Pensions Act 1995 requirements where a refund is made to an employer, the preferred route is reallocation.
As an example, the process involved in re-allocating the surplus may be summarised as follows:
After legal advice, Trustees advise provider that a reallocation is to proceed. Trustees advise provider of the amount and destination of surplus
Provider issues HM Revenue & Customs approved rule change in the form of a Deed of Amendment for completion by the Trustees
Trustees issue announcement to all members detailing the proposed rule change and reallocation
Members return signed confirmation that they agree to the rule change and reallocation
Completed Deed of Amendment and member agreements returned to the provider
Provider reallocates surplus in line with Trustee’s instructions
On completion of relevant discharge/application forms etc., provider can now transfer reduced fund to a personal pension
Note that this is an example of the process. Individual providers will have their own process to follow.
This method can be particularly useful in small family companies – the transfer can proceed to a Personal Pension and the spouse or other family member benefits from the reallocation of the surplus.
Note however that the Capital Taxes Office may treat such a reallocation as a transfer of value and therefore subject to IHT. Whilst this shouldn’t be a problem for spouses due to the annual exemption, the Trustees would be wise to check with their local tax office if a reallocation is to be made to anyone other than a spouse.
Although HM Revenue & Customs and DWP have confirmed that this method of reducing a member’s fund is permissible, due to the complex nature of DWP legislation and HM Revenue & Customs practice, we would always strongly recommend that the Trustees seek legal advice before proceeding.
6. Other options
These are not the only options available to members who wish to transfer but fail the test - occupational drawdown has been around for a while and, where this is available, should also be taken into account.
Some words of warning
Although members who require a test often enjoy a considerable degree of control over their pension arrangements, certain actions designed purely to enable them to pass the test (e.g. change of normal retirement age or salary manipulation) are likely be viewed by HM Revenue & Customs as not consistent with approval - possibly leading to loss of approval and taxation of benefits.
Paragraph 10.26 of HM Revenue & Customs Practice Notes IR12 applies to any transfers from occupational schemes. This small paragraph in the Practice Notes will not allow the transfer of any benefits where the transfer value exceeds that which could provide maximum benefits under the scheme. So for overfunded schemes, the only option may be to wait until the fund value falls.
As we have seen, although the transfer regulations appeared at first to further restrict transfers for those who require a test, requesting a re-run of the test after exercising one of the above five options may well mean that a transfer can now proceed.
For IFAs in the know and for those clients who would clearly benefit from a transfer to a personal pension plan, now may be a good time to request a re-run of the test!
The information provided is based on our current understanding of the relevant legislation and regulations and may be subject to alteration as a result of changes in legislation or practice.
All references to taxation are based on our understanding of current taxation law and practice and may be affected by future changes in legislation and the individual circumstances of the investor.
We cannot accept direct transfer business from members of the public. Transfers are complex and individuals should consult an Independent Financial Adviser for advice. Transfers depend on personal circumstances and may not always be in an individual’s best interest. Production of a transfer value analysis is a necessary requirement of the transfer process.
For professional advisers only