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Adviser  >  Technical Central  >  Support material  >  Case Studies  >  Occupational pensions and low retirement ages

Occupational pensions and low retirement ages

The minimum age at which a member can take (crystallise) their pension benefits under an occupational pension scheme (OPS) will change from 6 April 2010 from 50 to 55. There are also changes for those who have a normal retirement age of less than 55 pre A-Day. This case study will look at two different scenarios. One for David, an existing OPS member who had a pre A-Day benefits value of £2 million. He’s worried about how this change will affect him and if there is anything he can do to protect his pension benefits. In the other scenario we’ll look at Susan, who’s also an existing OPS member who had a pre A-Day benefits value of £0.5 million. She also wants to know how the increase in the minimum retirement age will affect her.

Before we look at each scenario it’s worth going over the conditions that must apply under OPSs to protect the right to take benefits at a low retirement age. These are:

• the member had the right to take benefits earlier than age 55 on 5 April 2006
• the scheme rules confirm the right to take benefits at the agreed low retirement age on 10 December 2003
• benefits are taken in full at the same time
• after becoming eligible for benefits they no longer work for any employer sponsoring the scheme.

Scenario 1 – Pre A-Day pension benefits of £2m

David is a professional footballer. He’s been a member of an executive pension plan (EPP) since 1997. The scheme retirement age is 35. He’s obtained a benefit statement confirming that he has a pre A-Day benefits value of £2 million with tax-free cash (TFC) of around £600,000. At age 35 his benefits are expected to be worth £3 million. David has contacted his financial adviser as he wants to know how the change in minimum retirement age will affect him. He’ll be 35 on 10 December 2010. He’s also heard from a work colleague that he may need to protect his pre A-Day TFC and pension benefits and wants to know more about this.

David’s financial adviser explains that he can still crystallise his pension benefits at age 35 provided the conditions outlined above apply. However, it’s not all good news - unless he chooses enhanced protection, David’s pension benefits will be tested against a reduced standard lifetime allowance (SLA) when he reaches age 35. The SLA is reduced by 2.5% for every complete year between the age that he takes his benefits and the minimum pension age of 55. His financial adviser does a quick calculation for him:

Assumed SLA at 2010 £1.8 million New minimum pension age 55 Protected pension age 35 Difference 20 years Reduced SLA = (100% - (20 x 2.5%) x £1.8m) = £900,000 £900,000 will be David’s personal lifetime allowance (PLA) in 2010

David’s financial adviser explains the range of protection options available and does some rough calculations for him based on his estimated benefits value at age 35:

No protection – If David does nothing he will be subject to a lifetime allowance charge (LAC) when he crystallises his pension benefits. David’s pre A-Day TFC will be increased in line with the SLA when he chooses to crystallise his pension benefits.

Estimated benefits value at age 35 £3m PLA £900,000 PCLS* £600,000 x [£1.8m x (100% - 20 x 2.5%)/£1.5m] = £360,000 Plus 25% of the increase in the value of the policy since A-Day. For this purpose the A-Day value is increased in linewith the SLA. (£3m – £2m) x [£1.8m x (100% - 20 x 2.5%)/£1.5m] x 25% = £150,000 Total PCLS available £360,000 + £150,000 = £510,000 Balance of benefits value within reduced SLA £900,000 - £510,000 = £390,000 LAC payable: • If taken as a lump sum £3m - £900,000 x 55% = £1,155,000 • If taken as income £3m - £900,000 x 25% = £525,500** *from A-Day tax-free cash is known as pension commencement lump sum (PCLS) **subject to PAYE in payment

Primary protection – As David’s pre A-Day benefits value is over £1.5m he can select primary protection. He will be able to register his own personal lifetime allowance (PLA) which normally would reduce the possibility of a LAC applying when he crystallises his pension benefits. His PLA would be £2m, his benefits value at A-Day, increased in line with the SLA. However, as David is subject to a reduced PLA any benefits value he has over this limit increased in line with the SLA will be subject to a LAC. David’s pre A-Day TFC will be increased in line with the SLA when he chooses to crystallise his pension benefits.

Estimated benefits value at age 35 £3m Reduced PLA of £2m x £1.8m x [100% - (20 x 2.5%)/£1.5m] = £1.2m PCLS* £600,000 x [£1.8m x (100% - 20 x 2.5%)/£1.5m] = £360,000 Plus 25% of the increase in the value of the policy since A-Day. For this purpose the A-Day value is increased in line with the SLA. (£3m – £2m) x [£1.8m x (100% - 20 x 2.5%)/£1.5m] x 25% = £150,000 Total PCLS available £360,000 + £150,000 = £510,000 Balance of benefits value within reduced PLA £1.2m - £510,000 = £690,000 LAC payable: • If taken as a lump sum £3m - £1.2m x 55% = £990,000 • If taken as income £3m - £1.2m x 25% = £450,000** * from A-Day tax-free cash is known as pension commencement lump sum (PCLS) **subject to PAYE in payment

Enhanced protection – This provides full protection from any LAC when David crystallises his pension benefits. His financial adviser points out that one of the conditions of enhanced protection is that David would have to stop being an active member of the money purchase scheme and couldn’t build up any further benefits on or after A-Day.

In terms of TFC David has a right to more than £375,000 (25% of the SLA at A-Day) as TFC and this will be held as a percentage of his pre A-Day benefits value. The same percentage will be available when he decides to crystallise his pension benefits.

David’s financial adviser points out that there is no minimum benefits value to register at A-Day for enhanced protection and he can apply for both enhanced and primary protection at the same time.

Estimated benefits value at age 35 £2.8m* PCLS percentage of pre A-Day benefits value £600,000/£2,000,00 = 30% So PCLS, as a percentage of benefits value is £2.8m x 30% = £840,000 Balance of benefits value - £2.8m - £840,000 = £1.96m** *reduced benefits value as a result of choosing enhanced protection as no contributions/accrual after 5/4/06. **subject to PAYE in payment

In summing up David’s options his financial adviser explains that:

• In comparing the protection options available if David opts for enhanced protection he will receive the maximum amount of PCLS possible when he crystallises his benefits at age 35 and more importantly avoid any LAC. The bad news is that this will also mean that David will have to stop being an active member of the money purchase scheme and couldn’t build up any further benefits on or after A-Day.
• Unfortunately he cannot crystallise his pension benefits before 10 December 2010 (unless he’s in serious ill health).
• He could defer crystallising his pension benefits until he reaches age 40 provided he is still a registered professional. If he had applied for primary protection or decided not to protect his pre A-Day pension benefits this would increase the PLA from 50% to 62.5% (50% + (2.5% x 5)).He cannot partially crystallise his benefits, it is a condition of taking benefits at a low retirement age that all benefits must be taken at the same time.
• If he still wishes to crystallise his benefits at age 35 and get the most PCLS, he will have to accept the fact he will have to select enhanced protection and cannot remain an active member of the money purchase scheme and cannot build up any further benefits on or after A-Day.

Scenario 2 – Pre A-Day pension benefits of £0.5m

Susan is a motor racing driver. She’s been a member of her employer’s EPP since 2001. The scheme retirement age is 45. She’s obtained a benefit statement confirming that she has a pre A-Day benefits value of £500,000 and TFC of around £115,000. At age 45 her estimated benefits value will be £560,000. Susan has contacted her financial adviser, as she’s heard from a colleague that there’s going to be a change in the scheme retirement age. She will be 45 on 15 August 2008.

Susan’s planning to crystallise all her pension benefits at age 45 and hopes to start up a new minicab business with her brother. She’s particularly interested in finding out if there’s any scope for future pension provision when she sets up her new business.

Susan’s financial adviser explains that she can still crystallise her pension benefits at age 45 provided the conditions outlined below apply. Again, unless enhanced protection is used, Susan’s pension benefits will be tested against a reduced statutory lifetime allowance (SLA) when she reaches age 45. Her financial adviser does a quick calculation for her:

SLA at 2008 £1.65 million New minimum pension age 50 Protected pension age 45 Difference 5 years SLA = (100% - (5x2.5%)) x £1.65 m = £1.4375m

Susan’s financial adviser also explains the protection options available to her. She’s unable to choose primary protection, as her benefits value is less than £1.5m. She could choose enhanced protection but would have to cease being an active member of the scheme and couldn’t build up any further benefits in any other scheme on or after A-Day.

With no protection, as Susan’s benefit value is well within the reduced SLA further contributions can still be paid into her employer’s scheme. Provided her benefits value plus any additional contributions and any investment growth is within the SLA when she crystallises her pension benefits she would avoid a LAC.

Her financial adviser explains that Susan does not need to protect her pre A-Day benefits and TFC entitlement.

In summing up Susan’s options her financial adviser explains

• Unfortunately she cannot retire before 15 August 2008 (unless she's in serious ill health).
• She cannot partially crystallise her benefits, it is a condition of taking benefits at a low retirement age that all benefits must be taken at the same time.
• With no protection additional contributions can still be made into her current employer's EPP on her behalf as she's well within her reduced SLA.
• With enhanced protection Susan would have to cease being an active member of the scheme and couldn't build up any further benefits in any other scheme after A-Day. As her estimated benefits value is well within her SLA there is no need to opt for enhanced protection.
• With no protection it will be possible for Susan to fund another pension when she sets up her new business with her brother (subject to the new minimum pension age of 55). This can be funded up to the SLA available at age 55 after allowing for her previously crystallised benefits value which must be indexed in line with the SLA available at age 55. For example, if Susan sets up an EPP with a retirement age of 55 and the SLA available at this time was £2.31m* she would be able to build up additional benefits of £1.55m assuming her previously crystallised benefits indexed in line with the SLA had grown to £760,000.

* assumed increase in the SLA from 2006/07 to 2018/19 4% p.a. - based on the increase to the SLA figures announced from 2006/07 to 2010/11 [(£1.8m/£1.5m)/5 = 4% p.a.]

It should be noted that the reduction in the SLA does not apply to members of the armed forces, fire or police pension schemes.

This case study is an example only, and whilst it highlights some of the opportunities for planning, it should be recognised that it is not a complete or exhaustive description of the opportunities or pitfalls.

This information is based on our understanding of the Finance Act 2004, as amended by the Finance Act 2005.

Published 28 April 2007

Updated 28 April 2008