Section 32 arrangements, GMPs and transferring

Summary

Section 32 arrangements were introduced in the 1981 Finance Act, with their name coming from the relevant section of the Act.  Scheme Rules permitting, a member of an occupational pension scheme was able to choose to transfer to a Section 32, increasing their options on leaving.

Many clients will have a Section 32 from many years ago and will often have little understanding of how they work and what benefits they can expect.  It is therefore important to be able to explain the benefits from such a plan and how they fit into their overall retirement planning.  This will include targeting income and cash in retirement and when the open market option may be suitable. 

Facts and analysis

Section 32s were an option for individuals who had left their employer’s service and wanted to transfer their pension benefits out of their employer’s scheme.  Each arrangement normally only accepts one transfer and does not accept any regular or single contributions. 

Up to A-Day the benefits transferred remained subject to occupational pension HMRC rules including the calculation of tax-free cash.  Their introduction was obviously pre personal pensions, but even post 1988 they remained popular due to the preservation of GMP benefits.

In the post A-Day regime, the rules that apply to Section 32s are broadly the same as for a personal pension in terms of retirement age and maximum benefits.  There are, however, some key differences which may mean that a transfer to a personal pension to take benefits is an attractive option.  The benefits of the flexibility of a personal pension, and especially the new pension flexibility from 6 April 2015, would need to be balanced with the loss of guarantees under the Section 32.

The place to start with the guarantees under the Section 32 is the GMP.  GMP is of course the accrued benefit as a result of contracting out of the State earnings related pension scheme (SERPS) between 6 April 1978 and 5 April 1997.  GMP was normally built up in defined benefit schemes, and the guarantees attaching to this remained in place when transferred to a Section 32.  The main features of GMP are –

  • Guarantees a minimum level of pension, payable from age 60 for a woman and age 65 for a man
  • Calculated at the date of ceasing contracted out service
  • And re-valued to age 60 for a woman and 65 for a man
  • And any post 5 April 1988 GMP increased by the Scheme each year in payment from 60/65 in line with inflation up to 3%
  • With a 50% widow’s pension on the whole GMP, and a 50% widower’s, surviving civil partner’s* or same sex spouse’s on the post 5 April 1988 GMP
  • With no tax-free cash available

*please note that wherever spouse’s pension is referred to, it includes a civil partner and same sex partner

When the Section 32 provider accepted the transfer, they also agreed to provide the guarantees associated with the GMP.  The transfer value may have been made up of both GMP and excess benefits.  The provider agreed to revalue the GMP to age 60 (female) or 65 (male), but it is possible to take benefits earlier than this so long as the GMP commitment can be met at age 60/65.  Please note that although State Pension ages for men and women are currently being equalised, and then increased to age 67 by 2028, GMP remains payable at age 60/65.

GMP is reasonably easy to calculate because all of the information required is available at the date of the transfer: GMP at transfer date, rate at which it will be re-valued and the retirement age.  Hence, if a member wants to start benefits at age 55, the provider will need to calculate if the pension available at age 55 is sufficient to meet the GMP requirement at age 60/65.

There are three different methods of revaluing the GMP after the member has left contracted out employment –

  • Section 148 orders, which increases GMP in line with the annual rate of increase of National Average Earnings
  • Fixed Revaluation, which is a rate of annual increase laid down by Government, determined by the date that contracted out service ceased
  • Limited Revaluation, which is increases in line with Section 148 orders, but only 5% per annum compound will come from the scheme while any balance will be paid by the State in return for a payment made by the trustees at the time of leaving.  The Limited Revaluation option ceased for those who ceased contracted out service on or after 6 April 1997

The scheme documentation will set out which of these three options the scheme has adopted.

The fixed revaluation rates are –

Contracted out service ceased between

Fixed revaluation rate for each complete tax year between the date that contracting out service ceased and age 60/65

6 April 1978 and 5 April 1988

8.5%

6 April 1988 and 5 April 1993

7.5%

6 April 1993 and 5 April 1997

7%

6 April 1997 and 5 April 2002

6.25%

6 April 2002 and 5 April 2007

4.5%

6 April 2007 and 5 April 2012

4%

6 April 2012 and 5 April 2017

4.75%

6 April 2017 and onwards

3.5%

The GMP must also increase in payment, part from age 60/65 part from State pension age, in line with inflation.  The cost of this inflation proofing will be met by the State, the scheme or a combination of the two, depending on when the GMP accrued.

GMP accrued between

The cost of the inflationary increases met by

6 April 1978 and 5 April 1988

The State

6 April 1988 and 5 April 1997

The scheme must meet up to the first 3% per annum, and the State will meet any excess above 3%

Summary of information for the example for Jack discussed below –

  • Value of benefits on leaving service in 1987 £3,000 pa, including £1,000 pa GMP
  • Transfer value into section 32 in 1987 £32,000
  • State retirement age is 65, which is in 2017
  • Maximum cash at retirement at date of leaving is £7,500 (uplifted 80ths)
  • Revaluation rate is fixed at 8.5%, and increases to GMP in payment are met by the State

The revaluation to age 65 and increases in payment are both extremely valuable benefits.  For example, Jack left his defined benefit scheme and transferred his benefits to a Section 32 in 1987 when the GMP was calculated at £1,000 pa.  He will reach State pension age in 2017, when the GMP will have increased to £11,558 per annum (re-valued at 8.5% per annum).  If we assume an annuity rate of 12% in 1987, then the fund required to purchase a pension equal to the GMP of £1,000 pa for a male age 65 would be around £8,500.  If we then assume that the current annuity rate is 5%, the fund required to purchase a pension of £11,558 equal to the revalued GMP would be around £231,160.  This would mean that a growth rate of around 12% per annum would be required to meet this guarantee.

In our example for Jack, however, the transfer value is considerably higher than £8,500 because excess benefits are included.  Consider if Jack had been a member of his DB scheme for 9 years, accruing benefits at a rate of 1/60th for each year of service, leaving the scheme with a final salary of £20,000.  The pension would be valued at 9/60 x £20,000 = £3,000.  Of this the GMP is calculated to be £1,000 pa and the maximum tax free cash is £7,500.

If Jack’s transfer value in 1987 was £32,000, and the annual growth rate until retirement is 7%, then the fund will be valued at £243,592.  The first consideration is the GMP, which we know is £11,558 per annum and will cost around £231,160 to secure.  This will leave only £12,432 remaining in the fund.  No tax-free cash can be taken from the GMP, but the maximum tax-free cash calculation is based on the whole fund and hence the remaining £12,432 can be taken as cash.

In this example, the required growth in the fund was not achieved to preserve the GMP and the excess benefits are effectively subsidising the GMP.  Where GMP was a higher portion of total benefits, it is possible that the fund value at retirement will be insufficient to meet the GMP in which case the Section 32 provider must stand behind the guarantees, and a transfer to a personal pension would not be permitted.  For example, if Jack’s scheme had been an accrual rate of 80ths rather than 60ths, then the preserved pension would have been £2,250 rather than £3,000 but the GMP would be the same.  Let’s say the transfer value was £22,500, then with an annual growth rate of 7% the fund would be worth £172,276 in 2017, which is insufficient to meet the GMP on an assumed annuity rate of 5%.

There are a number of reasons why you may consider opting for the open market option, or even transferring a client’s benefits out of a Section 32 into a personal pension.  We now look at some of the situations where the open market option (OMO) or transfer to a personal pension may or may not be suitable.

Considerations

  • Is the fund sufficient to meet the GMP at State pension age?
    • If not, then the existing provider must make up the shortfall so an OMO is probably unrealistic and a transfer to a personal pension would not be possible.  The provider must refuse to agree to a transfer to a personal pension if it’s not possible to provide a transfer value that is at least equal to the value of the GMP 
  • Does the client want to retire earlier than age 60/65, and if so are they able to do this?
    • The GMP must be available at age 60/65, and hence if the client wants to retire earlier than this, when annuity rates and fund value are likely to be lower, the pension that it can purchase may be less than the GMP.  If this is the case, then early retirement may be refused by the provider, unless it’s possible to secure a smaller benefit from early retirement that then “steps-up” to the GMP from age 60/65
    • Using the OMO (i.e. purchasing the GMP liability on the open market) or transferring to a personal pension may be the only options to access the benefits early, although this would need to be carefully balanced with the loss of the GMP (on transfer), and potentially a lower pension from age 60/65. 
  • Is the client in good health?
    • Health and lifestyle considerations cannot be taken into account in calculating the cost of the GMP, but transferring to a personal pension may give access to an enhanced or impaired life annuity if the member qualifies
    • If a client is in poor health drawdown may be a preferred option if it can provide higher spouse’s benefits either as a lump sum or as a drawdown income
  • Spouse pension
    • The GMP must purchase a spouse’s pension, but a transfer to a personal pension would not require a spouse’s pension and hence could mean higher pension for the member
  • Increases in Payment
    • A valuable benefit of the GMP is the guaranteed increases in payment in line with inflation.  The cost of these increases is met by either the State or the Section 32 provider (or a combination of both) depending on when the GMP was accrued.
    • Transferring to a personal pension would result in the loss of the guaranteed increases that are met by the Section 32 provider. 
  • How important is the availability of tax free cash?
    • If the GMP is using up a large part of the fund it will reduce the amount of tax-free cash available.  In our example for Jack the fund at age 65 is £243,592, and the tax free cash is £12,432.  A transfer to a personal pension would give access to cash at 25% of the whole fund, which is £60,898, and is an additional £48,466.
    • Please note that a Section 32 taken out prior to A-Day will have automatic protection of tax-free cash if the maximum cash on 5 April 2006 exceeded 25% of their total benefit value and this is normally lost on transfer to a personal pension.  As can be seen from our example, however, where there is a substantial GMP entitlement it is unlikely that the cash available will be higher than on transfer to a personal pension.
  • Minimum retirement age
    • If the Section 32 was in force before 11 December 2003, then it’s quite probable that the policyholder has the right to take benefits, without tax charges, from age 50.  (This assumes that the value is sufficient to allow retirement from age 50, i.e. any GMP is covered).  If the Section 32 were to transfer to a personal pension, the protected early normal pension age would normally be lost, and benefits would not be available until age 55.  

Changes in the future

Historically we have seen continuous change to pension legislation, and this looks set to continue.  We will consider 2 specific changes, namely State pension age and equalisation of GMP.

The State pension age will be equalised for men and women at age 65 by April 2018, and increased to age 66 by April 2020.  It is anticipated that this will increase to 67 by 2028.  Although GMP is not impacted by this because it remains payable at age 60/65, it does have an impact on the client in terms of revaluation and increases of pension in payment.

GMP must be re-valued to age 60/65, but if the member does not retire at this age there is no requirement on the provider to revalue to a later date, although there are certain deferment increases that the provider has to provide.  These are explained later.  This may affect a large number of clients, and is already affecting women whose State pension age is in transition between ages 60 and 65.  The impact will be felt in two ways –

For those retiring prior to age 60/65

  • The GMP is still calculated to age 60/65.  For those with a State pension age higher than this the revaluation is not to this later age
  • This may facilitate early retirement when the GMP can be met at the lower age, but where revaluation to a later age would have resulted in a higher GMP that the fund could not support
  • It may also mean that less fund is used for the GMP and hence more cash should be available from the remaining fund
  • Although revaluation applies only to age 60/65, the State responsibility for increases in payment will not start until State pension age.  This means that clients with pre 1988 GMP will be affected, and those with post 1988 GMP where inflationary increases are in excess of 3%
  • Let’s consider an example to illustrate this -
  • Female with a date of birth of 5 September 1958 and will attain age 60 on 5 September 2018.  Her new State pension age is 5 September 2024
  • She has a Section 32 taken out in 1992
  • The GMP is re-valued to age 60, but she wishes to retire and take benefits at age 55
  • She will only be allowed to retire at age 55 if the GMP at age 60 can be met from the fund
  • She has both pre and post 1988 GMP, split 50/50
  • Which means that half of the annuity can be level, and half must increase each year in payment by 3% pa
  • The increases due on the pre 1988 GMP and excess over 3% on the post 1988 GMP will be met by the State, but this will not start until 5 September 2024

For those retiring after age 60/65

  • The GMP is still calculated to age 60/65 at which point the requirement to revalue will cease
  • However, if the GMP is deferred for 7 weeks or more, the scheme must increase the GMP by 1/7% for each complete week in the deferment period.  Also, any post 5 April 1988 GMP has to be increased in line with inflation up to 3% for each occurrence of 6th April after age 60/65

The second change which is likely to impact on GMPs is equalisation, although the impact of this is much less clear at the moment.  Different retirement ages for men and women have been an issue since 17 May 1990 following the European Court’s judgement in Barber v Guardian Royal Exchange.   As a result of the judgement occupational pension schemes must have the same retirement age for men and women, and the State pension age will also be equalised by 2018.  There has to date, however, been no equalisation of GMPs.

A consultation on equalisation of GMPs concluded in April 2012 and although an interim response was published in April 2013 we still await a full Government response.

GMP for men and women are not currently equal because the State pension age is not the same.  The unequal State pension age results in –

  • Different GMP accrual rates for men and women
  • Duration of the revaluation from the date of leaving service to State pension age
  • The increases in payment from State pension age

Briefly, the GMP is available to women 5 years earlier, but is likely to be less at age 65 than for a man as the revaluation rate is likely to be higher than the increases in payment

Next steps

There are still many clients with Sections 32s with a GMP entitlement, but with GMP ceasing many years ago the understanding and familiarity of the rules can be hard to find.  GMP is a complex benefit, but also often a valuable benefit in retirement which needs to be quantified and explained to a client.

Understanding GMP within a Section 32 will enable informed decisions about taking the benefit from the Section 32, utilising the OMO or transferring to a personal pension/SIPP.  This offers an opportunity to any adviser to add value by maximising pension benefits for a client. A summary of the rules and benefits is detailed below. 

 

Section 32

Open Market Option

Personal Pension/SIPP

Retirement age

Minimum age 50 (if policy in force prior to 11 December 2003, and policy conditions allow), otherwise 55, but only if any GMP (re-valued to age 60/65)  can be met from age 60/65

Minimum age 50 (if policy in force prior to 11 December 2003, and policy conditions allow), otherwise 55, but only if any GMP (re-valued to age 60/65)  can be met from age 60/65

Minimum age normally 55. 

 

Pension

Minimum pension is the GMP entitlement

Any GMP must include a spouse’s pension (except that pre 1988 GMP does not include the requirement for a widower’s pension, a surviving civil partner’s pension or a same sex spouse’s pension).  There is no need to purchase a spouse pension with non-GMP benefits.

GMP will increase in payment in line with inflation.  The cost of this is met in full by the State for pre 1988 benefits, and the excess over 3% on post 1988 benefits

Minimum pension is the GMP entitlement

Any GMP must include a spouse’s pension (except that pre 1988 GMP does not include the requirement for a widower’s pension, a surviving civil partner’s pension or a same sex spouse’s pension).  There is no need to purchase a spouse pension with non-GMP benefits.

GMP will increase in payment in line with inflation.  The cost of this is met in full by the State for pre 1988 benefits, and the excess over 3% on post 1988 benefits

No minimum

There is no need to purchase a spouse’s pension

Pension can be level or escalating with all of the cost met by the member.  This could mean that a higher initial pension is achieved for post 1988 benefits.

Tax-free Cash

Scheme specific tax-free cash protection may apply

No tax-free cash can be taken from the GMP benefit

Scheme specific tax-free cash protection may apply

No tax-free cash can be taken from the GMP benefit

Maximum tax-fee cash normally 25% of the whole fund.  

 

 

Income drawdown

Possible if the scheme rules allow, but not permitted for GMP

Our current understanding is that as GMP is a ‘defined benefit’, none of the flexible access options available from 6 April 2015 apply.

Not applicable

Possible if the scheme rules allow. 

Death Before Retirement

If married/civil partnership the GMP fund must provide widow’s GMP (for the pre 1988 GMP) plus a spouse’s GMP in respect of the post 1988 GMP)

Spouse could elect to purchase and spouse’s GMP on the open market.

All funds are available as a lump sum or as beneficiary drawdown

Important information

This information has not been approved for use with customers and is based on Aviva’s interpretation of current law and legislation, and our understanding of HM Revenue & Customs (HMRC) practice as at 6 April 2019. It is provided for general information purposes only and should not be relied upon in place of legal or other professional advice. Both the law and HMRC practice will change from time to time and our interpretation may be subject to challenge by HMRC or other regulatory body. Aviva cannot act as legal adviser for you or your clients. You should always seek appropriate legal or other professional advice.

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