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Defined benefits and cash balance arrangements: examples of adjustments to closing values - block transfers

Sections 232(6A)-(6D) & 236(5A)-(5D) Finance Act 2004

Example 1 - 鈥榤irror image鈥� benefits

Alec is a member of a final salary pension scheme (鈥榮cheme 1鈥�).

His pension benefit builds up at a rate of 1/60th of final pay for each year of scheme membership and he has an option to commute some of his pension for a lump sum.

At the start of his pension input period, Alec has 15 years scheme membership and his 鈥榝inal pay鈥� is 拢65,000.

The pension forms part of a bundle of benefit rights in scheme 1 which are payable to or in respect of Alec.

The other benefit rights are that Alec鈥檚 pension will increase at a set rate when in payment, the amount of payable pension is enhanced if Alec retires early on ill-health grounds, a defined lump sum payable on Alec鈥檚 death in service and dependants鈥� pensions up to certain limits payable in the event of Alec鈥檚 death before or after drawing his benefits.

During the pension input period in question Alec鈥檚 employer reorganises its pension schemes by transferring all of the sums and assets held by scheme 1 together with all the liabilities of scheme 1 to another final salary pension scheme (鈥榮cheme 2鈥�).

This results in all of the bundle of rights relating to Alec in scheme 1 being transferred to scheme 2 as part of a block transfer (Alec鈥檚 accrued benefits are transferred along with all the accrued benefits of all of the other members of scheme 1).

Alec鈥檚 pension benefit in scheme 2 also builds up at a rate of a pension of 1/60th of final pay for each year of scheme membership together with an option to commute some of his pension for a lump sum.

The pension forms part of a bundle of benefit rights in scheme 2 which are payable to or in respect of Alec. The other benefit rights are the same as those for scheme 1.

It is established by way of normal actuarial practice that the value of the bundle of rights relating to Alec in scheme 1 immediately before the block transfer is the same as the value of the bundle of rights which are granted in scheme 2 in relation to Alec immediately after the block transfer.

For the purpose of this example, the annual increase in CPI to the September before the tax year is 3.2 per cent.

Also the pension input periods for both scheme 1 and scheme 2 end in the same tax year.

Calculating the pension input amounts

Calculating the opening values

Alec鈥檚 opening value for scheme 1 is calculated as:

Find amount of annual pension

15/60 x 拢65,000 = 拢16,250

Multiply annual rate of pension by flat factor of 16

拢16,250 x 16 = 拢260,000

Add amount of separate lump sum

拢260,000 + 拢0 (there is no separate lump sum) = 拢260,000

Increase by CPI

拢260,000 x 1.032 = 拢268,320

The opening value for scheme 1 is 拢268,320

The opening value for scheme 2 is nil (Alec is a new member at the start of the pension input period for the arrangement under scheme 2).

Calculating the closing values

The closing values for both scheme 1 and scheme 2 need to be adjusted because of the block transfer. If this was not done the pension input amounts for both schemes would not be correct. This adjustment is only needed for the pension input period that the transfer takes place in.

Without an adjustment the closing value for scheme 1 would be nil (as all the benefits rights relating to Alec have been transferred to scheme 2).

The amount of Alec鈥檚 pension that formed part of the bundle of benefit rights immediately before the block transfer out is added back to the closing value for scheme 1. At the point the bundle of benefit rights relating to Alec were transferred he had built up a pension of 拢16,800 in scheme 1.

This means that the closing value for scheme 1 is:

Find amount of annual pension

拢16,800

Multiply annual rate of pension by flat factor of 16

拢16,800 x 16 = 拢268,800

Add amount of separate lump sum

拢268,800 + 拢0 (there is no separate lump sum) = 拢268,800

The closing value for scheme 1 is 拢268,800.

At the point of the block transfer into scheme 2 Alec is granted a pension of 拢16,800 as part of the bundle of rights that formed the block transfer-in.

In the pension input period for scheme 2 Alec builds up a further amount of pension of 拢800. This makes his total annual pension under scheme 2 at the end of the pension input period 拢17,600.

Without an adjustment to take account of the block transfer, the closing value for scheme 2 would be 拢281,600 (拢17,600 x 16).

To find the closing value for scheme 2 the effect of the block transfer is taken into account by deducting from the amount of pension built up at the end of the pension input period (拢17,600) the amount of the pension that was granted in scheme 2 immediately after the block transfer-in of the bundle of rights (拢16,800).

The closing value for the pension input period is based only on the benefit rights built up under scheme 2 further to the pension granted in scheme 2 as part of the block transfer-in - that is a further amount of pension of 拢800.

The closing value for scheme 2 is:

Find amount of annual pension

拢800

Multiply annual rate of pension by flat factor of 16

拢800 x 16 = 拢12,800

Add amount of separate lump sum

拢12,800 + 拢0 (there is no separate lump sum) = 拢12,800

The closing value for scheme 2 is 拢12,800.

Finding the pension input amounts

Alec鈥檚 pension input amounts are:

For scheme 1: closing value (拢268,800) - opening value (拢268,320) = 拢480

For scheme 2: closing value (拢12,800) - opening value (nil) = 拢12,800

As Alec is not a member of any other arrangement his total pension input amount for the tax year is 拢13,280 (拢480 + 拢12,800).

For future tax years, the pension input amount is calculated as normal, with no adjustment for the block transfer.

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Example 2 - not 鈥榤irror image鈥� but benefits of equal value

Alec is a member of a defined benefits pension scheme (鈥榮cheme 1鈥�).

His pension benefit builds up at a set rate and he has an option to commute some of his pension for a lump sum.

At the start of his pension input period, Alec has an accrued pension of 拢14,000pa.

The pension forms part of a bundle of benefit rights in scheme 1 which are payable to or in respect of Alec.

The other benefit rights are that Alec鈥檚 pension will increase at a set rate when in payment, the amount of payable pension is enhanced if Alec retires early on ill-health grounds, a defined lump sum payable on Alec鈥檚 death in service and dependants鈥� pensions up to certain limits payable in the event of Alec鈥檚 death before or after drawing his benefits.

During the pension input period in question Alec鈥檚 employer reorganises its pension schemes by transferring all of the sums and assets held by scheme 1 for a category of members (which includes Alec) together with all the liabilities of scheme 1 relating to that category of membership to another defined benefits pension scheme (鈥榮cheme 2鈥�).

This results in all of the bundle of rights relating to Alec in scheme 1 being transferred to scheme 2 as part of a block transfer (Alec鈥檚 accrued benefits are transferred along with all the accrued benefits of all of the other members of the membership category concerned).

At the time of the block transfer Alec had an accrued pension of 拢15,000pa in scheme 1.

Alec鈥檚 pension benefit in scheme 2 also builds up at a set rate with an option to commute some of his pension for a lump sum. However, the amount of pension that Alec is granted in scheme 2 as part of the block transfer is increased to 拢18,000pa. This is to reflect a later normal pension age in scheme 2 compared to scheme 1.

The pension forms part of a bundle of benefit rights in scheme 2 which are payable to or in respect of Alec. The other benefit rights are the same as those for scheme 1.

It is established by way of normal actuarial practice that the value of the bundle of rights relating to Alec in scheme 1 immediately before the block transfer is the same as the value of the bundle of rights which are granted in scheme 2 in relation to Alec immediately after the block transfer.

By the end of the pension input period for scheme 2 Alec had an accrued pension of 拢19,000pa.

The pension input period for scheme 1 ends in tax year 2012-13 and the annual increase in CPI to the September before the tax year is 5.2 per cent. The pension input period for scheme 2 also ends in tax year 2012-13

Calculating the pension input amounts

Calculating the opening values

Alec鈥檚 opening value for scheme 1 is calculated as:

Find amount of annual pension

拢14,000

Multiply annual rate of pension by flat factor of 16

拢14,000 x 16 = 拢224,000

Add amount of separate lump sum

拢224,000 + 拢0 (there is no separate lump sum) = 拢224,000

Increase by CPI

拢224,000 x 1.052 = 拢235,648

The opening value for scheme 1 is 拢235,648

The opening value for scheme 2 is nil (Alec is a new member at the start of the pension input period for the arrangement under scheme 2).

Calculating the closing values

The closing values for both scheme 1 and scheme 2 need to be adjusted because of the block transfer. If this was not done the pension input amounts for both schemes would not be correct. This adjustment is only needed for the pension input period in which the transfer takes place.

Without an adjustment the closing value for scheme 1 would be nil (as all the benefits rights relating to Alec have been transferred to scheme 2).

The amount of Alec鈥檚 pension that formed part of the bundle of benefit rights immediately before the block transfer out is added back to the closing value for scheme 1. At the point the bundle of benefit rights relating to Alec were transferred he had built up a pension of 拢15,000 in scheme 1.

This means that the closing value for scheme 1 is:

Find amount of annual pension

拢15,000

Multiply annual rate of pension by flat factor of 16

拢15,000 x 16 = 拢240,000

Add amount of separate lump sum

拢240,000 + 拢0 (there is no separate lump sum) = 拢240,000

The closing value for scheme 1 is 拢240,000.

At the point of the block transfer into scheme 2 Alec is granted a pension of 拢18,000 as part of the bundle of rights that formed the block transfer-in.

In the pension input period for scheme 2 Alec builds up a further amount of pension of 拢1,000. This makes his total annual pension under scheme 2 at the end of the pension input period 拢19,000pa.

Without an adjustment to take account of the block transfer, the closing value for scheme 2 would be 拢304,000 (拢19,000 x 16).

To find the closing value for scheme 2 the effect of the block transfer is taken into account by deducting from the amount of pension built up at the end of the pension input period (拢19,000) the amount of the pension that was granted in scheme 2 immediately after the block transfer-in of the bundle of rights (拢18,000).

The closing value for the pension input period is based only on the benefit rights built up under scheme 2 further to the pension granted in scheme 2 as part of the block transfer-in - that is a further amount of pension of 拢1,000.

The closing value for scheme 2 is:

Find amount of annual pension

拢1,000

Multiply annual rate of pension by flat factor of 16

拢1,000 x 16 = 拢16,000

Add amount of separate lump sum

拢16,000 + 拢0 (there is no separate lump sum) = 拢16,000

The closing value for scheme 2 is 拢16,000.

Calculating the total pension input amount

Alec鈥檚 pension input amounts are:

For scheme 1: closing value (拢240,000) - opening value (拢235,648) = 拢4,352

For scheme 2: closing value (拢16,000) - opening value (nil) = 拢16,000

As Alec is not a member of any other arrangement his total pension input amount for the tax year is 拢20,352 (拢4,352 + 拢16,000).

For future tax years, the pension input amount is calculated as normal, with no adjustment for the block transfer.