Defined Benefits pension pots...

worn_out

The final salary schemes are pretty easy to understand as far as the pension payable at the retirement date, and all the risk regarding the investment returns is taken by the employer.

But, at some point , a value of the fund has to be made because of the entitlement to a 25% yax free lump sum.

So my question is, how do these schemes put a value to the individuals entitlements so that the 25% can be determined. I know about commutation rates which convert this lump into reduced pension payment, but not how the fund pot is valued.

can anyone help ?

xylophone

http://www.pensionschampions.org.uk/?q=finalsalary

worn_out

perfect...thanks... had done the bit about LTA but made a mullock when looking at taking the lump sum into consideration..

worn_out

this might sound silly, but bear with me...

lets say the final pension from a DB scheme is £11,600, and that includes £5100 GMP, so the rest is 'excess'.

The pension after taking 25% is £7,150..so the lump sum is(£7,150x20+£47,667 = £190667) x25% =£47,667.

but. this assumes both the excess and the GMP have the same proportionate values.

For example, if you do the above without the GMP at all - so the pension is £6,500 pa and £4004 after taking the lump sum (£4,004 x20 + £26,697) = £106,777 x 25% = £26,697...

That assumes, if you take one from the other, that the GMP at £5,105 ,or after a lump sum £3,146 (£3,146 x 20 + £20,970) = £83,890 x 25% = £20,970 lump sum.

Is that correct, because the GMP can not be lower than £5,105..you can't reduce that by taking a lump sum, aren't they the rules ? In fact the GMP not only has a minimum guarantee, it has a maximum amount too, which in this case is £6,625.

So, where this has gone wrong (it it has) is that the excess element has been undervalued because the GMP can not be over valued beyond it's limits. This then suggests the LTA for the excess and the gmp must be calculated differently because of the restrictions to GMP ?

If this was true, and given the overall LTA/value of the fund was the same value, then all the lump sum payable based on the £11,600 original pension is entirely attributable to the excess..?

or would the overall fund value be reduced to address the GMP anomaly ?

PensionTech

I'm not entirely sure of the point you're making - nor of the "maximum value" of the GMP - but the GMP and the excess pension are valued in the same way (that is to say, 20x their annual rate). You take both into account when working out the maximum lump sum that can be taken from the pension. However, that lump sum is provided by the commutation of excess pension only; you can't commute GMP for it.

So in your example, your residual pension of £7,150pa is formed of £5,100pa GMP and £2,050pa excess.

If you don't actually have enough excess pension to commute for the full 25% lump sum, then you will be limited to the amount that can be purchased with the excess available.

So let's say that, in your example, your GMP is £10,000pa (rather than £5,100pa). The excess is therefore £1,600.

To get your maximum lump sum of £47,667, based on the numbers you've given (which imply a "commutation factor" of about 10.712) you would have to commute £4,450pa.

You don't have that much available excess so instead you will be limited to the amount of lump sum that would be provided from commuting your entire excess at a rate of 10.712:1 - i.e. £17,138.70.

Your residual pension is just your GMP at £10,000pa, so the total value of your benefits is £10,000pa x 20 + £17,138.70 = £217,138.70.

The lump sum of £17,138.70 only represents 7.89% of the value of your benefits - instead of the maximum 25% usually allowed - because you didn't have enough commutable pension to get the maximum lump sum.

worn_out

thank you pensiontech...that is how I would have thought it should have been calculated, but i've been quoted figures as per my example by my pension scheme..which assumes a reduced GMP. the reason this has arisen (to clarify it all) is that the original quote of £11,600 incorrectly assumed I had left my GMP in the company scheme, when in fact I t/f that bit via a S32. When I told them this they recalculated my figures, as per the above example..and the way they have done it seems to suggest an assumed reduction in both pension and lump sum for the GMP element.

My query really is when theydid the £11,600 quote they must have incorrectly calculated the lump sum due, because they used some of the GMP LTA bit. When they took the GNP out this anomaly was revealed because the lump sum dropped. So I guess my question was, if as you say both the excess and the gmp are valued the same, when you remove the gmp it then throws up the reduction in gmp to £3,146 pa, to make the figures fit...and that can't happen can it. So the original quote was wrongly calculated...??

That is why I wondered if both the excess and gmp 'should' have the same LTA rates,because when you unravel it, it doesn't work right.

PensionTech

If the GMP is no longer in the scheme so that your total pension in the scheme is actually £6,500 rather than £11,600, then the lump sum (being 25% of the total value of your benefits) you get will be lower, because the total value of your benefits no longer includes the GMP.

The implied commutation factor given in your ex-GMP example implies a commutation factor of about 10.696. That's quite close to the commutation factor in the with-GMP example, meaning the two are pretty consistent. It's a little further out than what I might expect for just a normal rounding error but that might be because the actual factors were revised in between the first quote and the second quote, or because they were based on slightly different ages... or all sorts of things. Of course it does depend heavily on the level of accuracy in the figures given on here.

Again I'm not really sure where you're getting the idea that the GMP had been reduced at any point. The 25% lump sum calculation is based on the following factors (assuming that the lump sum itself isn't restricted due to lack of commutable pension or proximity to the LTA):

1. The total amount of the pension
2. The amount of any cash included pre-commutation (such as money purchase AVCs, or automatic cash; doesn't sound like that's a factor here though)
3. The commutation factor

The respective values of the GMP and the excess don't play a part other than in the possible restriction scenario already discussed.

If the GMP is removed from the calculation altogether, because it has been transferred elsewhere, then the total amount of the pension will decrease and that is why the lump sum will also decrease. It doesn't mean that the "missing" lump sum was due to actually be taken from the GMP; it would have been taken from the excess.

In short I don't see anything to suggest that the figures given were wrong, other than that the first included the GMP which is apparently no longer in the scheme.

If I'm misunderstanding you, please do tell me - but maybe only one thought at a time! It's difficult to unpick the leaps of inference you've made.

worn_out

haha,yes I'm leaping around a bit, sorry. having read your comments I have concluded my assumptions were wrong, and indeed the pot is reduced because of the size of the pension...so when GMP was taken out, then obviously this is a new calculation. So, thanks for helping me through that.

My final comment would be that seperating GMP and the excess does have a detrimental affect, and I shouldn't have been advised to do it. By reducing the combined pension (by taking out GMP) I have caused the lump sum to be reduced..something not considered in the t/f discussions. meanwhile the stand alone GMP has no lump sum, unsurpisingly..The reduction in the lump some was £21,000, no small amount, albeit the pension would have been less each year.

The commutation factor of 10.7 doesn't sound overly generous.

Thanks for your help !

worn_out

oh, as an aside, you mentioned the 'maximum' pension I quoted. On my S32 policy it quotes the GMP...then quotes a maximum pension too, in several places, and shows how it is worked out..and that any returns above this maximum (ha ha) will be returned to the original scheme. I presume these represent the lower and upper limits of SERPS ?