Commentary on Sections Part 3 – General Changes to Legislation about Pension Schemes Section 40: Revaluation of accrued benefitsSchedule 1: Early leavers: revaluation of accrued benefits
When a member stops being an active member of a scheme more than a year prior to retirement, the accrued benefits are required to be “re-valued” at the scheme’s normal pension age to provide a measure of inflation protection over the period of deferral.  Sections 79 to 82 of, and Schedule 2 to, the Pension Schemes Act set out the procedure for revaluation based on benefit type.
The existing section 80 of the Pensions Schemes Act takes the final salary method as its default method of revaluation for accrued benefits. This method requires benefits to be increased by inflation capped at 5 or 2.5 per cent each year (depending on when pensionable service occurred), but there is an alternative for average salary, flat rate or money purchase benefits. In these cases, the legislation allows for revaluation using the average salary and flat rate methods, where trustees or managers consider these methods, respectively, to be more appropriate than the final salary method, and the money purchase method where benefits are money purchase or benefits from a personal pension scheme.
The basic principle behind the non-final salary provisions is that both active scheme members and those who have left the scheme before normal pension age should be treated in the same way. Their rights in relation to accrued benefits should not be affected because they have, for example, changed their place of employment and consequently left that pension scheme. The methods are set out in Schedule 2 to the Pension Schemes Act. For the final salary method, the annual Occupational Pensions (Revaluation) Order (Northern Ireland) sets out the percentages to be used for people retiring during the following year. The average salary and flat rate methods state that benefits are to be re-valued in the same way as they would have been had the member remained in pensionable service. In the money purchase method the requirement is to apply the same investment return on the accrued benefits to both active and deferred members.
The Pensions (2012 Act) (Consequential and Supplementary Provisions) Regulations (Northern Ireland) 2014 (S.R. 2014 No. 213) introduced an additional cash balance method for cash balance benefits not calculated by reference to final salary which accrue after section 27 of the 2012 Act is commenced. This also required active and deferred members to be treated in the same way.
Schedule 1 to the Act amends the Pension Schemes Act. There will be no changes to the method applicable for benefits which accrued before the changes come into operation or for relevant pension credits rights where entitlement arose before the changes come into operation. A new “default method” will apply for all benefits except those which are money purchase, salary related or flat rate. (“Salary related” will include final salary cash balance schemes). The default is simply to revalue benefits as they would have been had the member remained in pensionable service. The exceptions for the default method remain money purchase benefits, flat rate benefits and what are now termed “salary related” benefits. A salary related benefit must be re-valued using the final salary method except where those benefits are average salary and trustees or managers consider the average salary method more appropriate. Money purchase benefits should be re-valued using the money purchase method. These methods continue to apply the definitions set out in Schedule 2 to the Pension Schemes Act where referenced.
Collective benefits will be re-valued using the default method.
Schedule 1 (see new section 80D) also sets out the revaluation procedure for hybrid benefits – those benefits which are made up of different components, the highest of which is paid. In this case, each component will be re-valued separately before deciding which is the highest. This replicates the effect of provision currently contained in regulations. In new section 80E there is provision for schemes which have used certain alternative methods of revaluation (primarily public service pension schemes) to continue to do so.
There is also a power (in new section 81A) to add revaluation methods for personal pension schemes. This is to allow for the possibility that in the future the design of personal pensions introduces a wider range of benefits than are provided for by the new provisions.