Commentary on Sections Schedule 11: Deferral of retirement pensions and shared additional pensions
1226.Paragraph 4 inserts a new paragraph A1 at the beginning of Schedule 5 to the Social Security Contributions and Benefits Act 1992. This requires a person who has deferred their Category A or B pension for at least 12 months to choose between increments or a lump sum when they claim their pension. As this choice is not available for those who defer for shorter periods, this provision also effectively sets a minimum qualification period of 12 months for the lump sum.
1227.Regulations made under this paragraph will prescribe how the election is to be made and the period within which it must be made. If no choice is made within the prescribed period however, a person will be deemed to have chosen the lump sum (paragraph A1(2)). In other areas of social security legislation where potential entitlement to more than one benefit exists, the Secretary of State has the power to make the decision which is most advantageous for the claimant. In this instance, the Department recognise that for many people, a weekly increase to their pension would, over time, be financially more beneficial; however the lump sum is the “safe” alternative, as it carries no actuarial risk.
1228.Regulations made under paragraph A1(3) may provide for a limited "cooling-off" period, during which a person may change their original election, or deemed election.
1229.Paragraph A1(4) provides that where a person’s deferred pension includes an increase under paragraphs 5 to 6 of Schedule 5 in respect of increments inherited from a deceased spouse who had deferred a Guaranteed Minimum Pension (GMP), he or she is unable to choose between increments and a lump sum for that component of their deferred pension. The intention is that only increments for that element may be awarded, because pension schemes will not be required to change their rules to offer lump sums as an alternative to increments for deferred GMPs.
1230.Paragraph 5 substitutes paragraph 1 of Schedule 5. The new paragraph 1(1) provides that increments will be added to the pension where the person has either deferred for less than 12 months or has deferred for longer but has chosen increments rather than the lump sum.
1231.The new paragraph 1(2) carries forward the existing wording of the current paragraph 1. In conjunction with the increase in the incremental rate to 1/5th of 1% for each incremental period provided for in paragraph 2(3) of Schedule 5 (see in relation to section 297(3) above), this sub-paragraph provides a minimum deferral period of five weeks for increments by providing that no increase is payable if the increment would be less than 1%.
1232.Paragraph 6 corrects an omission in the current legislation. For the purposes of calculating increments, the intention is that additions to the pension for a dependent husband or wife under sections 83 and 84 of the Contributions and Benefits Act are excluded. As drafted, however, paragraph 2(5)(b) of Schedule 5 only excludes additions under section 83 (paid to a husband for his wife). From April 2010, both sections are replaced by section 83A which equalises the provision of additions for dependent spouses. Paragraph 6(1) therefore substitutes a reference to section 83 with a reference to section 83A; paragraph 6(2) provides that until section 83A comes into effect in 2010, it is to be read as a reference to sections 83 and 84.
1233.Paragraph 7 inserts a new paragraph 2A into Schedule 5 to provide for the calculation of the increase to the weekly pension that will be applicable where a person has elected a lump sum but their deferred pension includes an increase for inheritable GMP increments (see note to paragraph A1(4) above). The increment is to be calculated on that component of the deferred weekly pension alone (the rest being converted to a lump sum).
1234.Paragraph 8(1) inserts new paragraphs 3A and 3B into Schedule 5.
1235.Paragraph 3A provides that a person is entitled to a lump sum if they have both deferred entitlement to their state retirement pension and have elected to receive a lump sum under paragraph A1(1)(b) (or are treated as having made such an election) having deferred their entitlement to their pension for at least 12 months.
1236.Paragraph 3B sets out how the lump sum is to be calculated. This is modelled on the same principle as an interest-earning savings account: interest will be applied each week to the amount “saved”, and compounded.
1237.The weekly amount to which the rate of return will be applied is the amount of pension that the person would have been entitled to had they not deferred (subject to paragraph 3B(5), see below). Retirement pension is payable weekly in advance from the first benefit payday that coincides with, or follows, the date the person is first entitled to the pension. So for example, if a person reaches pensionable age on, say, a Thursday and their pension payday is a Monday, they will not be entitled to any payment for the days preceding that first Monday. At the other end of the claim however, if they cease to be entitled to the pension on for example, a Wednesday, their pension continues in payment to the end of that benefit week.
1238.In order to capture accurately the amount of state retirement pension forgone therefore, the definition of “accrual period” will mirror the provisions which determine what constitutes a person’s benefit week, and effectively provide that each benefit week which begins in the deferment period will be a week that counts for the lump sum calculation. This means that days in the period of deferment preceding the first notional payday will be excluded, but days which fall between the end of the deferment period (i.e. the date the pension claim is actually made) and the first date for which weekly pension becomes due will be included.
1239.For the purposes of the calculation, the amount of weekly pension forgone includes an invalidity addition(4) but excludes increases for a dependent adult or child or any Graduated Retirement Benefit (see below in relation to paragraph 17 of the Schedule). It also includes any increments inherited by the deferrer from a deceased spouse. This corresponds to the definition of “weekly benefit” as used as the basis for the calculation of increments.
1240.However, where the deceased spouse has been entitled to increments from deferring their GMP, the increase awarded in respect of those increments (and uprating of those increments) under paragraphs 5 to 6 of Schedule 5 will not form part of the weekly pension forgone for the purpose of the lump sum calculation, but will instead continue to be included as an increase to the weekly pension (cf. note to new paragraph 2A, above).
1241.Regulations made under paragraph 3B(5)(b)(iii) will provide for the amount of lump sum to be adjusted to take account of circumstances in which pension would have been reduced or not payable had the person been claiming at the time (for example, if another benefit which overlaps with retirement pension had been in payment, or the person had been serving a prison sentence).
1242.The percentage rate that is to apply will be the rate which is 2% higher than the Bank of England base rate, or such higher rate as may be prescribed by affirmative regulations (see paragraph 19 of the Schedule). The formula at paragraph 3B(3) applies the 52nd root of this figure to the amount accrued in each “accrual period”, to provide a compounded rate which at the end of a period of 52 weeks will equal this percentage rate.
1243.The following example demonstrates how the formula is intended to be applied. The weekly pension rates and rate of return shown here are to be read as illustrative only.
Assume Miss Smith would have been entitled to retirement pension of £100 per week from April 2005 had she claimed at that point, and that the prescribed interest rate at the start of the period of deferment is 6.00%. This is equivalent to a weekly increase factor of , where 1.06 refers to a prescribed interest rate of 6.00%.
At the end of the first accrual period, the amount accrued would be:
(note that in the first week, there is no “accrued amount” to bring forward from the previous week, therefore this is shown as zero).
At the end of the second accrual period the amount accrued would increase to:
At the end of the third accrual period, the amount accrued would increase to:
After 52 weeks, Miss Smith would have accrued a lump sum of £5,357.49.
Assume Miss Smith continues to defer and her retirement pension entitlement increases to £103 with effect from April 2006. The lump sum will continue to be calculated in the same manner as above, except that £100 changes to £103. At the end of the first accrual period using the new rate the lump sum would be:
At the end of the second accrual period using the new rate the lump sum would be:
If Miss Smith chose to defer for two years altogether, at the end of March 2007 she would be entitled to a lump sum of £11,197.15.
1244.Except where the rate has been set by regulations to give a higher rate than the norm, a change to the Bank of England base rate will automatically trigger a corresponding change in the lump sum rate of return in order to maintain the 2 percentage points differential. It is intended to apply any such new lump sum rate from the start of the first accrual period following a base rate change (paragraph 3B(4)). However, as a contingency, a regulation-making power has been taken to allow for a longer lead-in, in case it proves not to be technically feasible to implement the new rate as quickly as envisaged. Should this arise, these regulations would effectively maintain the legal status of the former rate until the new rate could become operative. This is to avoid the risk of incorrect awards being made in the interval between a new rate being announced and the adjustment being made to the computer systems calculating the lump sum.
1245.Paragraph 8(2) makes the same provision regarding the exclusion of dependency additions under sections 83 and 84 of the Contributions and Benefits Act before April 2010 for the purposes of calculating the lump sum as made by paragraph 6 above in respect of increments.
1246.Paragraph 9 inserts a new paragraph 3C into Schedule 5. This allows the surviving spouse of a deferrer who has died whilst deferring his pension (having deferred for at least 12 months) to be able to choose between “inheriting” increments or a lump sum in respect of his deferment. This choice is only to be exercised when the widow/er is claiming his or her own pension (and has not remarried before reaching state pension age): if the deferrer dies when the spouse is still under state pension age, the amount of increments or lump sum which would have been awarded had the spouse been entitled to his or her pension at the time the deferrer died will be increased annually, broadly to reflect price increases in the period between the deferrer’s death and the date the survivor claims his or her pension. (This provision already exists for increments; the equivalent provision for lump sums is made by new paragraph 7B(7) as inserted by paragraph 11 of this Schedule, and by the amendment to section 150 of the Social Security Administration Act 1992, as inserted by paragraphs 20 to 22 of this Schedule).
1247.Paragraph 3C(3) and (4) make provisions corresponding to those at paragraph A1(2) and (3) deeming the lump sum to be the surviving spouse’s choice if no election is made within the prescribed time limit, and enabling the regulations to allow the election to be changed within a “cooling-off” period to be specified in regulations.
1248.Paragraph 3C(5) provides that where the deceased was, or would have been, entitled to increments from deferred GMP, the surviving spouse will “inherit” an increase to the weekly pension in respect of that element, regardless of what election is made in relation to the rest of the deceased’s deferred entitlement.
1249.Paragraph 10 amends the existing paragraph 4 of Schedule 5 to provide that a surviving spouse who has not remarried before reaching state pension age will be entitled to inherit increments, either where increments were already in payment to the deceased when he died, or where this is the widow/er’s preferred option, or where the deceased had deferred for less than 12 months. The provisions relating to the actual amount of increments the surviving spouse inherits are not amended by this Act and are therefore not described here.
1250.Paragraph 11 inserts new paragraphs 7A and 7B into Schedule 5 which largely replicate paragraphs 3A and 3B in respect of the calculation of the lump sum for a widowed person.
1251.The only difference between the two calculations is that the amount of additional pension forgone will be adjusted to reflect the proportion of that pension component which the surviving spouse is entitled to inherit as part of her weekly pension. Paragraph 7B(3) shows the proportion as one-half. This would be modified in respect of additional pension that is derived from SERPS, by the Inherited SERPS regulations(5), made under section 52(2) of the Welfare Reform and Pensions Act 1999. Paragraph 25 of this Schedule amends section 52(2) so that those regulations may be amended to include references to the lump sum. This will enable the reduction in the inheritable proportion of the additional pension component of the lump sum to be phased in by October 2010, in line with the corresponding changes to inheritable SERPS itself.
1252.New paragraph 7C, inserted by paragraph 12, provides that the final amount of the lump sum will be rounded to the nearest whole penny. Sub-paragraph (2) provides that when exercising the power to prescribe an interest rate higher than 2% above the Bank of England base rate, the Secretary of State must have regard to the national economic situation and to any other matters which he considers relevant.
1253.Paragraph 14 makes consequential amendments to paragraph 8 of Schedule 5 to include references to the lump sum calculation. In particular, new sub-paragraphs (4) to (6) substitute the existing paragraph 8(4) which prevents increments being inheritable by a surviving spouse in respect of deferred pension that was either wholly or partly based on the survivor’s own contributions (i.e. it was either a Category B pension or a Category A pension that was increased by virtue of the spouse’s contributory record). This provision is now extended to refer to the calculation of lump sums.
1254.Paragraph 15 inserts a new Schedule 5A into the Contributions and Benefits Act to provide the choice between a lump sum or pension increase where a person has deferred their shared additional pension and how that lump sum or increase is to be calculated.
1255.Paragraphs 1, 2, 4 and 5 of the new Schedule 5A largely replicate the provisions made under paragraphs A1, 1, 3A and 3B of the amended Schedule 5 with respect to elections between increments and a lump sum, and the calculation of the lump sum. Paragraph 3 replaces the existing provisions in section 55C of that Act relating to the calculation of increments where shared additional pension is deferred, incorporating the changes to those provisions made under section 50(2) of the Welfare Reform and Pensions Act 1999 to take effect from 2010 and now brought forward.
1256.The only significant difference between the lump sum for Category A or B pension and the lump sum for shared additional pension is that, in line with the current provisions on shared additional pension increments, if the person entitled to that pension has subsequently remarried and dies leaving a widow or widower, the surviving partner will not be entitled to inherit the lump sum.
1257.Paragraph 17 amends section 62(1) of the Contributions and Benefits Act so that where entitlement to Graduated Retirement Benefit has been deferred, regulations may provide for the choice between a lump sum or increments for the deferment period.
1258.Paragraph 18 amends section 122(1) of that Act to include a definition of “Bank of England base rate” for the purposes of the lump sum calculation. It also extends the definition of “deferred” and “period of deferment” for the purposes of that Act to cover deferment of shared additional pensions.
1259.Paragraph 19 amends section 176 of that Act to provide that regulations prescribing the percentage rate applicable to the lump sum calculation shall be made by the affirmative procedure.
1260.Paragraphs 20 to 22 allow a lump sum to be uprated where a surviving spouse has not attained pensionable age when his or her spouse died and is therefore not yet entitled to their own state retirement pension (cf. notes to paragraph 9, above).
1261.Paragraph 24 omits section 50(2) of the Welfare Reform and Pensions Act 1999 which increased the rate at which increments accrue and removed the time limits for accrual in shared additional pension from 2010: these changes are now subsumed within the new Schedule 5A, as enacted by this Schedule.
1262.Paragraph 25 enables the modifications to the Inherited SERPS provisions to be extended to the calculation of the lump sum for surviving spouses (see under paragraph 11, above).
1263.Paragraph 26 restricts a widower from inheriting a lump sum or increments where he attains pensionable age before 6th April 2010 unless he himself was over that age when his wife died. This re-enacts and extends the corresponding provision made by paragraph 21(14) of Schedule 4 to the Pensions Act 1995 which applied in relation to entitlement to increments under the previous version of paragraph 4(1) of Schedule 5 to the Contributions and Benefits Act, and which is now substituted by paragraph 10(2) of this Schedule.
1264.Paragraph 27 provides a power to make regulations detailing the transitional arrangements that will apply in cases where a period of deferment spans 6 April 2005, the commencement date of these changes.
1265.In particular, it is intended that regulations made under this power will provide that any period of deferment that wholly precedes the commencement date will be subject to existing rules. That is, in respect of any such period, only increments at the current rate may be awarded. For the period beginning on the commencement date, the new provisions will apply so that, providing the part of the deferment period starting on the commencement date lasts for at least 12 months, the deferrer will have the choice of a lump sum or increments at the new rate. Corresponding provisions will be made in respect of a surviving spouse’s entitlement to inheritable increments or a lump sum.
1266.These sections and schedule, which make further provision in respect of deferred retirement pension or deferred shared additional pension and, in particular, introduce the option of a lump sum, involved consideration of Article 1 of Protocol 1 and Article 14 ECHR. Insofar as these Articles may be engaged it is considered that the further provisions for deferral are justifiable.