UK: Transfer Value Exercises: Transferring Responsibility To The Trustees, Employer And The Member? Part 1

Last Updated: 12 February 2007
Article by Peter Trotter and James Keith

Recent investment performance and changes to how pension schemes are valued may allow reductions in the rates at which employers require to contribute to their defined benefit (e.g. final salary career average) pension schemes. However, many employers are keen to explore other ways of reducing the need to contribute to such arrangements.

Transfer value exercises

A popular way of doing so has been to undertake a ‘transfer value exercise’. Often, these take the form of the employer offering scheme members a cash lump sum, if they transfer their benefits from the scheme to another pension arrangement. This can reduce the employer’s obligation to the scheme, because, once a member’s benefits have been transferred, the scheme will no longer have a liability to provide him with benefits and the transfer value will usually be significantly less than the cost of providing benefits from the scheme.

The cash sums offered can be quite generous and many people welcome the offer of money now, rather than pension later.

Most transfer payments will be made to defined contribution (money purchase) arrangements, where the benefits provided on retirement depend on the funds invested, investment performance and the cost of annuities. As most people know, investment returns are not guaranteed and investment values can go down as well as up. Without the necessary returns or a favourable change in the cost of annuities, the benefits provided from any new arrangement may be less than those that could have been provided from the employer’s scheme and this is why the Department for Work and Pensions, HM Revenue & Customs and the Pensions Regulator have all expressed their unease about such exercises.

The DWP and HMRC

The DWP’s concern is that, if lesser benefits are available, there is increased potential for individuals to seek means-tested state benefits to make good any shortfall. Its view is that this would be an unfair burden on other tax-payers and it considers that taking part in a transfer value exercise could be construed as a "wilful deprivation of capital". In light of this, the DWP is considering whether such individuals should be means-tested based on the pension that they would have received had they not transferred from their employer’s scheme (rather than by reference to any lower pension that they actually receive). In addition, HM Revenue & Customs has now stated that the tax treatment of any cash that is paid to encourage members to transfer their benefits from their employer’s scheme "must be subject to income tax and national insurance contributions". This tax treatment will not apply if the inducement comes in the form of an enhanced transfer value from the scheme and (rather than a cash payment to the member), which would be treated in the same as any other employer contribution to a registered pension scheme.

The Pensions Regulator

The Pensions Regulator has recently issued its own guidance on Inducement Offers and raises concern and questions as to the manner and extent of scheme trustees' active involvement in such exercises. One of the key issues raised by the Regulator is the information provided to members in such exercises. It should be noted that most employers already provide much, if not all of the information to which the Regulator refers and it is not prohibiting induced transfer values.

(i) Issues for the Employer

The Regulator has stated that the employer should explain that, where the transfer is from a defined benefit scheme to a defined contribution scheme, the receiving scheme may not provide the same level of benefits and the risks inherent in and the guarantees offered by the member’s scheme. This should include the risk of employer insolvency and the protection afforded by scheme wind-up legislation and the Pension Protection Fund. The employer should also explain that there may be tax implications for the member if he accepts an inducement payment and state why it is making the offer.

(ii) Issues for Trustees

The Regulator has stated that, when trustees become aware that an employer is contemplating or has begun an exercise to offer an inducement to members, they should check the material that the employer is issuing or has issued for the ‘key messages’ (some of which are described above). If any of the key messages are missing, the trustees should point this out to the employer. Importantly, the Regulator has stated that trustees should also consider issuing their own communication to members to ensure that the key messages do reach them to enable them to make a more informed decision.

Trustees should also think carefully about their fiduciary and data protection responsibilities before deciding whether or not it would be in the interests of members to assist an employer in offering inducements.

Other things to consider

Transfer value exercises are one way for employers to reduce pension scheme costs, but there are a number of other ways to do so. It is possible for employers to work with scheme trustees to achieve a result that is beneficial to both the employer and the scheme and that, for the same aggregate cost, may allow more to be paid to the scheme. The ongoing provision of good quality pension provision is increasingly being highlighted to employees, who are increasingly appreciating cost of defined benefit provision and the extent to which it can make a difference to their retirement income.

In Part 2, to follow next week, we shall comment on the DWP’s formal response to its consultation document "Approaches to the Calculation of Pension Transfer Values", what is likely to be the content of the proposed new regulations and what information may require to be issued to members considering a transfer of their benefits.

MacRoberts Pensions & Employee Benefits Group is well-placed to advise employers and pension scheme trustees regarding these matters.


The material contained in this e-update is of the nature of general comment only and does not give advice on any particular matter. Recipients should not act on the basis of the information in this e-update without taking appropriate professional advice upon their own particular circumstances.

© MacRoberts 2007

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