Nothing normal about it… The significance of normal pension age

Just to get this out of the way, I really like preservation.  I don’t know why, but it is far and away my favourite area of pensions law.  (I realise that may sound more than a little weird, but they say confession is good for the soul...) 

So, with that in mind, I thought it would be interesting to have a look at some slightly quirky preservation issues around when benefits should be paid to early leavers and what the significance of “normal pension age” is. 

Before I start and to reassure you that the rest of the blog is worth reading, this is of more than academic interest.  Issues around what normal pension age is in a scheme come up quite a bit in practice, particularly in relation to GMP equalisation (as it is relevant for anti-franking), de-risking and benefit restructuring.  

Some context

As contracting-out is now largely a thing of the past, preservation is the last bastion of the simpler world of pre-Maxwell, pre Pensions Regulator, pensions legislation, and has remained largely unaltered for over 30 years (except for one rather unfortunate tweak which we’ll come on to).   

This is both a good and a bad thing.  It means that the legislation is more principled in nature, fairly easy to read, and in the main requires reference to only one set of regulations.  Sadly, this also means that at times it lacks enough detail to enable you to understand what it actually wants you to do. 

This was not such a problem back in the 1990s, when you could ask the OPB what it was all supposed to mean and look at their guidance in Joint Office Memorandum 78 (which I still urge you to read if you are looking for answers), but there is no one to ask now, and sometimes the preservation regime seems painfully at odds with the practical realities of modern pensions. 

Preservation in a nutshell

So, to start with, what is preservation and why do we have it at all? 

The legislation originates from 1972 and the key provisions can currently be found in sections 69-86 Pension Schemes Act 1993 and the Preservation Regulations 1991.  The only guidance is in the old Joint Office Memorandum 78 (JOM 78).  This ceased to be in force in 1997, but there are still lots of copies figuratively lying around.  Because the legislation is older, the language used is often unfamiliar and different from anything used elsewhere.   

In principle, preservation protects or ‘preserves’ the rights of members who leave pensionable service before retirement – preventing the former practices under which an early leaver might receive absolutely nothing (not even a refund of contributions) in return for many years’ contributory membership of a scheme. 

Preservation is broadly aimed at ensuring that early leavers receive fair value for the benefits that they have accrued in the scheme.  To qualify for protection a member must currently have two years’ service in the scheme, unless they only have DC benefits, in which case they only need 30 days. 

Where a member meets the qualifying requirements, if they leave service before Normal Pension Age (NPA – and more on this below), they must be entitled to a “short service benefit” calculated on the same basis as “long service benefit”. You see the point about the language. 

Short service benefit is the early leaver / deferred member benefit, and long service benefit is what the member would receive if they stayed in service until NPA and continued to accrue benefits.  Where benefits do not accrue at the same rate over the whole period of service, short service benefit is a proportionate amount, related to the ratio between the member’s actual service and the total service they could have had if they had stayed to NPA. 

It is also worth noting that s72 Pension Schemes Act 1993 provides that: “A scheme must not contain any rule which results, or can result, in a member being treated less favourably for any purpose relating to short service benefit” than they are “entitled to be treated for the corresponding purpose relating to long service benefit.” This means that trustees and employers need to ensure that scheme rules treat early leavers fairly, and should bear this in mind when making amendments to benefit structures. 

However, be aware that the preservation protection needs to be included in scheme rules.  There is no overriding statutory protection for members and no overriding statutory provision which allows trustees to amend scheme rules to include the relevant protections.  This can create some problems, but you should always remember when considering early leaver rights that it is the scheme rules that govern the benefits that members are actually entitled to – however problematic that might be. 

Back to what NPA means 

So far, so good – scheme rules need to provide that a member who leaves pensionable service early will have their benefits calculated on the same or as favourable a basis as a member who stays in pensionable service to NPA.   What possible problems could there be?  (The answer is, of course, “more than you might think”, otherwise writing about it would be no fun.) 

The first question is what NPA actually means.  It is not the same as normal retirement date under the scheme rules.  NPA is defined in s180 Pension Schemes Act 1993 as “the earliest age at which the member is entitled to receive benefits (other than a guaranteed minimum pension) on his retirement from… employment”, disregarding “any scheme rule making special provision as to early retirement on grounds of ill-health or otherwise”. 

So what does this mean? JOM 78 says that where “members were given an unqualified right to retire on an unreduced pension from an earlier age [than NRD] if they so wished”, that would be their NPA, and this is the generally accepted interpretation. However, there is some debate as to how you arrive at this meaning from the legislation as it makes no explicit reference to a need for pensions to be unreduced.  What it does say is that you should disregard any “special provisions” in the rules about early retirement, and this is generally interpreted as including provisions which require actuarial reduction on early retirement (since that is not the normal benefit calculation for long service benefit). 

Short service benefits must be paid at NPA, yes? 

The significance of NPA now lies in the testing of benefits for preservation purposes rather than the date at which they must be paid.  You might think, logically, that those dates should be the same, but some “helpful” amendments introduced in the Pensions Act 2004 say otherwise. 

Prior to 6 April 2005, short service benefit had to be payable from NPA, or from age 60 if NPA was lower than 60.  This meant you had to work out the earliest age a member could receive an unreduced pension without needing consent and that (or age 60, if later) was NPA.  That was the date you had to pay deferred benefits from and the date statutory revaluation (indexation of deferred pensions before they come into payment) had to be paid up to.  Lovely. Simple.  

Then for reasons that no one properly understood and without any consultation, this was changed with effect from 6 April 2005.  The definition of NPA remained the same but the age at which short service benefits became payable was amended.  The legislation now provides that deferred benefits must be payable from an age which is no later than age 65 or, if NPA is above age 65, NPA. 

To illustrate the difference that this makes, take a scheme that has an NRD of 65 but provides for an unreduced early retirement pension without consent from age 62.  NPA is 62.  Before April 2005, the deferred pension should have come into payment at 62.  From April 2005, the member can still request payment of benefits from age 62 under the rules, but in the absence of a request, the benefit does not need to be brought into payment until 65. 

This change, which was intended to make life easier, had unintended consequences (I know, I know: it’s hard to believe that Parliament did not fully think everything through). 

Where a member leaves service before NPA, their benefits must be “revalued” (ie increased) to ensure that they retain their real value despite inflation.  In the case of DB benefits, the method of revaluation is set out in Schedule 3 of the Pension Schemes Act 1993.  This generally requires benefits to be increased during deferment by capped CPI in line with the last statutory revaluation order published before a member reaches NPA.  To go back to our member with an NPA of 62, this means that there is no statutory revaluation for them between age 62 and when their deferred benefit becomes payable at 65. 

Again, scheme rules may provide for something more generous and, in my experience, many do – providing for revaluation up to NRD.  However, some refer only to statutory revaluation, which would mean that no revaluation was provided for our member between age 62 and 65. 

This seems like a very odd result, and could so easily have been avoided if the revaluation legislation had been amended to align with the change to preservation legislation. However, given that it was not, trustees and administrators need to be aware of what NPA is under their scheme rules and how it affects revaluation. 

There can be only one? 

The legislation was drafted at a time when it was inconceivable that a member might have more than one NPA under a single scheme – benefit structures were once such simple things!  Then along came Barber and equalisation issues, and with them, the possibility that members might take different tranches of benefits at different times. 

Take, for example, a male member who had an NRD of 65 until 1990 and no early retirement rights. After Barber, he was then entitled to a NRD of 60 until the scheme properly equalised benefits at (say) 64 in 1995, from when he had an NRD of 64 – again with no early retirement provisions. This means that he will have 3 different periods of service, each with a potentially different NPA. 

The legislation absolutely does not contemplate various NPAs: all the references are to NPA in the singular. However, this does not mean that it is not conceptually possible. 

There are varying views on the topic, and the answer might actually depend on what it is that the member is actually entitled to.  Using my example above – is the member entitled to take some benefits at 65, some at 60 and some at 64 or, is he entitled to them all at 64 with early or late retirement adjustments applied to each tranche as appropriate?  If the latter is the position, the member only has one NPA. 

I tend slightly to the view that you can have more than one NPA, depending on the actual benefit promise, but that is only my view, and it would be fair to say there remains considerable disagreement.  In any event, any answer will require a careful analysis of what the benefit promise to the member actually was. 

That’s all folks…

The problems that can arise in relation to NPA are many and varied and will depend in every case on what the scheme rules say.  You just need to know that they might be there and when to ask for help.  

There is so much more to say about preservation, particularly around alternatives to short service benefit, including early and late retirement and purchasing insurance policies. But this is a blog, not a book, and attention spans  (including my own) are not endless. 

Perhaps I’ll come back and write Part II. 

PS - if you're wondering about my cover image - it's a stack of preserves, or alternatively, things in a state of preservation!