Occupational pension schemes often include options for members – in particular for commutation of part of the pension to a lump sum on retirement. As such a lump sum may be paid tax-free, it is generally seen as an attractive proposition.

But many schemes are using actuarial factors to calculate these lump sums based on rates that are seen increasingly as being out of step with current annuity rates, as well as commutation or capitalisation rates in other areas (eg for the lifetime allowance (20 to 1), annual allowance (16 to 1), commutation of money purchase assets to pension etc). One source of a difference is that some rates deal with the whole pension (eg including spouse), while others only deal with the member pension.

While those within the pensions industry have been aware of this issue for some time, it has recently begun to attract more attention, perhaps in light of increased regulation in other areas aimed at preventing members of occupational pension schemes from being short-changed. By way of example, an article published in Investors Chronicle in June followed the strap line: ‘Up to 3.6m retirees in line for “rip off” lump sums’.

So, if not already doing so, what are some of the things employers and trustees should be thinking about?

  • What do the trust deed and rules say about how the rate must be determined?
  • Can the tax impact be taken into account? What about the funding position?
  • What are other schemes doing and how do we compare?
  • Is there a clear policy for reviewing factors? If not, should there be?
  • Should members be issued with an appropriate risk warning?

In a forthcoming briefing we will consider in detail the trustee duties and role of the actuary in this area, and the factors they each need to consider in order to make reasonable decisions that will withstand scrutiny from members.