The long-awaited regulations dealing with trivial commutation and payments made in error have now come into force.
The changes surrounding trivial commutation are effective for payments made on or after 1 December 2009, while the provisions covering payments made in error apply to payments made on or after 6 April 2006.
Schemes have been able to act in accordance with the draft version of these regulations without sanctions, following HM Revenue & Customs' (HMRC) announcement saying this in January of this year. Nonetheless, it is good to see the regulations in their final form (the more recent predictions suggested that they would not be available before the autumn).
The new, alternative, £2,000 commutation limit applies on an individual scheme basis (irrespective of the benefits held by a member in other schemes). This should be welcomed by those schemes wishing to take advantage of the change, although it is likely that they are facing more pressing matters, higher up the agenda. The recognition that mistakes happen and can lead to payments being made in error is also helpful, although some common situations still appear to fall outside the scope of the regulations.
Trivial commutation payments
Trivial commutation involves exchanging what would be a very small pension for a cash lump sum. Schemes are not required to offer members the option of commuting small pensions but often will because of the scheme administration savings.
Trivial commutation has been available for some time. The tax regime for pensions introduced in 2006 changed the trivial commutation rules. The changes meant that members aged 60 or over but not yet 75 could commute their pension benefits if the total value of their benefits under all registered pension schemes did not exceed 1% of their lifetime allowance. Any member choosing to do this would need to take all their trivial commutation lump sums in one 12-month period.
The new regulations introduce extra, alternative, situations where trivial commutation can be made available. Most significantly, the new limit applies on an individual scheme basis, irrespective of the benefits held by a member in other schemes.
Trustees and employers wishing to take advantage of the new commutation rules will need to check their scheme documentation, to see whether any changes might be needed.
There are special provisions for larger pension schemes (classified as schemes with more than 50 members). For those schemes, although the value of benefits to be commuted is not limited (in contrast to smaller schemes, see below) the trivial commutation payment itself cannot exceed £2,000. There are several additional conditions to be met – for instance, there must not have been any transfers-in during the previous five years (unless, where the arrangement is a cash balance or defined benefit arrangement, the transfer-in happened in certain circumstances, such as a business transfer of at least 20 employees).
The requirements for smaller schemes differ in some respects (for instance, the member's benefits in a smaller scheme, regardless of the value of benefits the member may have in other registered pension schemes, must be valued at £2,000 or less).
The regulations also deal with a range of other small payments which can be commuted without being classed as unauthorised payments, such as compensation under the Financial Services Compensation Scheme and payments to or in respect of untraceable members aged 75 or over.
Payments made in error and arrears
Mistakes happen and the wrong benefits can get paid.
Trustees should start from the position of seeking to recover overpayments. However, they may find that recovery is not practical or financially sensible, so the payments made are treated as unauthorised. In recognition of this, HMRC has addressed some of those instances where classifying the payment as unauthorised seems unduly harsh.
Pension payments mistakenly made to living recipients are treated as authorised where the scheme administrator or insurance company believed that the recipient was entitled to the payment. Even if the payment is made after an error has been discovered, it may still be authorised in a range of circumstances (for example, where reasonable steps were taken to prevent the payment being made). The fact that the regulations require there to have been a belief, at some stage, that the recipient was entitled to the payment in question means that situations where a computer or clerical mistake caused the error do not appear to be covered.
One situation where, typically, pension payments are made in error for a short period is where the recipient dies and there is a delay in notifying the scheme. The regulations treat payments made within a six month period after the death as authorised if the scheme administrator or insurance company making the payment did not know (and could not reasonably be expected to know) of the death, or did know but took reasonable steps to prevent the payment being made. This is a helpful change because a bereaved family is unlikely to inform the scheme administrators of the death immediately.
Payments of pension arrears after death are also treated as authorised in certain circumstances (for instance, along with other requirements, the member must have died before reaching age 75 and must not have been, or been connected to, a controlling director of the scheme or a related scheme). Again, this is a welcome relaxation in spite of the fact that it is limited to defined benefit arrangements.
Logically, pension commencement lump sums based on a miscalculated pension (or on a wrongly valued money purchase pot) are also treated as authorised under the regulations.
Where a defined benefit arrangement pays what would have been a commencement lump sum had it not been paid after the member died, that lump sum is treated as authorised if certain other conditions are satisfied (for example, the payment must be made within one year of the date the scheme administrator first knew of the member's death or, if earlier, within one year of the date that the administrator could first reasonably be expected to have known of the death).