Many DB pension schemes are considering carrying out exercises to commute small pensions and/or introducing an option for members to commute small pensions at retirement. However, where those pensions include a guaranteed minimum pension (“GMP”), a number of issues arise, some of which may prevent trustees from commuting those GMPs.
While the continuing desire to de-risk DB liabilities is a significant driving factor behind schemes wishing to promote commutation, the abolition of contracting-out has led most DB schemes to carry out a GMP reconciliation exercise, sometimes in conjunction with a wider data cleansing exercise. This has in turn meant that schemes now feel more certain about the accuracy of their scheme records and that they are therefore in a position to commute benefits.
There are two principal types of commutation being used by ongoing schemes:
- “small pot” commutation – this is available where the aggregate value of a member’s benefits in the scheme is £10,000 or less (this includes any DC benefits in the scheme, such as AVCs), and the commutation will extinguish the member’s benefits under the scheme; and
- “trivial” commutation – this is available where the aggregate value of a member’s benefits across all registered pension schemes is £30,000 or less (again, this includes any DC benefits held by the member), and the commutation will extinguish the member’s defined benefits under the scheme (DC benefits cannot be trivially commuted).
Where the member’s benefits include a GMP, the commutation must not only satisfy the tests outlined above, but a number of specific criteria relating to the GMP must also be met. Meeting these criteria will raise issues for some schemes, particularly in relation to the revaluation that is applied to GMPs under the scheme.
If the criteria are not met and the GMP is commuted, the trustees will not be discharged from liability to pay the GMP. We therefore recommend that trustees take legal advice if they are considering carrying out a commutation exercise and/or introducing a commutation option for members.