Pension Trustees and Early Retirements
Peter Lester looks at augmented benefits and continued working after early retirement.
(taken from Issue No 17 – October 2001)
1.1 This article is concerned with the situation where the trustees of a final salary scheme have discretions:-
1.1.1 to pay at his or her request an immediate pension to a member aged at least 50 who leaves before normal retirement date (NRD) otherwise than on grounds of ill-health – incapacity pensions raise their own special questions and are outside the scope of this article. This pension will be based on the deferred pension to which the member would be entitled at NRD but reduced to take account of early retirement so that broadly it is equivalent in value to the deferred pension i.e. the substitution is cost neutral so far as the scheme is concerned;
1.1.2 to augment (usually with the approval or at the request of the employer and subject to Inland Revenue limits not being exceeded) the 1.1.1 pension. Typically the augmentation will restore the actuarial reduction but (subject to Inland Revenue limits) more generous treatment may be made available.
1.2 Specifically, I wish to address three questions:-
1.2.1 Can the Trustees pay an immediate reduced early retirement pension under 1.1.1 above?
1.2.2 What factors should the Trustees take into account in deciding whether to grant an augmented pension under 1.1.2 above?
1.2.3 What difference does it make if the member continues to work for the employer in a reduced or different capacity?
- Immediate reduced pension
2.1 The duty of the trustees is to administer the scheme in accordance with the rules of the scheme subject to the benefits provided not being in excess of Revenue limits.
2.2 Given therefore compliance with all the requirements of the scheme rules, the granting by trustees of a member’s request for an immediate reduced pension on early retirement on cost neutral terms does not usually create many difficulties although:-
2.2.1 The immediate pension from a contracted-out scheme in respect of pre-6thApril 1997 pensionable service must not be less at state pension age than the re-valued Guaranteed Minimum Pension1 and the Trustees should refuse a request for an immediate reduced pension where this condition will not be met;
2.2.2 If a winding up of the scheme is in contemplation, the grant of an immediate pension will convert the status of the member from that of a deferred pensioner to that of a pensioner and he or she will as a result enjoy a higher winding up priority. Trustees should take this into account.
2.2.3 Problems may arise where the member continues to work for the employer in a reduced or different capacity – see 4 below.
- Augmented benefits on early retirement
3.1 As a general rule, trustees are unlikely to turn down an employer’s request for a member to be provided with an augmented pension on early retirement if the employer makes a special contribution to the scheme equal to the cost of the augmentation (as advised by the scheme actuary).
3.2 If, however, winding up of the scheme is in contemplation, the point made in 2.2.2 above is equally applicable.
3.3 If no payment in by the employer is to be made, the trustees should check that they have the necessary power under the trust deed and rules to agree the proposal.
3.4 Given that they have, the trustees should bear in mind that in exercising their powers their duty is to act in the interests of the beneficiaries, holding the balance fairly between the competing interests of the beneficiaries.
3.5 It is, however, no part of the duty of the trustees of a pension scheme to seek to frustrate the reasonable objectives of the employer, if these can be achieved without prejudicing the interests of the members.
3.6 The case of Edge v Pensions Ombudsman was concerned with the application of surplus.
3.7 In this case, the trustees, with the consent of the employers, amended the scheme so as to provide enhanced benefits for the active members of the Scheme but not for the pensioners, who were already entitled to index-linked pensions and had enjoyed substantial benefit improvements in previous years. There was sufficient surplus left to allow the employer to take a contribution holiday.
3.8 The Pensions Ombudsman held that the trustees’ role was to try to promote the interests of the members to the exclusion of the employer, who were in a position to look after themselves. He concluded that the trustees were in breach of trust since they had `attempted to represent both sides of the negotiation at the same time, and make only such recommendations as they felt to be fair to everyone involved with the fund` including the employers.
3.9 Reversing the Ombudsman on appeal, the High Court held that `such an attempt [as in 3.8 above] would have been beyond reproach and exactly what responsible pension fund Trustees ought to have done2`. This view was upheld on appeal3.
3.10 The trustees need, however, to be satisfied that the interests of the members will not be prejudiced – they cannot merely `nod through` any proposal put to them by the employer. In considering any proposal, the trustees should take into account a number of factors including:-
3.10.1 the funding position of the scheme – the trustees can more readily agree where the scheme is in surplus and they are satisfied that its funding will not thereby be adversely affected to any material extent;
the employer’s contribution obligation – it will be much easier for the trustees to agree to the employer’s proposals if the employer is under an obligation to fund the scheme on a prudent past service reserve basis rather than (say) only to the extent required by the minimum funding requirements under the Pensions Act 1995;
security – the trustees should be aware of the extent to which the liabilities of the scheme are covered on a discontinuance basis;
consultation with the employer – the trustees may find it helpful to discuss with the employer what its funding intentions are and what its preferences are in relation to investment strategy. Switches from equities into gilts and bonds may reduce the risk of a shortfall in benefits on a winding up but can be expected to increase the cost of providing the benefits.
3.11 Problems may arise where the member continues to work for the employer in a reduced or different capacity – see 4 below.
- Continued working
4.1 The Inland Revenue’s current policy on early retirement can be summarised as follows:-
4.1.1 Benefits under an exempt approved scheme have to be paid on retirement.
4.1.2 `Retirement` means leaving the service of the employer.
4.1.3 A member who is a director of the employing company will not be treated as having retired if he or she continues as a director even on an unpaid basis.
4.1.4 Most scheme rules define service as service with the employer, and so simply going from full-time to part-time service in the same job without leaving employment would not constitute retirement.
4.1.5 Where a member retires from a full-time job with the employer and is subsequently re-employed by the employer in a clearly different occupation (not simply reduced hours) the Revenue will accept that the member has retired from the earlier full-time job.
4.1.6 The position is not quite so clear cut where the member `retires` from the full-time job and is subsequently re-employed by the employer in the same or similar job but in a part-time capacity. What the Revenue is looking for in this situation is a genuine `retirement` and not an attempt to extract benefits in a situation where the job being pensioned under the scheme effectively continues, albeit with perhaps reduced hours.
4.1.7 Where a member takes benefits without retiring, there is a tax charge (Schedule E under s.600 ICTA 1988) on any lump sum paid to the employee.
4.2 Approaching the Inland Revenue Audit & Pension Schemes Services (previously the PSO) used to be a method by which prudent trustees protected themselves. The current situation is, however, that the Inland Revenue Audit & Pension Schemes Services will not comment on whether any particular case of early retirement is `genuine`. They now say it is for the scheme’s trustees to decide whether or not early retirement benefits can be paid, having due regard to the provisions of the scheme’s rules and relevant Inland Revenue requirements.
4.3 The recent decision of the High Court in Venables v Hornby4 provides some welcome relief. In this case:-
4.3.1 Mr Venables was a member of the Company’s pension scheme with a normal retirement age of 60. The Trustees had a discretion to provide an immediate pension to those who retired in normal health at or after the age of 50.
4.3.2 Mr Venables worked for more than 30 years in the company (of which he and his family trusts were the controlling shareholders) for between 30 and 50 hours a week.
4.3.3 In 1994, at the age of 53, he decided on health grounds to retire and spend a large proportion of his time in Florida, returning from time to time to the UK.
4.3.4 He ceased to be an executive director of the company but continued as a non-executive director on an unpaid basis.
4.3.5 He continued to provide advice to the company on a wide range of matters. It was usually done by telephone and he received no remuneration from the company.
4.3.6 As a non-executive director, and still ultimately in control through shareholdings, he was useful, conscientious and available, even addressing himself to particular matters such as the adequacy of credit control; he did not, however, run the company and could in his personal circumstances (he had three heart attacks since 1994) scarcely have done so.
4.3.7 He had taken his commuted lump sum from the pension scheme and the Inland Revenue sought to assess him to tax under s.600 ICTA 1988 on the grounds that the payment was not authorised since retirement had not taken place.
4.3.8 The Court held that the continuation of the directorship did not of itself mean that he had not retired.
4.3.9 There was accordingly no reason for disturbing the finding by the Special Commissioners that (on the facts) Mr Venables had retired.
4.3.10 There was an early retirement rule on normal (but not ill) health. The trust deed and rules of a pension scheme have to be given a practical and purposive construction. On this basis, the Court held (reversing the Special Commissioners) that Mr Venables was in normal health (see 4.3.1 above – `high blood pressure and mild diabetes are common conditions in overweight middle-aged men`) and therefore entitled to take the immediate early retirement pension.
4.3.11 It followed that the commutation payment to Mr Venables was authorised by the rules of the scheme and was not therefore chargeable under s.600 ICTA 1988 as a payment `not expressly authorised by the Rules of the Scheme`.
4.3.12 The Revenue has been given leave to appeal against Venables v Hornbyalthough no hearing date has yet been fixed.
4.4 Ironically whilst seeking to tax commutation payments under s.600 ICTA 1988 by attacking the genuineness of early retirements, the Inland Revenue is at the same time consulting on the introduction of greater flexibility on early retirement. In more detail:-
4.4.1 Benefits from personal pensions can come into payment at any age between 50 (60 for protected rights) and 75 even though the member still works for the same employer.
4.4.2 Benefits from exempt approved schemes are payable on retirement at or after age 50 or earlier incapacity.
4.4.3 The Revenue’s proposals in this area were first contained in a Discussion Paper dated 2nd February 1998 and were intended (following personal pensions) to permit the drawing of pensions whilst service continues.
4.4.4 The proposals ran into difficulties initially because a pre-condition for their introduction was DSS sponsored amendments to the primary legislation.
4.4.5 These legislative amendments are now in place but the government has asked for further information on the cost implications and the effect on the workforce.
4.4.6 There is concern about the scope for abuse in relation to controlling directors and high risk earners (those earning more than 50% of the cap) because pensions (unlike earnings) are not liable to employer’s class 1 National Insurance contributions. There will therefore be a NIC saving if an employee receives a combination of pension and earnings instead of wholly earnings.
4.4.7 This information is in the course of being gathered following which there will be an industry-wide consultation (perhaps early next year) with proposals.
4.4.8 Any changes will not be retrospective so that the problems in relation to current cases will not be removed.
4.5 The trustees will not necessarily know when they consider an application for an early retirement pension whether the member will continue to work for the employer in a reduced or a different capacity. The employer, in good faith, may not be aware of the relevance.
4.6 In the normal case where the member is not a director of the employer, the trustees should seek the employer’s confirmation that the retirement is genuine in terms of 4.1.4, 4.1.5 and 4.1.6 above.
4.7 The trustees should take advice if the member (being a director of the employer) is retaining his directorship They can usually do this jointly with the employer as there is a common interest in meeting the requirements of the rules and the Inland Revenue.
Sacker & Partners
1 Defined in si.8(2) Pensions Schemes Act 1993
2  2 All ER 547 at 571
3  4 All ER 546
4 unreported 14th June 2001