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# Accrual world

Last week, I started to look at the way in which transfer values are calculated for early leavers from final-salary pension schemes and the implications of some of the issues arising from these calculations.

I noted that the first stage is to identify and quantify the value of the benefits accrued up to the date of leaving and would like to start this week&#39s article by confirming that, for most early leavers, this calculation is very simple and straightforward, as typified by the example below. However, there is a slight complication relating to the accrued rights to a tax-free lump sum.

Imagine that Fred leaves his company after 10 years of service on a final pensionable salary of £48,000 a year. The final-salary scheme has an accrual rate of pension of 1/60th, with 3/80ths tax-free cash accrual by commutation. His entitlement to pension at the date of leaving is therefore 10/60ths of £48,000 a year, that is, £8,000 a year. His entitlement to tax-free cash is 30/80ths of £48,000, that is, £18,000.

Tax-free cash being by commutation, it is not possible to specify the amount of pension that Fred will have to forgo if he wants to take maximum tax-free cash as commutation factors are subject to periodic variation. But, as an example, if the commutation factor were said to be estimated at 12:1, Fred&#39s pension would be reduced at date of leaving by £1,500, that is, 1/12th of £18,000, to enable him to take the maximum permissible tax-free lump sum.

The transfer value will be based on the accrued pension rights of £5,000 a year and no account will be taken of the tax-free cash entitlement as this is deemed to represent equal value to the commuted amount of pension.

This is all very simple – and is even simpler where the tax-free cash entitlement accrues in addition to the pension, rather by commutation, as in many public sector schemes. Unless the scheme&#39s benefit structure makes allowance for state scheme offset, that is.

According to the latest survey from the National Association of Pension Funds, around 45 per cent of members of final-salary schemes in the private sector and 24 per cent of members in the public sector have state scheme offset (otherwise known as integrated state scheme) imposed against their pension benefits.

This is done in a number of different ways but the most commonplace method for a scheme member with a full 40 years of service is to deduct the value of the basic state pension entitlement (broadly, around £4,000 a year) from the pension he would otherwise have expected to receive from the pension scheme.

For early leavers, the formula becomes a little more complex, with usually only a proportion of the basic state pension being deducted from the accrued benefits. Thus, in our example, Fred has served 10 years out of a notional possible maximum of 40, so one-quarter of the basic state pension will be deducted from his entitlement from the scheme. Instead of a preserved pension of £8,000 a year, the sum of £1,000 will be offset, reducing his preserved pension to £7,000 a year.

This reduction means that Fred&#39s preserved pension benefits are lower than would be the case if offset had not been imposed, thereby reducing his transfer value (which is based on the level of his preserved pension benefits) by about one-eighth.

This is an extremely important point to note as I am aware that some pension transfer advisers may not identify the presence of offset and may calculate the client&#39s preserved pension benefits on the unreduced amount, overvaluing the current benefits.

When the transfer analysis is processed, this will lead to a much higher critical yield than should be indicated as the transfer value represents the reduced amount but the analysis is trying to match or better the unreduced level of preserved benefits. Thus, the client might be incorrectly advised not to transfer his benefits.

Moreover, an important issue of which to be aware is that the whole issue of state scheme offset is under attack, led by the trade unions. They are following at least one lead case from which they may then proceed to attempt to outlaw the practice of imposing clawback, possibly retrospectively to around 1976 (following the success of the Preston Wolverhampton case, which won backdating of pension rights to the date of the Defrenne case in April 1976).

If they are successful, it is possible that all employees in clawback schemes will have their benefits recalculated back to their date of joining or 1976, ignoring the offsetting of the value of the basic state pension. Pension transfer advisers should therefore exercise caution. Potentially, pension scheme members whose benefits are subject to state scheme offset could have their benefits increased retrospectively if they remain in the scheme, leading to a substantial increase in the transfer value. A recommendation to effect a transfer out could be held at some later date to have been negligent in not waiting for the outcome of the trade union initiatives.

Personally, I believe that, even if the trade unions are successful, the vast majority of preserved pensions will not be affected. This belief comes again from the Preston case, in which the backdating of pension rights was (and is) only available to those individuals bringing a claim within six months of the date of leaving service.

The hoped-for abolition of state scheme offset relies heavily on drawing a parallel with Preston, so I believe that a similar time bar on claims would be applied, meaning that only enquirers who have left service very recently may be able to claim. I stress that this is a personal view on which, as a pension transfer adviser, I am acting for clients.

So, in many cases, the calculation of preserved pension benefits at the date of leaving is not always a straightforward task, due in part to this need to identify the presence or otherwise of state scheme offset. However, other complications arise at this stage in the calculation of the value of death benefits, primarily the pension payable to a surviving spouse or other dependant.

The majority of final-salary schemes include within their benefit structure a dependant&#39s pension payable on the death of a member. However, the terms under which this becomes payable should be of particular interest to early leavers. Here, it is important to look at the scheme&#39s rules on a: which spouse qualifies, b: would a common-law opposite-sex partner qualify and c: would a same-sex partner qualify?

This is an important issue I will discuss next week but, fundamentally, the issue relates to the adviser ascertaining whether the terms under which a dependant&#39s pension is payable by the scheme matches the past, present and likely future marital circumstances of the preserved pensioner.

Keith Popplewell is managing director of Professional Briefing

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