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Section 32 has a role in new regime

Recently, I have been reminded how useful a role the old section 32 buyout policy can play in the new pension scenarios, regardless of whether we are looking at group or individual business.

Starting with group business, the trend away from defined-benefit towards defined-contribution business, already well established among small and medium-sized employers, has now become visible at the top of the corporate scale. There are reasons to believe this trend will intensify.

For example, uncertainty about the replacement for the minimum funding requirement, the new accounting standard FRS17, increased longevity, reduced expected real rates of return (especially after Chancellor Gordon Brown&#39s tax raid in 1997) and the new contracting-out terms must all make employers wonder whether defined-benefit business is worth the candle.

When employers decide to switch from a defined-benefit scheme to some form of money-purchase arrangement, the odds are that the new vehicle will be stakeholder or a group personal pension.

But that begs a serious question. What will we do with the accrued defined-benefit entitlement?

If existing members of the defined-benefit scheme are to continue accrual in the old scheme, the question does not really arise. But if the old scheme is going to be wound up and if it has been contracted out on the reference scheme test, any benefit transfers to the new regime will result in loss of tax-free cash in respect of all accrual after April 6, 1997. That was the date when the concept of the guaranteed minimum pension was abolished for future accrual. Any transfer of later accrual to a personal pension or stakeholder will result in all of that portion of the transfer being called protected rights, which has no element of tax-free cash. This is an unfair transfer trap which I urge the Government to remove.

The section 32 buyout plan, whether member or trustee proposed, allows the rights to tax-free cash to be preserved. This is because the section 32 plan does not involve a change of regime – the same concepts of Inland Revenue maxima and contracted-out benefits apply to section 32 as applied to the defined-benefit pension scheme from which the section 32 buyout arises.

However, this does not mean that everyone with any post-April 1997 service should favour a section 32 buyout plan. The tax-free cash issue is very complex when comparing section 32 with a transfer to the new regime. Every individual should have comparative calculations done before choosing. Other important aspects include guarantees, investment choice and death benefits.

The individual pension example arises from the new transfer regulations. Since April 6, 2001, it has been possible for someone to transfer from the occupational regime to the new stakeholder/personal pension regime without an over-funding test, provided the person is under 45 and has not been a controlling director in the 10 years prior to transfer.

Note that there is no earnings restriction here. So, a young, high-earning executive could be pensioned using the funding flexibility of the old regime and, as he or she approaches the age of 45, a decision could be taken on whether the best thing is to transfer to the new regime.

But what if something goes wrong with the grand plan? For example, the executive becomes a controlling director or is earning more than the cap but forgets to review the situation before age 45 and will not pass the over-funding test which is consequently required?

There is still the good old section 32 buyout plan. The accrued entitlement could be parked in the section 32 and funding could switch to the new regime according to the usual contribution limits.

Long-term planning for pensions, especially where it involves the old occupational pension regime, is especially complicated at the moment because nobody yet knows how the old regime is going to be affected by the Inland Revenue&#39s simplification project.

But isn&#39t it comforting to remember that the section 32 option exists to preserve benefits on an individual basis in the old regime, if that turns out to be the right thing to do?

Never forget that you can transfer from section 32 to stakeholder or a personal pension but you cannot transfer from stakeholder or a personal pension to section 32.


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