I’m sure all the pension experts reading this blog will be familiar with the Lloyds judgement from October 2018. At that time, the High Court ruled Lloyds bank scheme trustees must equalise benefits between women and men who have Guaranteed Minimum Pensions (GMPs) because of contracted out benefits.
GMP equalisation is estimated to affect 80% of UK defined benefit schemes and members, or beneficiaries of members, who built up a GMP between 17 May 1990 and 5 April 1997 (when GMPs ceased to accrue). Members who transferred in benefits from a previous scheme which include GMP built up over this same period will also be impacted. Other members are unlikely to be affected by the judgment.
The complexity of the equalisation process along with lack of clarity in relation to tax consequences, has been an ongoing headache for scheme trustees, so progress to rectify the inequality has not been swift with only a few schemes completing this task to date. Another reason for delay is uncertainty over the methodology to use and concern that if a different method is ultimately prescribed, the exercise will need to be repeated.
However, the latest guidance issued by HM Revenue & Customs on 20th February 2020, attempts to clarify some of the potential tax issues that could arise as a result of GMP equalisation and help break the current impasse.
Why are GMPs not equal?
The method for calculating GMPs is set out in legislation and there are several reasons why inequality can arise:
- GMPs are payable from different ages (65 for men, 60 for women)
- GMPs consequently accrue at different rates (with a female’s benefits accruing more quickly)
- different payment ages also create differences in the periods for which GMPs are subject to pre- and post-retirement increases
- revaluation of GMPs is usually higher than revaluation applicable to non-GMP excess benefits (which is more favourable to women), and
- statutory increases on GMPs tend to be lower than those applicable under scheme rules to non-GMP excess benefits (which is more favourable to men).
Identifying where GMP inequalities may lie is the easy part, the real difficulty and complexity arises when schemes come to right this situation.
What methods are used to equalise GMP benefits?
The main methodologies for the equalisation of GMP benefits include utilising ‘dual records’ or ‘conversion’. GMP conversion considers the actuarial value of the unequalised male and female pensions and converts the more valuable of the two into other pension benefits e.g. non-GMP benefits, thus achieving equalisation and the potential for significant simplification.
Dual records methodology is inherently more complex from an administrative perspective, and the various sub-methods broadly involve some form of comparison between the members GMP record and benefits that they would have received if they were of the opposite sex.
The key point to note is that the value of members’ pensions will not go down as a result of GMP equalisation. Any underpayment from previous payments made will also need to be equalised, and some members may be due a back payment.
What are the tax issues the latest HMRC guidance seeks to clarify?
HMRC formed a working group of selected industry representatives to help them consider the pension tax issues arising when equalising GMP benefits. This latest guidance covers pension tax issues such as annual allowance and lifetime allowance including protection.
An important question that this guidance addresses, is whether any increase resulting from a GMP equalisation is treated as a new entitlement or not. The answer to this question is significant as it determines the outcome of many of the other tax related questions that implementing GMP equalisation (and conversion) raises, including the treatment of any increase in benefits for annual allowance purposes and the potential loss of lifetime allowance protection for some members.
In the HMRC’s view, “any increase to the amount of a pension due at retirement (as a result of GMP equalisation) is not a new entitlement as the increase results from membership of a pension scheme in the period 17 May 1990 and 5 April 1997”.
In relation to the annual allowance, HMRC has confirmed that in its view:
- an individual who became a deferred member before 6 April 2006 under an arrangement and who has remained outside of the annual allowance provisions since that date in relation to that arrangement should remain outside of those provisions on the basis that GMP equalisation benefit adjustments should not result in any benefit accrual after 5 April that would otherwise bring the arrangement within the annual allowance provisions;
- a deferred member who is otherwise within the annual allowance deferred member carve out (DMCO) in relation to an arrangement should remain within the DMCO even where an adjustment is made to their benefits to equalise for the effect of GMPs, and
- past annual allowance calculations do not need to be revisited. In addition, the opening and closing value of a member’s benefits in the tax year that equalisation is implemented should both be adjusted to reflect the revised amount of a member’s benefit entitlement.
This tells us that GMP equalisation adjustment will not be tested against the annual allowance, but there is no clarity on the potential loss of DMCO where a member’s GMPs are converted into ordinary scheme benefits.
Some scheme members may have registered for protection against the lifetime allowance charge, which has the potential to be lost in certain circumstances.
In relation to lifetime allowance protection:
- Individual and primary protections – Will not be lost if benefits increase as a result of a GMP equalisation adjustment. However, equalisation could mean that the value of the rights protected differ to those originally notified to HMRC. Individuals would be required to notify HMRC of the revised value of their protected benefits without delay and Trustees should consider informing their members of the need to do this.
- Fixed protection (FP, FP14 & FP16) – Any individual who otherwise has fixed protection should retain this.
- Enhanced protection – For individuals who have been deferred members since 6 April 2006 any GMP equalisation benefit adjustment should not be ‘relevant benefit accrual’, meaning they will retain their enhanced protection. Individuals who have not been deferred members since 6 April 2006 will have accrued benefits that with any GMP adjustments could result in ‘relevant benefit accrual’ meaning protection could be lost. When carrying out the relevant accrual calculations, the value of the members’ rights under the arrangement as at 5 April 2006 needs to include the adjustment for GMP equalisation valued at that date.
Where GMP equalisation benefit adjustment results in an increase in the value of an individual’s benefits, meaning the individual would qualify for protection from the lifetime allowance charge, the guidance indicates that the individual may be able to apply for late registration for the relevant protection.
Looking at Lifetime Allowance and BCE calculations:
- BCE 2 (LTA test at the point the pension came into payment) – Where a member is already in receipt of a pension which started on or after 6 April 2006, it will be necessary to correct the original benefit crystallisation event BCE 2 calculation.
- BCE 5 (member reaches age 75 without drawing pension) – A recalculation will also be required in this scenario.
- It will also be necessary to revisit (where relevant) any notional BCE as at 5 April 2006 and any subsequent BCEs that have occurred in respect of the member. Affected members will also need to be issued with an updated BCE statement.
- Where the recalculated BCE results in a member exceeding the lifetime allowance, a charge will be due. This means that some members could find themselves with a tax bill following an equalisation exercise, albeit not likely to be significant.
Any arrears of pension may be paid to a scheme member as a lump sum as part of a GMP equalisation exercise. The guidance confirms that schemes are required to operate PAYE on any such lump sum payment. However, it notes that the amount of pension income charged to tax is the amount of the pension the member is entitled to in the relevant tax year (on the accruals basis). Tax may also be due on any interest that is paid on arrears of pension.
The latest HMRC guidance has given some clarification of the tax issues that may arise on equalisation but has equally thrown up other points that need to be clarified before scheme trustees can proceed with confidence.
Most notably, conversion is not covered, and we are still unclear how any allowance breaches as the result of this method of GMP equalisation will be treated. HMRC has also stated that it will issue more guidance on the treatment of lump sum and death benefit payments “as soon as possible”, thus we may see these other outstanding issues clarified at that point.
The fact that significant questions still need to be answered is unlikely to add a lot of impetus to the process at this stage. HMRC have also remained impartial on the equalisation methodology chosen, so this is a further consideration for trustees. As each equalisation method has winners and losers, pension schemes will still have to make an individual decision on which method is most appropriate for their members.