Every so often, a question crops where you have an awareness of the subject but the finer detail escapes you. This week, for me, it was GMP franking.
When the GMP anti-franking rules were introduced in 1984, I was still in primary school and I’m sure a number of pensions experts reading this article were yet to be born! With the removal of pension exams like the old G60 (showing my age here) and more recently AF3, awareness of older pension legislation may be on the decline. However, anti-franking crops up quite regularly in practice when advising in relation to members’ entitlements on retirement under a scheme that used to be a contracted-out salary-related (COSR) scheme. It’s therefore well worth taking the time to refresh your knowledge in this area, so that you can deal with these schemes when encountered.
What is franking?
Simply put, the term “franking” refers to the offsetting of GMP revaluation against a member’s non-GMP (excess) benefits once a member left contracted out employment.
Prior to anti-franking legislation, COSR schemes could revalue a deferred member’s guaranteed minimum pension (GMP) without increasing the overall deferred pension. The pension in excess of the GMP was effectively reduced so the overall deferred pension remained the same. This is known as ‘franking’, and ‘anti-franking’ refers to the legislation which prohibits this.
A very simple example of franking would be as follows:
- A member left contracted out employment with an accrued pension of £1,000 a year, £400 of which was GMP and £600 of which was excess benefits.
- By the time that the member reaches GMP payment age, revaluation on the GMP has increased the GMP to £650 (so revaluation has increased the GMP by £250 a year)
- Instead of paying a pension of £1,000 a year plus the £250 GMP revaluation, the scheme offsets (or “franks”) the GMP revaluation against the non-GMP element and so only puts a pension of £1,000 into payment.
- As a consequence of this franking, the member has not benefited from the GMP revaluation at all. This example is referred to as “Full Franking”.
What are the GMP anti-franking requirements?
The situation illustrated above was clearly unfair on the member, so the Health and Social Security Act 1984 made amendments to the Social Security Pensions Act 1975 to prevent this. These “anti-franking” requirements are now enshrined in Sections 87 – 92 of the Pension Schemes Act 1993.
Importantly, the anti-franking requirements apply where a member’s contracted out service ceased on or after 1 January 1985. After this date, the member would be protected by the anti-franking requirements, which in their most basic form require a scheme to pay GMP revaluation on top of the member’s accrued rights on leaving.
Where the anti-franking rules apply and where the member’s accrual of benefits under the scheme ceased on the same day as contracted out service ended, the anti-franking requirement is that the member’s benefits at GMP payment age must consist of:
- The member’s accrued rights on the date on which contracted out service ceased (known as “the Relevant Sum”); plus
- An amount equal to the difference between the GMP at the date of cessation of contracted-out employment and that GMP revalued to the date of commencement of payment of the GMP (sometimes referred to as “the GMP increase”).
In addition to member protection, anti-franking legislation also requires schemes to provide a minimum level of benefit for the spouse/civil partner on the death of a member. It applies to a spouse’s/civil partner’s GMP in a similar way as to a member’s GMP.
Exemptions from the legislation
Anti-franking protection only applies fully to a member retiring at the scheme’s Normal Retirement Age that is on or after GMP Age. This is a complex area of pension legislation, but there are three main scenarios which can still result in partial or full franking of protected benefits:
For a member retiring at the scheme’s NRA but before GMP Age
Any member who retires at the scheme NRA, will at least receive their excess revalue to NRA plus their GMP at GMP age; however if there is any escalation in payment on the excess pension between retirement and GMP age, the scheme is perfectly able to frank these increases against the GMP revaluation.
In this scenario franking is permitted on the escalation only (‘Partial Franking’)
Where the member retires before the NRA of the scheme
If a member retires early, then anti-franking protection is forfeited. The scheme need only test that GMP is covered at GMP age and the entire excess pension can be franked to provide for this.
In this scenario Full Franking of the excess pension is permitted even for post 85 leavers.
Partial franking can also apply to public sector style schemes:
If the scheme revalues the entire pension including the GMP at a single rate that is equal to RPI or CPI, then on retiring at the scheme’s NRA, the minimum pension on reaching GMP age will be the sum of:
GMP revalued to GMP age (usually by Section 148 orders)
Excess at Date of Leaving
In this scenario, the scheme can frank the revaluation of the excess pension, but not fully frank the whole excess.
Key points to take away:
- The anti-franking requirements apply where a member’s contracted out service ceased on or after 1 January 1985.
- Contracted out service prior to this date can be fully franked against excess benefits.
- ‘Partial franking’ can still occur in public sector style schemes or where the scheme NRA is prior to the member’s GMP age.
- ‘Full franking’ can occur where the member retires prior to scheme NRA.
Whilst I have provided a simplistic view of the exceptions and conditions, this is intended to provide you with an awareness of anti-franking rules rather than an all-encompassing guide. It would therefore be prudent to do some further research if you are unsure how anti-franking applies to the particular scheme you are dealing with.
For those who wish to delve a little further, there are a few links to further information below: