Between 1978 and 1997, contracted-out defined benefit pension schemes were required to provide a Guaranteed Minimum Pension (GMP). This note looks at the arrangements for index-linking GMP rights for people reaching State Pension age before and after 6 April 2016 and for members of public service pension schemesJump to full report >>
The old State Pension
The State Pension for people who reached State Pension age before 6 April 2016 had two tiers:
From the time the additional State Pension was introduced in 1978, it was possible to contract-out of it into a pension scheme that meets certain criteria. Where an employee was contracted-out scheme, they and their employer paid a reduced rate of National Insurance (NI), designed to reflect the cost of providing the benefits foregone. Between 1978 and 1997, contracted-out schemes were required to provide a Guaranteed Minimum Pension (GMP). Since 1997, a different test has applied but contracted-out schemes still have to provide a GMP for rights accrued between 1978 and 1997.
Pension schemes are required to index GMP rights accrued between 1988 and 1997, in line with prices, subject to a 3% cap. The increase required by schemes each year is provided for in a Statutory Instrument - the Guaranteed Minimum Pension Increase Order.
There is a link between the GMP and the additional State Pension in that, when a person reaches pensionable age, the total amount of GMP is subtracted from the total amount of additional state pension built up between 1978 and 1997, and any net amount is paid. This is referred to as a ‘contracted-out deduction’. It reflects the fact that reduced National Insurance (NI) was paid during the period of contracting out in return for meeting legislative requirements. This calculation is performed each year that the pension is payable.
The effect of these arrangements is that, although schemes are not required to provide increases on the GMP on rights accrued between 1978 and 1988 (or in excess of 3% on rights accrued between 1988 and 1997), the additional State Pension built up during that period is subject to increases. When the contracted-out deduction is subtracted from the additional state pension, the remaining additional state pension includes an increase linked to prices. The effect is that, an amount broadly equivalent to the GMP, but which is in fact additional state pension is subject to an increase (HC Deb, 6 January 2014, c51W).
The new State Pension
Under the Pensions Act 2014. a new single-tier State Pension (nSP) was introduced for future pensioners from 6 April 2016. The NAO described the implications for people who had been contracted-out as follows:
9 The new state pension ends contracting out. From April 2016 the government will replace the basic and additional state pensions with a new single state pension. Employers will no longer be able to contract their pension schemes out of the state pension scheme. Working-age people will have their existing state pension entitlement adjusted for previous periods of contracting out and transferred to the new state pension scheme. Occupational pension scheme providers will continue to revalue any Guaranteed Minimum Pensions that people have built up (paragraphs 2.6 to 2.11).
10 For people retiring after 6 April 2016, the government will no longer take account of inflation increases to Guaranteed Minimum Pensions when uprating people’s new state pension. Scheme providers will continue to uprate occupational pensions – including part of Guaranteed Minimum Pensions – in accordance with scheme rules and statutory requirements. The changes mean any Guaranteed Minimum Pensions that people have accrued between 1978 and 1988 will not be uprated, and the scheme provider will only uprate Guaranteed Minimum Pensions built up between 1988 and 1997 to a maximum of 3% each year. People who have already started claiming their state pension will be unaffected (paragraphs 2.19 to 2.21). (NAO, The impact of state pension reforms on people with Guaranteed Minimum Pensions, HC 907, March 2016).
It concluded that the impact on of these reforms on individuals would depend on a number of factors:
17 The uprating of Guaranteed Minimum Pensions is a complicated area. The impact of reforms on individuals will depend on a number of factors including their age, employment history, earnings and future inflation. Some people are likely to lose out and they have not been able to find the information they need.
18 We are concerned that the Department has limited information about who is affected by the impact of pension reforms on Guaranteed Minimum Pensions. It is now seeking to improve how it communicates the impact of pension reforms, and will need to help people identify how they are affected and provide them with accurate and more complete information so that they can make informed decisions about their future pension arrangements (Ibid).
Public service pensions
The arrangements in place before 6 April 2016 ensured that public servants received indexation on their GMP, while preventing double increases. (HM Treasury guidance, May 2001).
Because the mechanism in the old State Pension for providing full indexation of GMPs, is not part of the new State Pension, the Government had to consider how to deliver on commitments by previous governments that public service pensions would be fully indexed. In March 2016, it announced that those reaching State Pension age between 6 April 2016 and 6 December 2018 would receive a fully-indexed public service pension for life. (HM Treasury press release, 1 March 2016).
In November 2016, it launched a consultation on whether public service schemes should pay full indexation on GMP for people reaching SPA after 5 December 2018. On 22 January 2018 it announced that “this solution will be extended for a further two years and four months”, covering members of public service schemes with a GMP who reach SPA on or after 6 December 2018 and before 6 April 2021. During that period, the Government would “investigate the possibility of an alternative long-term methodology, known as conversion.”
The issue of overpayments due to incorrect payments of GMP is discussed in CBP-4919 Public sector pension overpayments (April 2018).
Commons Briefing papers SN04956
Author: Djuna Thurley