NHS PENSION SCHEME REVIEW NOTE ON THE APPLICATION OF EARLY AND LATE RETIREMENT FACTORS TO THE SCHEME

Transcription

1 NHS PENSION SCHEME REVIEW NOTE ON THE APPLICATION OF EARLY AND LATE RETIREMENT FACTORS TO THE SCHEME Date: 19 September 2007

2 1. Background and tables 1.1 This paper has been produced by the Government Actuary s Department at the request of the Technical Advisory Group (TAG) to the NHS Pension Scheme review. It is intended as a supplementary paper to TAG in which various sets of specimen early and late retirement factors were set out and should be read in conjunction with that paper. Focusing now specifically on early and late retirement factors which are designed to be broadly cost neutral in their operation, the purpose of this supplementary paper is a) to describe how early and late retirement factors would apply in schemes in which members have a choice over how much pension and how much lump sum they wish to take on retirement; b) to describe various policy options around the type of late retirement factors which might be adopted. 1.2 The factors used in this paper have been extracted from the tables of possible specimen early and late retirements factors set out in TAG , or from tables constructed on a consistent basis. For ease of reference, these are set out below in Tables 1A to 1C. Table 1A: Illustrative ERFs Percentage reduction to benefits taken before 60 % reduction to retirement Pension lump sum 50 40% 30% 51 37% 27% 52 34% 24% 53 31% 22% 54 27% 19% 55 23% 16% 56 19% 13% 57 15% 10% 58 10% 7% 59 5% 3% 1

3 Table 1B: Illustrative ERFs Percentage reduction to benefits taken before 65 retirement % reduction to pension 50 56% 51 53% 52 51% 53 49% 54 46% 55 43% 56 40% 57 37% 58 33% 59 30% 60 26% 61 21% 62 17% 63 12% 64 6% Table 1C: Illustrative LRFs Percentage addition to benefits taken after 65 retirement % addition to pension 66 5% 67 10% 68 16% 69 23% 70 30% 71 38% 72 47% 73 56% 74 67% 75 79% 1.3 The increase factors in Table 1C have been constructed to apply to a pension based on service up to age 65, but on final pay at the point of eventual exit. Alternative approaches are discussed later in this paper. 1.4 The above factors have been based on the assumptions which it is expected will be used the 2004 valuation of the NHSPS. However, it should be noted that these assumptions might not necessarily be the most appropriate set of assumptions on which to base any new sets of early or late retirement factors, depending on when such factors were to be introduced. In particular, more regard might be had to current financial conditions in determining tables of factors than in setting longterm valuation assumptions. 2

4 1.5 The illustrative factors have been set out solely in order to provide a clearer understanding of how any new system might work in practice there is no implication that we would currently recommend these illustrative factors as suitable replacements for the existing factors. Such a recommendation would need to follow on from a far more detailed analysis than that from which the illustrative factors have been derived, and is outside the scope of this paper. 1.6 It is assumed that proportionate factors will apply on retirements between birthdays. 2. Application of factors Example Consider a member of the existing scheme retiring at age 56 with 20 years service and final pensionable pay of 25,000. Her benefits before reduction are calculated as: Annual Pension = 20/80 * 25,000 = 6,250 a year Basic Lump Sum = 3 x pension = 18, These benefits are then reduced for early payment, the relevant factors of 19% for pension and 13% for lump sum being taken from Table 1A. The reduced benefits are 5, pa and 16, respectively, but the member decides she wishes to commute some pension to take the maximum permissible amount of tax-free lump sum. The maximum permissible lump sum can be obtained by multiplying the basic pension by 30/7 and adding on 5/14 of the basic lump sum, so obtaining 27,522.32, 11, more than the basic lump sum of 16, Thus the pension needs to be reduced by 11,209.82/12 = a year to 4, a year. 2.3 Thus the final benefits payable from age 56 are a lump sum of 27, plus a pension of 4, a year. One quarter of the total HMRC value is thus 25% x (20 x 4, ,522.32) = 27,522.32, as required (allowing for rounding errors). 3

5 Example Consider now a member of the new scheme retiring at age 56 with 20 years service and final pensionable pay of 25,000. His pension before reduction is calculated as: 20/60 * 25,000 = 8, a year 2.5 This pension is then reduced for early payment the relevant factor of 40% being taken from Table 1B. The reduced pension is 5, pa, but the member decides he wishes to commute sufficient pension to take the maximum permissible amount of tax-free lump sum. The maximum permissible lump sum can be obtained by multiplying the basic pension by 30/7, so obtaining 21, Thus the basic pension needs to be reduced by 21,428.57/12 = 1, a year to 3, a year. 2.6 Thus the final benefits payable from age 56 are a lump sum of 21, plus a pension of 3, a year. One quarter of the total HMRC value is thus 25% x (20 x 3, ,428.57) = 21,428.57, as required (allowing for rounding errors). Example Finally, consider a member of the new scheme retiring at age 68 with 20 years service and final pensionable pay (calculated at the date of retirement) of 25,000. His pension before reduction is calculated as: 20/60 * 25,000 = 8, a year, of which 7, a year was accrued before age The portion of this pension accrued up to age 65 is then increased for late payment, the relevant factor of 16% being taken from Table 1C. The increased pre-age 65 pension is 8, and the total pension after increase is 9, pa. The member then decides he wishes to commute sufficient pension to take the maximum permissible amount of tax-free lump sum. The maximum permissible lump sum can be obtained by multiplying the basic pension by 30/7, so obtaining 40, Thus the pension needs to be reduced by 40,571.43/12 = 3, a year to 6, a year. 2.9 Thus the final benefits payable from age 68 are a lump sum of 40, plus a pension of 6, a year. One quarter of the total HMRC value is thus 25% x (20 x 6, ,571.43) = 40,571.43, as required (allowing for rounding errors). 4

6 3. Alternative approaches to late retirement factors 3.1 The factors at Table 1C are designed to be applied to an amount of pension calculated based on service accrued up to the Normal Pension Age of 65 and final salary as at the date of actual retirement. This is the approach outlined in most previous work for the TAG. However, alternatives are possible, and the principal one would be to adopt factors designed to be applied to an amount of pension calculated based on service accrued up to and final salary calculated as at the Normal Pension Age of 65 (but then subject to pension increases between age 65 and the date of retirement). Under the latter approach, the LRFs would be higher, because they do not need to incorporate any allowance for earnings increases exceeding pension increases from age 65 to retirement (the latter being linked to price-increases). A specimen set of such factors is set out in Table 2. Table 1C: Illustrative LRFs Percentage addition to benefits taken after 65 retirement % addition to pension 66 7% 67 14% 68 22% 69 30% 70 40% 71 51% 72 62% 73 76% 74 90% % 3.2 Decisions on the structure of the late retirement factors should take into account the detailed arrangements agreed around benefits for returners, early drawdown of benefits and the extension of the final salary referencing period to ten years. 3.3 The main advantages of basing factors on final pay at age 65 are as follows: (i) (ii) (iii) (iv) (v) may be more consistent with the concept of banking benefits already accrued, as might apply for drawdown or in the case of re-employed pensioners; factors appear more attractive to members, so encouraging longer retention after age 65; member knows amount of banked benefit in advance, at least in terms of its purchasing power; member not subject to risk of decline in final pay (although the ten year reference period offers significant protection under either approach ); the scheme does not bear the small but open-ended risk of the continued link to increasing earnings. 3.4 The main advantages of basing factors on final pay at eventual exit rather than at age 65 are as follows: 5

7 (i) to the advantage of members if pay progresses more than assumed in factors (but there is an equivalent financial risk to the scheme, particularly where members can anticipate good pay progression); (ii) achieves more consistency between treatment of those retiring early and retiring late. 3.5 Consideration has also been given previously to the possibility of finding some means of increasing benefits accrued after age 65 to allow for late payment, although there are potential problems in defining exactly how each year of accrual of benefits following age 65 might be regarded as paid late in relation to an original target age of 65. In practice, it would appear that such problems could be solved only by assuming that (for example) benefits accrued from age 65 to 66, and coming into payment at age 68, are paid 2.5 years late on average. This means that any such factors would need to rely heavily on an assumed pattern of retirements after age 65, and if actual retirements followed a significantly different pattern from that assumed, the factors could in practice fall far short of (or significantly surpass) a cost neutral position. In our view, such an approach is insufficiently robust, and an approach which only increases benefits accrued up to the Normal Pension age would be preferable (whether based on final pay at 65 or at the subsequent date of retirement). Government Actuary s Department 19 September