Spotlight on the Pension Protection Fund
Bernadette Lewis, Financial Planning Manager
The recent high profile difficulties of some defined benefit pension schemes – often called final salary pensions – shone a spotlight on the Pension Protection Fund (PPF). So how does it work?
Sponsoring employers provide significant funding to defined benefit workplace pension schemes. The PPF protects members of defined benefit pensions that are in deficit when a sponsoring employer goes into liquidation – causing concern that the scheme won’t be able to meet its pension promises. The scheme enters PPF assessment, which has three possible outcomes:
- a new employer rescues the scheme
- the scheme secures benefits with an insurance company at or above PPF compensation levels
- the PPF takes on the scheme.
Where the PPF takes on a scheme, compensation replaces the members’ scheme benefits based on their existing pension entitlement as at the date the scheme enters PPF assessment. However, their entitlement can be adjusted in line with the ‘admissible rules’ and to take account of any equalisation of guaranteed minimum pension (GMP) benefits. The admissible rules set aside most non-statutory pension scheme rule changes and discretionary increases made in the three years before a scheme enters PPF assessment.
There are two levels of PPF compensation, depending on each member’s status as at the date the scheme enters PPF assessment.
90% compensation, subject to the compensation cap
- active, deferred and pension credit members who are under the scheme’s normal pension age at the assessment date
- pensioners under normal pension age at the assessment date (apart from those who’ve taken ill health retirement).
100% compensation, no compensation cap
- pensioners over normal pension age at the assessment date
- active and postponed members over normal pension age who hadn’t taken benefits at the assessment date
- survivor’s pensions in payment at the assessment date
- members under normal pension age receiving legitimate ill-health pensions at the assessment date.
Deferred members’ compensation is revalued in line with the scheme’s admissible rules up to the assessment date. Where relevant, PPF compensation is also revalued between the assessment date and the member’s normal pension age, or the date they take benefits if earlier. For schemes entering PPF assessment from 31 March 2011, revaluation is in line with the consumer prices index (CPI) capped at 5% for pensionable service up to 5 April 2009 and CPI capped at 2.5% for pensionable service from 6 April 2009. This type of revaluation doesn’t normally apply to pension credit members or if there was no revaluation under the scheme rules.
PPF benefits are also restricted by the compensation cap, which applies at the member’s normal pension age or when taking benefits earlier. The cap normally increases each year. From 6 April 2016, it’s £37,420.42 at age 65, adjusted for members taking benefits at other ages. Compensation is payable at 90% of the lower of the member’s entitlement at the point they’re taking their benefits and the cap. So the maximum capped compensation at age 65 is £33,678.38 based on the 6 April 2016 cap. Members can normally commute up to 25% of their PPF compensation for tax-free cash.
PPF compensation can be paid earlier or later than normal pension age, between age 55, or a protected early retirement age, and age 75. If so, benefits are revalued and the compensation cap applies up to normal pension age, or the age the member takes benefits if earlier. The compensation is then subject to an actuarial reduction or increase. The PPF confirms that deferring benefits doesn’t increase the chance of the cap applying. Early or late payment of PPF compensation isn’t normally available to pension credit members.
For schemes that enter PPF assessment from 1 January 2012, PPF compensation in payment is indexed at CPI capped at 2.5% for benefits built up in respect of pensionable service from 6 April 1997 only. This means that over time, members who would have received indexation (inflation-linked increases) on the part of their pension entitlement relating to service before April 1997 will receive less than originally expected.
PPF members with a life expectancy of six months or less may be able to take a PPF terminal ill health lump sum. This is equivalent to two years annualised compensation and payment is subject to meeting certain conditions. The PPF doesn’t offer any other ill health retirement options.
In terms of death benefits, the PPF pays 50% survivors’ pensions to spouses, civil partners and cohabitees, provided they would have been eligible under the original scheme rules. It also pays dependent children’s pensions. In this case, the requirement for the child to be eligible under the scheme rules only applies during the assessment period.
For employer use only.
Information correct as at October 2016