From the blog: Most pension schemes are considering derisking and most of those are considering trivial commutation.
Why? Probably because it seems like the pension scheme equivalent of decluttering – a quick and painless way of reducing administration costs, taking out some risk, and reducing the liabilities.
But there are some complexities to think about.
Why? Probably because it seems like the pension scheme equivalent of decluttering – a quick and painless way of reducing administration costs, taking out some risk, and reducing the liabilities.
But there are some complexities to think about.
Small-pot versus traditional
First, there are two kinds of trivial commutation. The simpler one is commonly known as small-pot commutation.
Commute up to £10,000 worth of pension from any scheme for a taxable cash lump sum. Simple.
Where the transfer value might be higher than the trivial commutation lump sum, offering one without mentioning the other might lead to some members not making the best choice. Is that a problem for trustees?
Then there’s traditional trivial commutation. That’s a bit more complicated because the £30,000 limit applies across all defined benefit pension schemes and all benefits have to be commuted within the same 12-month period.
If that condition is breached, any payment becomes unauthorised and a tax charge applies.
In fact, up to three tax charges apply – two on the member (up to 55 per cent) and one on the scheme.
HM Revenue and Customs can waive the scheme tax charge where the scheme reasonably believed the payment was not a chargeable payment.
So most schemes will require the member to sign a very clearly worded discharge confirming they have no entitlement under any other schemes.
Another potential complication is the code of practice on incentive exercises which, on the face of it, applies to trivial commutation exercises if the option ‘is not ordinarily available’.
If a member has a right to trivially commute without anyone else’s consent then the option is ‘ordinarily available’.
If the right is subject to trustee or employer consent, and the consent is usually given, then it is probably ordinarily available.
However, if the option is brought to members’ attention but is time-limited then it won’t be considered to be ordinarily available and the code would apply.
Key transfer points for trustees to consider
A DB member usually has a statutory right to transfer to a DC arrangement.
Sometimes that transfer value will be higher than the trivial commutation lump sum, because schemes give trustees a wide discretion over what conversion factor to use when trivially commuting, but calculation of transfer values is more prescriptive.
It is possible that, even after taking into account the defined contribution provider’s fees, a member would do better to transfer to a DC arrangement and take cash from there rather than trivially commute.
Where the transfer value might be higher than the trivial commutation lump sum, offering one without mentioning the other might lead to some members not making the best choice. Is that a problem for trustees?
At the very least, shouldn’t trustees consider giving members information about the transfer option? Or bringing the commutation factors closer to those used for transfers?
That way, the scheme still saves some administration costs and takes out some risk, but maybe without saving very much on liabilities.
Still, two out of three ain’t bad.
Pete Coyne is a partner and Daniel Shaw a senior associate in the pensions practice at CMS
