Bernadette Lewis explains how the Pension Protection Fund works when an employer enters liquidation.
The Pension Protection Fund (PPF) is sometimes referred to as the pension lifeboat, as it protects members of defined benefit schemes in deficit when a sponsoring employer goes into liquidation.
As a first stage, 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.
Calculation
When the PPF takes on the scheme, PPF compensation replaces scheme benefits. The level of compensation is based on the member’s existing entitlement at the date the scheme entered assessment, but adjusted if necessary in line with “admissible rules” and guaranteed minimum pension (GMP) equalisation.
The admissible rules set aside most non-statutory rule changes and discretionary increases made in the three years before the scheme entered assessment.
The basis for calculating PPF compensation depends on the member’s status at the date the scheme entered assessment:
90% compensation, subject to the compensation cap – as at the assessment date:
• Active, deferred and pension credit members under the scheme’s normal pension age/ normal benefit age (NPA/NBA)
• Pensioners under NPA (does not apply to legitimate ill-health retirement).
100% compensation, no compensation cap – as at the assessment date:
• Pensioners over NPA/NBA
• Active and postponed members over NPA who hadn’t taken benefits
• Survivor’s pensions in payment
• Members under NPA receiving legitimate ill-health pensions.
Deferred members’ compensation is revalued under the scheme rules up to the assessment date. Where relevant, PPF compensation is revalued between the assessment date and NPA, or the date the member takes benefits if earlier.
For schemes entering 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 capped at 2.5% for pensionable service from 6 April 2009.
This does not apply if there is no revaluation under the scheme rules or for pension credit members.
Where relevant, the compensation cap applies at NPA, or taking benefits if earlier. From 6 April, the cap is £38,505.61 at age 65 with adjustments for other ages.
Where the cap applies, compensation is payable at 90% of the lower of the member’s entitlement and the cap. The maximum capped compensation at age 65 is currently £34,655.05.
A higher long service compensation cap is due to come into effect from April 2017, applying to all PPF members with more than 20 years of scheme membership.
Members can normally take PPF compensation early or late, between age 55 (or a protected early retirement age) and age 75, subject to a PPF actuarial adjustment. Revaluation and the compensation cap apply up to NPA, or taking benefits if earlier. Deferring benefits does not increase the chance of the cap applying.
It is possible to commute up to 25% of PPF compensation for tax-free cash, using the PPF’s own commutation factors.
For schemes entering assessment from 1 January 2012, PPF compensation in payment is indexed at CPI capped at 2.5% for pensionable service from 6 April 1997 only, with no indexation for any earlier service. So even uncapped members could see their expected benefits reduce over time.
Once a member is in the
PPF, the only ill-health retirement option applies to those with six months or less life expectancy, who can take a PPF terminal ill-health lump sum equivalent to two years annualised compensation, subject to conditions.
The PPF can pay 50% survivors’ pensions to spouses, civil partners and cohabitees, subject to eligibility under scheme rules. It also pays dependent children’s pensions, subject to eligibility under scheme rules during the assessment period.
Bernadette Lewis is financial planning manager at Scottish Widows
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