Guaranteed Minimum Pension explained

What is a GMP pension? 

Guaranteed Minimum Pension (GMP) is the minimum pension entitlement for members who were contracted out of occupational pension schemes, salary related pension schemes (COSRs) and State Earnings Related Pension Schemes (SERPS) prior to April 1997. SERPS is now known as the State Second Pension (S2P).

The underlying principle is that COSRs will provide members (and widows/ers) with pensions at ‘GMP age’ at least equivalent to what they would have earned under SERPS. GMP entitlement ages are 65 for males and 60 for females despite changes in the State Pension Age.

Since April 1978 pension schemes have been able to contract out and in return for providing a minimum level of benefits (i.e. a GMP) employers and members were allowed to pay lower rates of National Insurance. This all sounds fine in principle, but as might be expected there is a good deal of administrative work that goes with contracting out, involving the employer, pension administrators and the National Insurance Contributions Office (NICO) of the Inland Revenue. In particular administrators need to make sure the GMP recorded under the scheme aligns with that held on NICO’s records. This is known as GMP reconciliation.

Barnett Waddingham provides trustees and sponsors of pension schemes all the support and guidance they may needwhen it comes to delivering their GMP projects. Watch our overview:

Changes to GMP in April 2016

As part of the adjustments introduced, workers can no longer build up pension rights under a SERPS. From April 2016, a one-off calculation determines the pension amount that a retiring individual receives. If an individual has been regularly contracted out, they will receive the basic state pension figure.

COPE – Contracted-Out Pension Equivalent

A new single-tier State pension is being introduced from 6 April 2016 for members who will reach State Pension Age after that date. This is known as COPE.

What is COPE?

COPE is an estimated amount for people who have previously been ‘contracted-out’ of the additional state pension to see how their National Insurance (NI) contributions paid prior to 6th April 2016 will contribute to the income of their overall pension. Members of the LGPS (Local Government Pension Scheme) were contracted out of the additional state pension to allow them to pay lower National Insurance contributions.

For each individual the Department for Work and Pensions (DWP) will compare entitlement under the old and new arrangements at 6 April 2016 to determine a starting amount for the single-tier State pension. The better of these two amounts will be used to determine the State pension an individual receives and in most cases there will be an opportunity to add to this amount by paying NICs in future years.

One of the changes is breaking the link between occupational schemes and the State pension for future service, i.e. the end of contracting-out. For members who have been contracted-out, a deduction will be made to take into account any periods of contracted-out employment and any GMP that has been earned.  This will be expressed as a Contracted-Out Pension Equivalent, or 'COPE', and this amount should be broadly the same as a member’s GMP.

Individuals can find out what their COPE is by requesting a State Pension Statement; these are available to members from age 55. This statement should also include an estimate of your starting amount under the single-tier State pension.

When a member leaves a COSR scheme whether due to retirement, death or leaving service, the GMP needs to be calculated. The GMP calculation is complex and is based on contracted out earnings (i.e. earnings between the lower and upper earnings limits) for each year of contracted out service. Prior to 6 April 1987 contracted out contributions rather than earnings are used. When a member leaves a scheme the GMP is calculated as a weekly amount. This amount is then revalued to protect it against inflation to age 65 (men) or 60 (women).

GMP revaluation

The GMP must be increased for each complete tax year in the period from leaving pensionable service to retirement or death. COSR schemes can adopt one of the following ways to revalue GMP.

The first way uses an index based on National Average Earnings, known as Section 148 Orders or ‘full rate’ revaluation. This is most common in public sector pension schemes. The Secretary of State will publish a Social Security Revaluation of Earnings Factors Order (known as 'Section 148 orders') each year specifying the minimum increase that must be applied to each member’s GMP which is based on National Average Earnings.

The other way to revalue GMPs is the ‘fixed rate' method. This allows for an administrator to calculate the likely amount of GMP payable at retirement as the level of increase is already known. The amount of fixed rate revaluation depends on the date the member left contracted out service and is as follows:

Another historic method is ‘limited rate revaluation’ where the increase is also linked to the rise in the National Average Earnings index over the period from a member’s date of leaving and retirement, but limited to a maximum of 5% per annum over the whole period. A Limited Revaluation Premium was paid to NICO to reflect the difference between limited rate and full rate revaluation. Limited rate revaluation was abolished from 6 April 1997.

GMPs receive an increase on every 6 April from date of leaving to retirement, but not including the 6 April immediately prior to GMP age (65 for men, 60 for women).

Usually a scheme’s Trust Deed and Rules will give the trustees freedom to adopt any of the three methods of revaluation at the commencement of the scheme. Fixed rate is most common in private sector schemes.

Death

Provision of GMP extends to a spouse's or civil partner's pension of one half of the GMP; although for widowers and civil partners this only applies to GMP earned after 6 April 1988. This is payable on the death of a member. If the widow is below age 45 or remarries, then this entitlement is forfeited although many pension schemes would continue paying this benefit.

Transfers

A GMP liability can be transferred to another COSR, or other contracted out Personal Pension or occupational money purchase scheme. Before 6 April 2012, when transferring into a Contracted Out Money Purchase Scheme (COMP) a GMP would have been converted into Protected Rights, but these have since been abolished (see below).

Abolition of Protected Rights

Before 6 April 2012, money purchase schemes had the option to contract-out on a Protected Rights basis whereby each member received Age Related Rebates (ARR) the following tax year. The final value of these rebates, known as a member’s Protected Rights, was subject to special rules when used to purchase benefits at retirement or death. However, Protected Rights have now been abolished and members of COMPs were contracted back into the S2P from 6 April 2012.

Changes over the years

In April 1997, COSRs stopped needing to provide GMP in respect of contracted out service after that date. A much simpler test applicable to the whole scheme known as the Reference Scheme Test was introduced to evaluate the overall level of benefits being provided by the scheme rather than an individual guarantee for each member. If a scheme passed the Reference Scheme Test, it could remain contracted-out.

GMPs in payment

COSRs are required to provide increases on a GMP earned after 6 April 1988 in line with the annual measure of UK inflation each September, with a maximum of 3%. There is no requirement on COSRs to provide increases on GMP earned before 6 April 1988. These increases take effect from age 65 for a male and age 60 for a female.

Individuals reaching State Pension Age before 6 April 2016…

The Government takes into account inflationary increases on pre 6 April 1988 GMP and increases above 3% on Post 6 April 1988 GMP when calculating an individual’s State Pension entitlement. Where appropriate these increases are added to the overall annual increase in State Pension.

However, the female State Pension Age (SPA) is in the process of increasing from age 60. As any increases relating to GMP paid by the State are linked with the payment of state pension benefits, any such increases for females with a SPA greater than age 60 will not be paid until the revised SPA is reached.

Individuals reaching State Pension Age after 6 April 2016…

The Government will not be paying any appropriate increases relating to pre/post 6 April 1988 GMP along with the state pension.  For these individuals, an adjustment will be made to their single-tier pension starting amount in relation to GMP.  Please see the COPE section for more details.

Members who retired prior to GMP entitlement age should have their pension split into tranches once GMP becomes payable. If a member asks to take early retirement, a check should be made to see if the early retirement pension will be sufficient to cover GMP at entitlement age. If not, the member may be barred from retiring or from taking the maximum cash lump sum, or if the scheme rules allow, the member could receive a ‘step up’ at GMP entitlement age.

Ending of defined benefit (DB) contracting-out

From the 6 April 2016 a single-tier State pension will be introduced; as a result contracting-out on a DB basis will end. Contracted-out schemes will automatically cease to be contracted-out after April 2016. This means HMRC will no longer track contracted-out rights and will issue closure schedules to schemes so they can compare these against GMP amounts held on scheme records.

This will have a number of administrative, financial, and scheme design implications for employers, trustees and members. There are key issues for employers and trustees to address even where they have closed their DB schemes to future accrual prior to April 2016.

For instance the Government will not be paying any appropriate increases relating to pre/post 6 April 1988 GMP along with the state pension. Refer to this note on GMPs in payment for more information.

Furthermore from December 2018 schemes will no longer be able to query GMP amounts with NICO as this is when HMRC are planning to finalise their records send individuals information about their contracting-out history. This means that all outstanding GMP discrepancies will need to be sorted out by that time and GMPs between the scheme and NICO fully reconciled.

Recognising the tight timescales involved HMRC have launched a Scheme Reconciliation Service (SRS) to enable schemes to start comparing their non-active GMP amounts (e.g. for deferred and pensioner members) in advance of the scheme ceasing to contract out in April 2016.

Barnett Waddingham helps with GMP for the public sector, including equalisation via our GMP equalisation methods. Find out more about what we do by contacting us today.