The Pensions Administration Standards Association (PASA) has published a Guidance Note on GMP Conversion — Equalising for the Effects of Guaranteed Minimum Pensions (GMPs)[1]. The guidance, prepared by the cross-industry GMP Equalisation Working Group, provides examples of how GMP conversion is being used by early adopters, and explains the issues they faced and how they were addressed.
It should be noted that many of the ‘workarounds’ that are used in response to the concerns associated with conversion (in particular, tax issues) are just that – practical solutions that have not been properly tested in law but, that said, some have received ‘clearance’ from HMRC in respect of individual schemes.
The Guidance
The guidance explains what GMP conversion (‘Method D2’) is within the context of GMP equalisation (GMPE) and then includes sections on the schemes likely to use GMP conversion, the process, the interaction with the pensions tax regime and examples of GMP conversion in practice.
As a reminder, GMP conversion requires an active decision by the trustees to use this method of GMPE and the employer must agree to it. In addition, conditions set out in DWP regulations must be complied with.
If GMPs are converted then they are no longer subject to the GMP requirements in legislation. Instead, converted benefits will be subject to the requirements in scheme rules and overriding requirements (other than GMP regulations).
Whilst the list is not exhaustive, schemes that may find the concept of conversion attractive include smaller schemes, particularly those seeking to buy-out; schemes with a significant number of lower earners where GMP rules restrict member options; and schemes where the additional complexity of operating the ‘year by year’ approaches (methods B, C1 and C2) on an ongoing basis would be particularly onerous.
The rationale for deciding to use conversion will also impact other decisions, such as the shape of post-conversion benefits.
Possible processes for using GMP conversion for GMPE, either as part of a ‘bulk exercise’ or for an ‘at retirement’ approach, are both explained and illustrated in the guidance (section 3). As explained in section 4, subsequent examples in the guidance have been prepared on the premise that schemes will want to achieve both equality of present value on the conversion date and equality of benefit payments thereafter. When determining the nature of the post-conversion benefits, trustees also need to be mindful that GMP conversion legislation states that any amendment is ‘necessary or desirable as a consequence of, or to facilitate, the GMP conversion’. This, in turn, will depend on the trustees’ views and objectives.
A range of outcomes are possible but, in practice, many schemes have implemented an approach which, whilst entailing more than simply ‘relabelling’ GMP, does not make dramatic changes to pension indexation. Typically, a desired outcome will be some reduction in administration complexity.
Where more significant reshaping is proposed, then the question of member consent and member options should be considered.
Section 5 of the guidance is devoted to tax considerations, covering the annual and lifetime allowances and the various HMRC protections. One overarching point worth noting is that, broadly speaking, doing conversion at, or after, retirement can alleviate some of the risks (such as loss of deferred member carve-out), whereas conversion before retirement can increase the benefit options available to members. This is illustrated through worked examples in section 6 (which also highlights that, in some cases, some members, such as those with fixed protection, may be excluded from a conversion exercise or at least given the option to opt-out).
Comment
Overall, the guidance is helpful and should provide reassurance that conversion as a means of addressing GMP inequalities is possible and, for schemes where conversion may be the only or optimum solution, it can be done now, provided it is done with care.
[1] PASA publishes GMP Equalisation Group Guidance on Conversion – The Pensions Administration Standards Association (pasa-uk.com)