Need to know:
- Following the Lloyds Banking Group case, organisations must explore how to equalise historical guaranteed minimum pensions (GMP) between men and women.
- Employers can opt to convert into a non-GMP pension scheme, or they can use dual records to calculate the correct amount of pension benefit on a year-by-year basis.
- Although employers are waiting for further industry and government guidance before undertaking GMP equalisation, issues to be aware of include additional tax charges for members and accurate data collection.
In October 2018, the High Court ruled that financial services organisation Lloyds Banking Group must equalise its guaranteed minimum pensions (GMP) for men and women. This has created an industry-wide re-evaluation of historical GMP payments, as trustees and sponsoring employers seek to ensure their occupational pension adheres to the High Court’s judgement.
A GMP is the minimum pension that an occupational pension scheme, contracted out of the additional state pension between 6 April 1978 and 5 April 1997 on a salary-related basis, has to provide to scheme members. GMPs were abolished for contracted-out services after 5 April 1997.
Although employers are still waiting for HM Revenue and Customs (HMRC) to issue guidance around the tax implications of GMP equalisation, this should not put them off beginning to explore the available data, or starting the decision-making process, says Duncan Buchanan, chair of the GMP Equalisation Working Group and member of the GMP Working Group at The Pensions Administration Standards Association (PASA).
“Employers and trustees can start to get their thoughts together and talk to administrators about the availability of data, because once HMRC issues guidance, there’s going to be a wave of schemes wanting to do it and that [creates] a capacity issue [among] administrators,” he explains.
Although implementing GMP equalisation can take around three months depending on the method used, organising the required data and methodology can extend this project timeframe to two to three years.
Choosing the right method
The High Court ruling for the Lloyds Banking Group case specified four methods for GMP equalisation. These have boiled down into two main approaches.
First, organisations can introduce a dual records approach, where employers calculate and maintain records year-on-year, tracking what pension benefit employees of either gender would receive. Typically, the employer will then award the higher of the two amounts across the board.
The other popular approach requires employers and trustees to convert their GMP into a non-GMP pension scheme. While this is initially the higher-cost option, it has lower long-term cost penalties in terms of upkeep and enables employers to simplify their pension offering while eliminating GMP inequality.
This approach also requires fewer changes to administrative systems and can make the converted pension scheme more attractive for insurers, an important consideration if employers are thinking of buying out their scheme in the future.
According to John Cormell, head of GMP equalisation at Barnett Waddingham, around 80% of the organisation’s client base are considering conversion as their method.
These businesses will need to consult with staff prior to converting their scheme. Traditionally, this is done via the pension scheme’s trustees, because they have a greater understanding of the complexities surrounding GMP.
“It’s important to look after the membership, to engage with members and trustees,” Cormell explains. “Even if [employers] think of a really good way of simplifying [the pension scheme], if they rile the membership up in the process, then that’s not what they want to do.”
Potential challenges
The main issue arising from the GMP equalisation process, to date, relates to the tax treatment.
Once GMPs have been equalised, this could result in some members receiving higher pension benefits or back payments. Initially, this might cause some members to have to pay the higher 40% tax rate, when they may be used to paying the basic 20% rate.
A further potential complication is if these extra pension or back payments lead to members unexpectedly hitting the annual allowance or lifetime allowance limits.
Matt Davies, head of GMP equalisation at Hymans Robertson, says: “The industry has flagged that this is an area where there really needs to be more guidance from HMRC. Otherwise, there’s a risk that relatively small changes to benefits could have much larger tax consequences for some people.”
Data collection and analysis might also pose a problem for employers. “One big pitfall is the quality of historical data, and the availability of it," adds Davis. "The Lloyds judgment brings [employers] back to looking at benefits from the 1990s; it’s unlikely that many schemes will have perfect data going back three decades."
Other challenges that employers and trustees may need to grapple with include whether to search for data on no further liability members, how to deal with those who have transferred into an employer’s occupational pension scheme with a GMP, and making sure to re-examine and apply any forfeiture rules.
Collaboration
At the heart of any GMP equalisation project should be collaboration between employers and pension scheme trustees. This is vital to ensure that rectifying GMP inequality works for both pension members and the wider organisation.
Cormell concludes: “It should be a joint exercise where the employer is engaged and the employer and trustees are working together as a team to get the best outcome for everybody; I see it as a collaborative approach.”
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