What is a Guaranteed Minimum Pension?
It’s a promise to pay a certain level of income at retirement age. If you were contracted out of SERPS (State Second Pension) between 6th April 1978 and 5th April 1997 through a final salary scheme, the scheme receiving your national insurance contribution had a liability to pay a Guaranteed Minimum Pension (GMP). The GMP had to provide an income at least equivalent to those who didn’t contract out, this effectively privatised part of the state pension.
It provided an effective inflation proofed income in retirement which is shared by the scheme and the state once in payment.
You may have an investment fund which runs alongside the promised guaranteed income but whether there is enough in this fund to cover the GMP doesn’t wholly matter. Schemes which took onboard the contributions have to meet the guaranteed income requirement. This is to ensure you were not disadvantaged by contracting out of SERPS.
If you left the scheme your income would have been re-valued up to retirement age to ensure it kept its spending power. Depending on when you left the scheme this could have been re-valued at substantially advantageous rates. This could have been re-valued by an index based on the national average earning index. Alternatively this could have been a fixed rate depending on when you left the scheme as follows.
From 1978 to 1988 @ 8.50% per annum (p.a.)
1988 to 1993 @ 7.50% p.a.
1993 to 1997 @ 7.00% p.a.
1997 to 2002 @ 6.25% p.a.
2002 to 2007 @ 4.50% p.a.
2007 to 2012 @ 4.00% p.a.
If you left before 1988 for example this is the equivalent of having a guaranteed income growth rate of 8.5%. This is well above current inflation rates and probably better than most growth rates in unit linked pension funds.
Limited tax free cash
At retirement a calculation is done to establish the cost of providing the GMP. For scheme which have been re-valued at the higher rate above 7% the cost can be high. If the underlying fund hasn’t performed sufficiently the scheme can restrict accessibility to the usually expected 25% tax free cash.
Fund size £100,000
Calculated cost of providing the GMP £90,000
Accessibility to tax free cash £10,000
Schemes can use any tax free cash available to pay for the cost of providing their liability to pay the GMP.
This is where transfers are often sought and where I can help. If appropriate, a GMP scheme can be transferred away to purchase another pension income. Members doing this will have to relinquish the benefits GMP offers, but in certain circumstances this can be appropriate.
GMP’s don’t take into consideration medical history unlike annuities. Therefore annuities could provide a substantially higher income providing the member with more income in their early retirement years.
Alternatively a member might wish to use their fund more flexibly and move into income drawdown.
A full transfer would also open up the ability to release access to the full 25% tax free cash element.
If a member wants to explore one of the more flexible options, such as income drawdown or fixed term annuities they can transfer into these.
Transferring out of GMP schemes isn’t possible without a financial adviser with special pension transfer permissions however. There are many factors to consider. I will be able to assess appropriateness based on your needs and provide analysis on what your benefits are verses what can be gained by transferring benefits away.