01 June 2010 - Post by:Caroline Overton
For better, for worse; in sickness but not in health?
Payment of a scheme pension to a pensioner can bear a certain resemblance to a marriage. That’s to say, there’s a formal relationship between the pension scheme and the member intended to last for the rest of the member’s life, and generally death alone can sever the commitment. Like a marriage, when a member becomes incapacitated, calculating pension payments can get more tricky. There are convoluted rules to reducing and reinstating ill-health early retirement pensions which trustees need to know about – what are they?
Unlike most other types of scheme pensions, incapacity pensions don’t come with a lifelong commitment, and can be reviewed, reduced or even suspended depending on what the scheme rules say. I have found that recently a number of clients have been considering their procedure for reviewing incapacity pensions in payment. This usually lead to lots of practical questions – what happens where the member builds up further pension benefits, where the member’s health deteriorates again, or when the member finally comes to retire?
Payment of an incapacity pension depends on certain tax conditions being met. The member must have stopped working, and the trustees must have received evidence that the member is, and will continue to be, incapable of carrying on his occupation because of a physical or mental condition. Schemes can, of course, make their incapacity test stricter than the legal minimum.
Trustees should certainly review incapacity pensions in payment and reduce or suspend as appropriate where their scheme rules give them the power to do so, as this is in keeping with their duties as trustees. After a pension has been reduced or suspended, the pension may resume (or increase back to the earlier rate or to some intermediate amount) if the member meets the scheme’s incapacity test again. Otherwise, the pension would only recommence when the member finally retires and takes his benefits.
In terms of pension commencement lump sums and measuring an incapacity pension against a member’s lifetime allowance, calculations are made and any lump sum paid at the time the incapacity pension comes into payment. Even if payment is suspended, once payment resumes (following later incapacity or on retirement) the pension is viewed as still representing payment of the original scheme pension rather than being a new benefit. Once it comes back into payment the monthly pension will be increased by the amount by which the pension would have increased between the time it was suspended and the time it recommenced under the scheme’s formula for increasing pensions in payment. Provided that the annual rate of increase during the time the pension was suspended wasn’t more than RPI capped at 5% (or £250 if greater), it is treated as the same pension and not tested again against the lifetime allowance. No further pension commencement lump sum entitlement is available for the member from that arrangement.
So – incapacity pensions don’t necessarily come with a lifelong commitment. And with many employers and trustees taking a careful look at their pension liabilities, this may be something that more people might find out.
Caroline Overton is a senior associate at Allen & Overy LLP.