Protected rights problem: risk to short service refunds from pension schemes

Sonya Fraser

I’ve been considering the impact of the abolition of protected rights since last summer and yet new issues keep coming out of the woodwork!  The latest is the possibility that paying short service refund lump sums from a pension scheme where the member has ex-protected rights could be an unauthorised payment unless the scheme rules are amended.  Do you need to amend your rules?

We all know that pension schemes which were contracted-out on a protected rights basis (or on a mixed benefits basis) pre-6 April 2012 need to consider amendments to their rules to remove protected rights related provisions.  New regulations give trustees the power to remove such provisions by resolution until 6 April 2018 (and with effect retrospectively to 6 April 2012).  However, it’s worth checking now what your rules say on short service refund lump sums and amending that rule as soon as possible if necessary. 

This is because HMRC have issued a statement confirming that scheme rules which exclude contributions relating to protected rights from short service refund lump sums will result in any such payments after 6 April being unauthorised.  To be authorised, the lump sum payment has to extinguish the member’s entitlement to benefits under the pension scheme except to the extent that it is prohibited from being extinguished by reason of the operation of provision made by or under any enactment.  Pre-6 April 2012, schemes had to keep members’ contributions relating to protected rights in the scheme so a limited refund was allowed.  Since the protected rights legislation fell away, that exemption doesn’t apply and so you have to pay the lot, or not at all.  But scheme rules might stop trustees paying out contributions relating to ex-protected rights.

So the message is, check your scheme rules on short service refund lump sums and, if necessary, make sure the trustees don’t pay out any such lump sums until the rule is amended or until HMRC fix the position.  (HMRC mention in their statement that they will be changing the tax rules in due course but it will be for a transitional period only to allow affected schemes to amend their rules and, importantly, the tax change won’t be retrospective.)  Otherwise trustees may end up paying out unauthorised payments. 

HMRC have also confirmed that, for a member who previously took a short service refund but had to leave his contributions relating to protected rights in the scheme, a second short service lump sum can be paid in respect of this retained amount (subject to it satisfying the requirements for short service refunds at the time it is paid).  Whether or not trustees want to give that option to affected deferreds (and whether they will want to take it) is a story for another time!

Sonya Fraser is an associate at Allen & Overy LLP.

Comments published on Pensions Talk do not necessarily reflect the views of Allen & Overy or its clients.

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