Hymans Robertson’s Ian Colvin points out that the ‘lightning-quick’ consultation on the Local Government Pension Scheme’s revaluation date does not allow enough time for administrators to update systems before the changes take effect.
Local Government Pension Scheme (LGPS) practitioners waiting for legislation to issue forth from the Department for Levelling Up, Housing and Communities (DLUHC) have become used to decoding civil servants’ comments. We are assured that statutory instruments will arrive “in the autumn” (which can mean any time before Christmas Eve) or that guidance will be issued “shortly” (six to 12 months, normally).
So, it was a bit of departure from the usual stately legislative approach when, in February, DLUHC launched a two-week consultation on changes to revaluation in the LGPS, with the aim of implementing those changes by April. Why the rush? And what will the changes mean?
The purpose of the change is to move from 1 April to 6 April the date on which the LGPS increases Career Average Revalued Earnings (CARE) benefits in line with inflation. The idea behind this is to reduce the number of individuals who will receive a tax charge from the annual allowance during the 2022/23 tax year. Although the proposed changes will apply to the more than two million active scheme members, for most the impact will be neutral. In fact, it’s likely that only around 1% will actually benefit.
Each tax year, every member of a defined benefit pension scheme has the growth in the value of their benefits assessed against a threshold called the annual allowance (which, for most people, is £40,000). If the growth in the value of benefits exceeds this allowance, then, depending on the member’s previous levels of pension growth, the excess is taxable at the individual’s marginal income tax rate. Naturally, it’s the members with the largest pensions – those with the highest salaries and longest service – who are most likely to breach the annual allowance.
Any growth in line with inflation is excluded when assessing by how much benefits have increased. This means that benefits can keep pace with the cost of living without contributing to a tax charge.
The rapid increase in prices that occurred in 2022 – resulting in a jump in CPI – has brought the issue into focus.
Inflationary mismatch
The problem is that this cost-of-living increase is different from the increase that is applied to CARE benefits within the LGPS, so a mismatch arises. This mismatch has always been there, but the steady, low inflation of recent years meant that the consequences were minimal. However, the rapid increase in prices that occurred in 2022 – resulting in a jump in CPI, which is used to revalue CARE pensions – has brought the issue into focus.
If the changes outlined in this consultation were not applied, then the inflationary allowance used in the 2022/23 calculation would be 3.1%, while CARE benefits would increase by 10.1%. This would mean significantly more people breaching the annual allowance and paying a tax charge.
The consultation aims to even out these inflationary fluctuations by moving from 1 April to 6 April the date on which CARE benefits are revalued each year. By shunting back the date, the next revaluation falls outside the 2022/23 annual allowance, which ends on 5 April 2023. So, the inflationary allowance allowed for in the 2022/23 calculation would be 3.1%, but CARE benefits themselves would not have any inflationary increase applied during that period. That means less growth to measure against the annual allowance, and fewer members triggering tax charges.
In subsequent years, the inflationary allowance and the increase in CARE benefits would be aligned. For example, in the 2023/24 annual allowance calculation, members would be permitted a 10.1% growth in benefits to sit outside the pension growth assessment. Meanwhile, their CARE benefits would increase by 10.1% – so they would effectively cancel each other out. The only growth in the value of pension benefits measured against the annual allowance would be new accruals built up over the year plus any increase in final salary benefits as a result of pay increases.
Systems will not be ready in time to apply the changes correctly on 6 April, leaving administrators facing the challenge of carrying out manual calculations until the software can be updated.
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An overly hasty approach
So, are the changes a good idea? There’s certainly a logic in using a consistent measure of inflation within a single calculation. And the changes mean that only “true” growth in benefits’ value will be measured against the annual allowance. However, the concern for many is that this issue, which has been known about since 2015, is only now being addressed, with mere weeks to consult, draft legislation and update pension administration systems before the changes take effect.
These systems will not be ready in time to apply the changes correctly on 6 April, leaving administrators facing the challenge of carrying out manual calculations until the software can be updated. It is to be hoped that the changes can be incorporated in time for the 2022/23 annual allowance exercise, as the complexities of trying to manage that process without updated systems really do not bear thinking about.
The lightning-quick consultation and, in all likelihood, introduction of these changes is a lesson in being careful about what you wish for. Let us hope that, in future, DLUHC can find a happy medium between the usual lengthy wait for legislation and this overly hasty approach.
Ian Colvin is head of LGPS Benefit Consultancy at Hymans Robertson.
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