Pension funds warned of buyout bond hazard

Is there a serious and unintended flaw in pension buyout bonds - the increasingly popular pension transfer option for thousands of employees who leave their occupational pension schemes each year? Some pension advisers are concerned that a clause in the Pensions (Amendment) Act 1996, which resulted in the buy-out bond no longer being considered an occupational pension scheme, could have inadvertently changed the status of these bonds when the bond-holder joins a new company. If their interpretation of the amendment is correct, bond holders, who would have accumulated at least five years service in their old pension scheme, (two of those years served after January 1st, 1991) may find that this service is not recognised by the company they are joining, and they will have to serve another five years in their new company's scheme before being allowed membership.

The amendment, we are told was made in order to simplify the administration of these bonds: the Pensions Act has formalised the way in which trustees of pension schemes must be report back to members, but applying such reporting structures to buy-out bonds, we are told, was seen as unnecessary and overly bureaucratic and so the bonds were deemed to be no longer occupational schemes. According to Mr Tony Gilhawley, an actuary and pension specialist with Technical Guidance Ltd., which advises mainly corporate clients and professionals, one of the most important features of the 1990 Pensions Act is that it introduced the concept of a statutory minimum preserved retirement benefit when someone left an occupational pension scheme. Employees with benefits schemes no longer had to encash their pensions, taking away only their own contributions, minus a portion of tax. Instead they could leave their accumulated pension fund with the ex-employer; take it with them to a new one, or purchase a buy-out bond. Having served at least five years with the previous company, this service would also be recognised by the new company.

The pension buy-out bond option has become popular because some people do not necessarily have a new company to join when they leave the old one. Sometimes this is due to redundancy, but increasingly, it is because many more are choosing to work on a contract basis or as self-employed. Recognising this, the pension legislation gives former employees (and their ex-employers) a two year grace period after leaving their job to decide whether to purchase a buy-out bond.

"It was also intended that service would also travel with a buyout bond," says Mr Gilhawley. "A buy-out bond that transferred into a new scheme would bring with it the service from the scheme from which it came and this service would count towards entitlement to a preserved benefit in the next scheme."

If buy-out bonds are no longer, legally, an occupational scheme, the danger is that previous service would not count towards entitlement to a preserved benefit under the new scheme. "If I am right, my advice to people would be to consider transferring their vested interests directly to the new company's pension scheme," says Mr Gilhawley, where it will count towards automatic membership in the new scheme.

The Pensions Board told Family Money it will be writing to Mr Gilhawley about their legal findings, which are based on the interpretation of other clauses in the Pensions Act.