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Section 9(2B) rights - what are they?

These are rights built up on a defined benefit basis under a contracted out salary related pension scheme (or other pension scheme contracted out on a reference scheme basis) from 6 April 1997 to 5 April 2016. The name comes from section 9(2B) of the Pension Schemes Act 1993 (inserted by the Pensions Act 1995).

These rights are also sometimes referred to as reference scheme test benefits or post '97 COSR benefits.

Before 6 April 1997, schemes contracted out on a salary related basis had to provide a certain level of guaranteed minimum pension (GMP). But any excess benefits above this minimum benefit level were not treated as contracted out rights. The key difference after 5 April 1997 is that all of the defined benefit built up until 5 April 2015 is treated as section 9(2B) rights - although any additional money purchase benefits, such as additional voluntary contribution funds, are excluded.

As section 9(2B) rights are contracted out rights, special DWP rules apply. These rules mean that a scheme must be able to identify any Section 9(2B) rights it holds for an individual.

In addition to schemes that were contracted out on a reference scheme basis, section 9(2B) rights can also be held within a suitable buy out contract (often referred to as a section 32 or deferred annuity) following a transfer from such a pension scheme.

Pensions paid from defined benefit schemes can only ever be provided as scheme pensions, so this is the only option for providing a pension from Section 9(2B) rights.

More flexible benefit options, such as income drawdown, could be available if the benefits are transferred to a scheme which isn't defined benefit - but this would mean giving up the pension guarantees offered on a defined benefit pension.

Although there are other minor differences, there are now only four key areas where the rules for section 9(2B) rights differ from the usual HMRC pension rules - pension age, minimum level of pension, pension increases and death benefits.

Retirement Benefits

The benefits provided from section 9(2B) rights must meet contracting-out rules set by the DWP, as well as the usual HMRC pension rules. These special rules continue to apply, even though contracting out under defined benefit schemes was abolished on 6 April 2016.

Pension age

An individual's retirement benefits from section 9(2B) rights must be available to them from age 65, even if the pension scheme's contractual retirement age is higher.

However, they can, in theory at least, be paid from the same normal minimum pension age as other benefits (age 55) or earlier if the member is in ill-health or has a protected low pension age.

Permission may be needed from the scheme trustees or the sponsoring employer if the member wants to draw benefits before the earlier of age 65 or the pension scheme's contractual pension age.

Minimum level of pension and the 'reference scheme test'

Any pension provided from section 9(2B) rights must be at least at the level needed to pass the ‘Reference Scheme Test’. Broadly speaking, this means a pension from age 65 of at least 1/80th of average qualifying earnings in the last three complete tax years for each year of service (up to 40).

The ‘reference scheme’ was a notional scheme which had:

• a normal retirement age of 65 for both men and women
• an accrual rate of 1/80th of average qualifying earnings in the last three complete tax years, for each year of service (up to 40)
• qualifying earnings were 90% of the amount by which earnings exceeded the weekly lower earnings limit multiplied by 52 and didn't exceed the weekly upper accrual point (or upper earnings limit for tax years before 6 April 2009) multiplied by 53
• 50% widow's/widower's/civil partner's pensions. The death in service pension was 50% of the amount the member would have received if the date of death had been their normal retirement date.
• benefits - at least 90% of the members in each benefit category had to pass the test. This test covered active members' and their spouse's/civil partner's benefits in service, retirement and deferment
• the defined benefit scheme had to be a registered pension scheme (or a relevant statutory scheme)

However, if a transfer to a money purchase section 32 has taken place, the benefits will just be based on the amount of fund that the section 9(2B) rights represent.

Pension increases

Other than section 9(2B) rights held under a money purchase section 32, pensions provided from section 9(2B) rights must be inflation proofed to some extent, with different levels of increase required depending on when the pension was built up:

• Pensions provided from section 9(2B) rights built up between 6 April 1997 and 5 April 2005 must increase in line with the RPI capped at 5%
• Pensions provided from section 9(2B) rights built up after 5 April 2005 must increase in line with the RPI capped at 2.5%
• Where the section 9(2B) rights are held as money purchase benefits in a section 32, no indexation in payment is required

Bear in mind that the rules of some occupational pension schemes might promise pension increases that are better than the minimum the law requires.

Tax-free cash entitlement

Subject to the pension scheme rules, when a member first brings their retirement benefits into payment (or crystallises them, as it's known) up to 25% of the total value of the benefits being crystallised can normally be paid as tax-free cash, provided they have sufficient remaining 'lump sum allowance' (LSA).

Where these benefits include section 9(2B) rights, all or part of the tax-free cash can be provided from these rights.

There are, however, also some special circumstances where an individual's tax-free cash rights can be more, or less, than 25% of the crystallised value of their benefits.

Other considerations: serious ill-health & triviality

Serious ill-health: Uncrystallised pension funds can generally be paid as a serious ill-health lump sum under the serious ill-health rules where the member's life expectancy is less than a year.

When section 9(2B) rights are involved the amount of the lump sum depends on the member's marital status:

• Single - the full value of the section 9(2B) rights can be paid as a serious ill-health lump sum.
• Married or in a civil partnership - the scheme needs to keep sufficient funds to provide a 50% survivor's pension in respect of the section 9(2B) rights and the balance can be paid out as a serious ill-health lump sum.

Triviality: As with other benefits, small section 9(2B) rights benefits can be paid as a one-off lump sum (known as a trivial commutation lump sum) subject to the normal triviality rules.

Transferring section 9(2B) rights

Section 9(2B) rights can be transferred to any other registered pension scheme, such as:

• a personal pension scheme
• an occupational money purchase scheme
• a contracted in or contracted out salary related scheme
• a suitable buy out contract
• a qualifying recognised overseas pension scheme (QROPS)

The way the section 9(2B) rights are treated following a transfer depends on the nature of the receiving pension scheme.

• PPP or money purchase OPS: On transfer to a personal pension scheme (including a SIPP or stakeholder pension scheme) or an occupational money purchase scheme, the section 9(2B) rights will be treated as normal 'ordinary' benefits - the same as any non-contracted out rights being transferred.
• COSR: On transfer to a contracted-out salary related pension scheme (or other pension scheme contracted out on a reference scheme basis), the rights will keep their status as section 9(2B) rights. The form of the benefits has to mirror the shape of the benefits the receiving scheme provides for other members.
• Buy out contracts: On transfer to a suitable buy out contract (often referred to as a section 32 or deferred annuity), the rights will keep their status as section 9(2B) rights. However, depending on the nature of the contract, they may be held within a money purchase structure rather than maintaining a pure defined benefit promise.

Unfunded public sector schemes: Members of unfunded public sector defined benefit schemes can't transfer to money purchase schemes to access flexible benefits, unless their transfer request was made before 6 April 2015.

But they are still allowed to transfer to a money purchase scheme if it's unable to provide flexible benefits. This allows transfers to access conventional annuities, which could help those who are unlikely to get value for money from their defined benefit promise - for example, those in poor health or single people who have no need for a survivor's pension on their death.

Divorce: If section 9(2B) rights are awarded to an ex-spouse as part of a pension sharing order, they're no longer treated as section 9(2B) rights and are treated in exactly the same way as excess benefits.

Death Benefits

If a member with section 9(2B) rights is married or in a civil partnership when they die, their surviving partner must normally receive a survivor's pension based on the deceased member's section 9(2B) rights. The rules are different depending on whether the member died before or after the scheme's normal pension age.

• Death after the scheme's normal pension age - the survivor must normally receive a pension of 50% of the member's section 9(2B) rights pension at the date they died.
  
  
• Death before the scheme's normal pension age - the survivor must normally receive a pension of 50% of the section 9(2B) rights pension that the member would have received at their normal pension age.

The only exceptions to these rules are if the survivor:

• was not married to, or in a civil partnership with, the member when the pension from their section 9(2B) rights came into payment (in which case a survivor's pension doesn't need to be paid) or
  
  
• was cohabiting with another person as if married or in a civil partnership when the member died (in which case a survivor's pension doesn't need to be paid) or
  
  
• remarries, enters a civil partnership or starts cohabiting with another person as if married or in a civil partnership after starting to receive a survivor's pension from the scheme (in which case their survivor's pension can be stopped)

The survivor's section 9(2B) rights pension must increase in the same way as the member's section 9(2B) rights pension. The pension payments will be taxed as income - even, from 6 April 2015, if the member dies before age 75.

If the member is single when they die, there will normally be no benefit payable from their section 9(2B) rights. The only exception may be where the section 9(2B) rights are held within a money purchase or mixed benefit environment, in which case a lump sum death benefit might be available from the funds underpinning the section 9(2B) rights promise.