Select Committee on Social Security Fifth Report


Memorandum submitted by William M Mercer (PS 1)


1. Rationale

  There has been some public concern that a member who loses a substantial part of his pension rights as a result of the new pension sharing proposals may not be able to make good part or all of his loss (known as "debit" in the regulations). Under the current proposals, the only method available is the Company's Additional Voluntary Contribution (AVC) Scheme or a Free Standing AVC (FSAVC) Scheme. However, there are two problems with using these arrangements:

    —  the maximum limit of 15 per cent contributions may not be enough to make good the loss, especially for older members who have large debits against their pension;

    —  the debit will be deducted from the Revenue Maximum Pension in determining the maximum amount the member may receive. Again, this may mean that a member with a substantial debit cannot receive a good pension in retirement.

  The Treasury have so far refused to allow higher contributions or remove the debit from the Revenue Maximum Test, because (a) they feel that there will be a loss of tax revenues (even though it is really only a deferment of tax revenues) and (b) they do not wish a divorced couple to be in a better position than a married couple.

2. Proposal

  Allow the divorced member to make contributions to a special type of FSAVC, with no limit on the contributions. Benefits from this arrangement will only be payable as pension. The total benefits payable to the member from all sources will be subject to the Revenue Maximum (i.e. no reduction for the debit).

3. Effect of Proposal

  Since the benefits will be solely in pension form, there will be no ultimate loss to the Revenue (the only real loss comes where benefits can be taken as a tax-free cash sum). Also, the deferral of any tax revenues would be minimal because:

    —  the FSAVC will only apply to members who have substantial debits and have to pay high contributions (>15 per cent) to make these good;

    —  these members are likely to be old (i.e. they were married for a long time and incurred a substantial debit);

    —  the maximum benefits will only be payable to a very small number of people, since the vast majority of members do not receive Revenue Maximum benefits anyway.

4. Possible selection by a member

  One possible downside is that a divorced couple could be in a better situation than a married couple, in that the maximum benefits payable to a divorced couple could be two thirds to the member plus the spouse's credit, whereas only two thirds would be payable to the member if the couple remain married. There is, therefore a theoretical risk of selection by a member to improve his benefits through divorce.

  I feel that the possibility of selection in this way is exceedingly small, if not nil. This is because for it to happen, first of all his financial adviser would have to advise him that, in order to achieve the higher benefits, the member should divorce his/her spouse. This would obviously take a number of years and would incur a large number of costs (not to mention the hassle), including all the costs of the new proposals for setting up credits and debits. Additionally, the member would presumably have to provide proof to the Courts that the marriage has broken down.

  Even if the financial adviser convinces the member to do this, the member would then have to explain to the spouse that they were only divorcing so that ultimately they could get a bit more pension. This would take a great of convincing!

  Finally, even once the divorce has gone through, and the extra contributions are paid (as stated above, this would only affect older members who have substantial debits), the benefits would only be paid as pension. This means that effectively the Treasury would not lose tax revenue and any deferral of tax would be for a minimal period. (A small reward to the couple for three or four years divorce proceedings and associated costs!)


  The risk to the Treasury is exceedingly small in allowing this new contract. However, if they wish, they could impose some restrictions, e.g. only allow the special FSAVCs to over 55-year-olds and/or limit the contributions to, say, 25 per cent of earnings.

R Andrew Scott

27 January 1999

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