General principles: arrangements: cash balance and other money purchase arrangement differences
Under the legislation the difference between a cash balance and an other money purchase arrangement is in the calculation of the amount available for the provision of benefits to or in respect of the member (the member’s pot).
In an other money purchase arrangement the pot is calculated wholly by reference to payments made under the pension scheme by or on behalf of the member. This means amounts going into the pension scheme under the individual’s arrangement and may include:
- individual and employer contributions
- transfers into the scheme of the member’s rights under another pension scheme, and
- pension credits received following a pension sharing order.
So the member’s pot is solely derived (whether directly or indirectly) from payments made under the arrangement.
Where the scheme administrator or trustees use the payments to make investments of any kind on behalf of the member, then, as long as the pot ultimately used to provide benefits is wholly derived from the original payments, the arrangement is an other money purchase arrangement.
This is the position however the scheme chooses to invest the payments. It may do so, for example, by depositing cash or by investing in shares, investment property or other assets. The subsequent investment income and any capital gains are derived from payments made under the arrangement, and they themselves become part of the member’s pot.
The scheme may choose to use some of the payments to pay premiums on a life insurance policy that will provide a fixed capital payment in the event of the member’s death. If the member dies the proceeds of the insurance policy will be paid to the scheme. These proceeds will then form all or part of the member’s pot and the scheme may choose to pay them out either as a death benefit lump sum or as beneficiaries’ pensions. This may all be within the definition of an other money purchase arrangement.
In a cash balance arrangement the pot is not calculated wholly by reference to such payments made by or on behalf of the member. In a cash balance arrangement all or part of the member’s pot is promised or guaranteed, and so the pot cannot be said to be calculated wholly by reference to payments under the scheme. In the examples at PTM023400, the amount that goes into the pot year on year, either actually or notionally, is fixed, regardless of what the scheme does with any actual contributions made. This promise or guarantee breaks the connection between the amounts going into the scheme and the pot that will eventually be made available to provide benefits, making these cash balance arrangements.
It is a feature of other money purchase arrangements that the member bears all the investment and mortality risk. The scheme simply pays out whatever benefits the amount in the pot, including the proceeds of all the investments that have been made using the payments into the scheme, will support. In a cash balance arrangement some of this risk is transferred to the scheme (or, if there is one, the employer). The fact that all or part of the pot is guaranteed or promised means that the promised amount must be made available to provide the means to arrange benefits irrespective of the level of actual funds held.