What is a career average revalued earnings pension scheme (CARE scheme)? Preserved Members
There are many types of pension scheme. This Factsheet looks at the variations of the career average revalued earnings pension scheme (CARE scheme) that have developed to meet the changing priorities of employers in an ever more complex world.
It is written for people who are preserved members of a CARE scheme.
Introduction
A CARE scheme is a type of defined benefit scheme.
Most defined benefit schemes provide benefits based upon 4 key elements:
- the length of the pensionable service you were credited with whilst you were an active member of the scheme
- your pensionable salary
- the formula or rate of ‘accrual’ which uses service and salary to work out your pension
- the circumstances under which benefits are taken from the scheme (retirement, early payment, early leaver, ill-health, death etc).
Your pension scheme will use a formula, to calculate your pension benefits using these elements. The formula (and the definitions for each part of it) will be set out in the Scheme Rules.
The two most common forms of defined benefit schemes are:
- ‘final salary’ schemes where your pension is based upon your ‘final pensionable salary’ in the years immediately before you take your pension, and
- ‘career average revalued earnings schemes’ (CARE scheme) where your pension is based upon your ‘averaged pensionable earnings’ throughout the whole of the time you were an active scheme member.
Because both types of scheme use your pensionable salary as one part of the formula in order to calculate your pension, they are both commonly referred to as ‘salary related’ schemes, but there is a significant difference between the two.
Example of a ‘final salary’ formula:
length of pensionable service x final pensionable salary
accrual rate
A ‘final salary’ type defined benefit scheme would have used your pensionable earnings near to the date when you ceased to be an active member. Different schemes use different definitions, so it is the definition of your final pensionable salary (or ‘final pensionable earnings’) that is important in this type of scheme.
A common example of ‘final pensionable salary’ would be your last year’s pensionable earnings before you became a preserved member.
Example of a ‘CARE scheme’ formula:
length of pensionable service x averaged pensionable salary
accrual rate
A CARE scheme would have used your averaged pensionable earnings over the lifetime of your active scheme membership.
It is therefore, the definition of your pensionable earnings that is important in this type of scheme. Usually, the pensionable earnings used are increased (called inflation adjustment) to allow for inflation between the date they were received and the date on which you became a preserved member.
The ‘inflation adjustment’ could be structured in many ways, but would be based upon one of the Prices Inflation Indexes (such as RPI or CPI) or in a generous scheme on Average Earnings increases.
What is a CARE scheme?
As we have established, a career average revalued earnings scheme, uses the average of your pensionable earnings over the entire period that you were an active member of the pension scheme.
Example of a ‘CARE’ defined benefit scheme:
Pauline Lewis was an active member of her pension scheme, and retired from work. She received a pension from her employer’s CARE scheme. She had been a member of the scheme for 5 years. She earned a pension equal to 1/60th of her averaged pensionable salary for each year she was in pensionable service (the ‘accrual rate’).
To calculate her averaged pensionable salary, her pensionable salary was increased by the rate of inflation each year up to retirement, whereupon it was averaged over the years she was a scheme member. Inflation was 3% at the end of year one, 2.5% at the end of year two, 3.5% at the end of year three, 2% at the end year four and 1.5% at the end of year five.
The calculation would look something like this:
Pensionable Inflation Adjustment Inflation adjusted
Salary pensionable salary
£21,000 x 3% x 2.5% x 3.5% x 2% x 1.5% = £23,754
£24,000 x 2.5% x 3.5% x 2% x 1.5% = £26,359
£23,000 x 3.5% x 2% x 1.5% = £24,645
£31,000 x 2% x 1.5% = £32,094
£34,000 x 1.5% = £34,510
making a total = £141,362
So her total pensionable salary was £141,362. This was then divided by the number of years she was a scheme member – i.e. 5 years, making an averaged pensionable salary of £28,272 (£141,362 divided by 5).
Her pension at retirement would have been:
Pensionable Service, 5 years
Averaged Pensionable Salary, £28,272 (£141,362 / 5)
‘Accrual rate’, 1/60th
Her pension was: 5 years x £28,272
60
= £2,356 p.a.
Usually, the earnings used are increased to allow for inflation. The ‘inflation adjustment’ could be structured in many ways, but would generally be based upon one of the Prices Inflation Indexes (such as RPI or CPI) or in a more generous scheme, on Average Earnings increases.
There are many different types of CARE schemes, each having its own formula to calculate members’ benefits.
Note that in a defined benefit scheme (whether ‘final salary’ or CARE’), your ‘pensionable service’ was not necessarily the same length of time you were employed by your employer.
Similarly, the salary used to calculate your pension benefit may not have included all of your pay.
What is an accrual rate?
The ‘accrual rate’ is the rate at which you built up pension benefits whilst you were an active member of the pension scheme.
It is most commonly expressed as a fraction, such as 1/30th, 1/60th, 1/80th, 1/120th etc. The lower the bottom number, the better the pension benefit you will receive for an equivalent amount of pensionable service e.g.
Example 1, using a 1/60th ‘accrual rate’
Pensionable Service, 20 years
Averaged Pensionable Salary, £30,000
‘Accrual rate’, 1/60th
Pension: 20 years x £30,000
60
= £10,000 p.a.
Example 2: using a 1/80th ‘accrual rate’
Pensionable Service, 20 years
Averaged Pensionable Salary, £30,000
‘Accrual rate’, 1/80th
Pension: 20 years x £30,000
80
= £7,500 p.a.
An accrual rate can sometimes be expressed as a percentage e.g., 1.25% (which is simply another way of saying 1/80th in this example). So, in a CARE scheme for example, you may accrue 1.25% of your averaged pensionable salary for each year of pensionable service.
Advantages of a CARE scheme
In a CARE scheme, the sponsoring employer pays the lion’s share of the cost of providing benefits.
A CARE scheme also provides members with protection from ‘investment risk’ and ‘mortality risk’ as it is the sponsoring employer (or taxpayer in respect of some Public Sector schemes) who shoulders this risk. For more details on these and other risks, see our Factsheet, Security and Risk.
As well as these obvious advantages, a CARE scheme is also particularly advantageous to active members whose pensionable earnings:
- fluctuate significantly, (a sales person whose earning depend upon performance-related targets for example)
e.g. £29,000; £28,000; £24,000; £29,000; £31,000
- are likely to reduce the closer the member gets to retirement (because of declining physical or mental abilities for example)
e.g. £31,000; £29,000; £27,000; £26,000; £25,000
- are unlikely to increase significantly in the years immediately before retirement (those whose earnings don’t vary much for example)
e.g. £21,000; £21,500; £21,750; £21,500; £21,800
For those active members who experience a sudden unforeseen drop or decline in pensionable earnings (e.g. going part time), the averaging effect of a CARE scheme takes the pain out of a reduction in income, and the corresponding effect that would have on retirement.
A CARE scheme falls within the scope of The Pensions Regulator, so the scheme would be monitored by a regulatory body.
Disadvantages of a CARE scheme
CARE schemes provide a promised (rather than a guaranteed) retirement pension. The pension benefit paid will depend upon many factors, with the most important being the scheme’s ability to pay benefits to members as they fall due. If the employer’s business fails, it is likely that benefits will be reduced for some, if not all members (although Public Sector schemes are different in this respect). For further information on this, please refer to our Module, How secure is my pension?
With no link to active members’ pensionable salary close to retirement, a CARE scheme could be less beneficial (to a comparable ‘final salary’ scheme) for scheme members:
- whose pensionable earnings are likely to rise regularly (or consistently) throughout their career, ahead of inflation-
e.g. £29,000; £30,000; £32,000; £33,000; £34,000
- whose pensionable earnings are likely to rise through promotion or career progression -
e.g. £29,000; £30,000; £38,000; £39,000; £45,000
Burdensome and (some say) excessive legislation and regulation has further increased costs and placed greater financial pressures on sponsoring employers.
When can I get my pension benefits?
Benefits will normally be payable to you when you reach your scheme’s normal pension age or Normal Retirement Date. This is important as it is the date at which you would normally be expected to start to draw your pension benefits without the consent of the employer or the Trustees.
Depending upon the rules of your scheme (not all schemes allow these alternatives), you may also be entitled to receive benefits at other dates such as:
- Early retirement
- Retirement due to ill-health
- Terminal illness
- Late retirement (where you choose to work beyond normal pension age)
What are my benefits worth?
You know what your preserved pension benefits were when you left your pension scheme as these should have been spelled out in your benefit statement given to you shortly after leaving.
To estimate what you benefits will be worth at retirement will depend upon a number of factors, not least of which is the date you left your pensionable service. Successive Governments have introduced legislation which requires pension schemes to increases preserved pensions between the date of leaving and retirement. This is called ‘revaluation’. The level of increases depends upon when you left your pension scheme.
Your pension may also be made up of different slices, each of which may receive a different amount of pension increases up to your normal pension age.
Until the final calculation is made at the time you are due to take your benefits, any other figures you receive will be just an estimate.
The ‘value’ of the benefits depends upon other factors which are personal to you (such as the inclusion of dependents’ benefits, pension increases after retirement etc).
If you want to investigate this further, you should consult an independent financial adviser who is experienced in advising on defined benefits.
Are my benefits secure?
They are only as secure as the funds which have been set aside to pay for the benefits, and the employer’s willingness and ability to continue to support the scheme.
In the event of the employer going into receivership, if the scheme does not have sufficient funds to pay all benefits it is possible that the scheme might qualify to join the Pension Protection Fund which would provide a level of ‘compensation’ (but might still mean a reduction in your benefits). There are some schemes that don’t qualify for the Pension Protection Fund, such as Public Sector schemes. For further information on this, please refer to our Module, How secure is my pension?
After you retire, your benefits will be more secure.
Can my benefits be changed?
Any changes in pensions’ legislation might mean that the scheme has to change.
Otherwise, there are legal requirements that certain changes can only be made after consulting some classes of members. All benefits you have already earned cannot be changed including any future inflation adjustment to those benefits (unless your scheme is wound up). Any improvements which don’t involve you in a higher cost would not require your consent. You would however be told of any change.
A scheme must take care that where it grants extra benefits for one class of member, that it does not diminish the security of others. If this is a significant risk, the Trustees should request specific financial funding or guarantees to cover the extra benefits.
What rights do I have as a member to ensure the scheme is run properly?
Any member can seek election to become a Trustee of their pension scheme, where there is a Board of Trustees. A Trustee is responsible for ensuring the scheme operates according to all the rules.
If you are unhappy about any aspect of the scheme contact the Trustees and if they do not satisfy you having formally pursued the Internal Dispute Resolution Procedure, you can contact The Pensions Ombudsman or The Pensions Regulator depending on your problem. Also, see our list of Useful Contacts.
Summary & Key Points
When making enquiries about your pension benefit it is very important that you make it clear that you are a preserved member of the scheme rather than an active member or pensioner member. Active, preserved and pensioner are different classes of membership of a pension scheme and any definitions and paragraphs contained within your Scheme Rules or scheme literature relating to any benefit may differ considerably between these categories.
For each pension benefit you need to consider the following items:
- Is your pension scheme a defined benefit pension scheme? If yes, is it a CARE type or final salary type?
- How much of your earnings, including any bonuses, overtime, allowances and benefits in kind, went towards your pension earnings?
- What is the formula or ‘accrual rate’ used in calculating your pension benefit? Has this changed at any time during your membership of the pension scheme?
- What pension benefits are provided by your pension scheme? Pension, lump sum, death benefits, ill-health benefits, early payment, pension increases?
- Keep informed. Your scheme may modify benefits and Rules. Legislation may change. Your circumstances may alter.
- Rules differ from scheme to scheme and are wide and varied in content. Don’t assume that what applies to one of your pension schemes will necessarily apply to others that you may have.
- HMRC impose rules which registered pension schemes must conform to.
People seldom have identical pensions and you should avoid drawing comparisons with colleagues whose circumstances may at first appear the same but could emerge as having significant differences.
This Factsheet forms part of our Module Types of Pension Scheme and should be read alongside the other Factsheets and Quicknotes in the series.
This is not an authoritative document. Seek professional advice from an appropriately experienced and qualified adviser.
What is a career average scheme v3.2 - Preserved
Last updated 13/01/2007
