If you decide to take some of your benefits as a cash sum when you retire, Nestlé Pensions will need to calculate the value of your chosen cash sum amount. If you’re a DC Start or DC Core member, we will pay your chosen cash sum directly from your account (subject to any tax). If you’re a DB Core or DB CorePlus member, you will need to exchange part of your DB pension for your chosen cash sum. This is known as ‘commutation’, and the Fund uses ‘commutation factors’ to calculate how much cash you get in exchange for your pension.

The commutation factor used to calculate your cash sum depends on:

• your age when you retire, and
• the rate your pension is due to increase each year once it’s being paid.

As a result, more than one factor may apply to different ‘parts’ of your pension – depending on when it was built up.

If you have a DC account in addition to your DB benefits (for example, built up in DC Core or DC Start), you also have the option to use some or all of that DC account to ‘fund’ your cash sum. This means you can give up less DB pension to provide your chosen cash sum.

Reviewing the commutation factors

The Trustee Board, who have an overall duty to run the Fund, review the commutation factors each year to ensure they remain reasonable and fair to members looking to retire, while also ensuring the Fund’s assets and liabilities are managed responsibly. The commutation factors are impacted by external financial conditions and as such there is a process in place (agreed by the Trustees and the Company) to review the factors each year

The current process for reviewing commutation factors is:

• The Fund’s Actuary reviews the financial conditions over the 12 months to 31 July, and advises the Trustees if they should change as a result.
• The Trustees consider the Fund Actuary’s advice at their September meeting
• The Trustees then consult with the Company before making a decision on whether to revise the commutation factors. If they decide to do so, the Fund Actuary provides Nestlé Pensions with a full set of new factors in October
• Nestlé Pensions then add the new commutation factors to the administration system so that they can be used in new retirement quotations from 1 November.

Retirement quotes produced by Nestlé Pensions use the commutation factors in place at the date of the calculation of the quote. As such, please note that figures in retirement quotes issued before 1 November for a retirement date after 1 November may change if commutation factors change on 1 November.

What can cause a change to the commutation factors?

There are several things that the Fund’s Actuary takes into account when calculating the commutation factors. The most significant of these include:

• Future investment returns based on the assumed return above gilt yields (the rate of interest paid by UK Government Bonds),
• Future inflation rates (both CPI and RPI), and
• Mortality rates (that is, an assessment of future life expectancy).

Depending on the financial conditions, the impact of the review may increase the amount of cash a member receives in exchange for their pension, and at other times reduce it.

How could a change to commutation factors affect pension figures?

Very broadly, the commutation factor represents the amount of money that would need to be held now to be able to afford to pay a pension of £1 a year over the rest of a member’s life allowing for assumed future pension increases (which depend on future inflation), assumed future investment returns and how long the member is assumed to live.

A higher commutation factor means that a member will receive more cash sum for every £1 of pension exchanged (or commuted). A lower commutation factor means that a member will receive less cash sum for every £1 of pension given up.

For example, a commutation factor of 20 means that a member will receive £20 of cash sum for every £1 of pension given up. A commutation factor of 18 means that a member will receive £18 of cash sum for every £1 of pension given up.

If the commutation factor used to calculate a member’s chosen cash sum goes down, then they will receive a lower pension each year because they have had to exchange more of their pension to receive their chosen cash sum. Conversely, if the commutation factor goes up, they will receive a higher pension each year because they have had to exchange less of their pension to receive their chosen cash sum.

We expect commutation factors to increase or decrease from one year to the next as UK Government Bonds (and the other relevant assumptions) vary.

The calculation of the maximum tax-free cash sum is set out by HMRC. This calculation takes account of the commutation factor. Therefore, the commutation factor also affects the maximum amount of tax-free cash a member can take.

The table below shows the effect if a commutation factor was changed from 20 to 18. In this example we show a member with a yearly DB Core pension of £12,000 from age 65, who has chosen to take a cash sum of £50,000. This example shows that, in this scenario, a 10% reduction in the commutation factor, leads to a reduction in the residual pension of only about 3%.

Before change
Commutation factor = 20

After change
Commutation factor = 18

Member’s pension before taking any cash sum

£12,000

£12,000

Member’s chosen cash sum

£50,000

£50,000

Amount of pension exchanged for chosen cash sum

£2,500 a year
(£50,000 ÷ 20)

£2,778 a year
(£50,000 ÷ 18)

Remaining pension received by member

£9,500 a year
(£12,000 – £2,500)

£9,222 a year
(£12,000 – £2,778)

The table below shows the effect of the same change in commutation factor for a member with a yearly DB Core pension of £12,000 from age 65, and who has £25,000 of DC savings. In this example, the member has chosen to use their DC savings to fund the first half of their chosen cash sum and then exchange some of their DB Core pension to fund the remaining half. As a result, the member gives up less DB pension to provide their chosen cash sum. This example shows that, in this scenario, a 10% reduction in the commutation factor, leads to a reduction in the residual pension of only about 1%.

Before change
Commutation factor = 20

After change
Commutation factor = 18

Member’s pension before taking any cash sum

£12,000

£12,000

Member’s DC savings

£25,000

£25,000

Member’s chosen cash sum

£50,000

£50,000

Amount of pension exchanged for chosen cash sum

£1,250 a year
(£25,000 ÷ 20)

£1,389 a year
(£25,000 ÷ 18)

Remaining pension received by member

£10,750 a year
(£12,000 – £1,250)

£10,611 a year
(£12,000 – £1,389)

As mentioned above, a lower commutation factor reduces the maximum possible tax-free cash sum that the member could take because of the technical way in which HMRC rules work for the calculation of the maximum tax-free cash.

In summary, we expect commutation factors to change each year – up or down – due to changes in market conditions and other relevant assumptions. You should bear in mind therefore that if you choose to take a tax-free cash sum when you retire, the pension figures in any retirement quotes you receive may be different from the actual figures you will receive when you retire.

We wouldn’t normally expect changes in the Fund’s commutation factors from year-to-year to have a significant impact on a member’s benefits (although it is possible in the rare event that gilt markets are very volatile). For example, if the current approach to setting commutation factors had been in place over the last 15 years, then changes in the factors due to changes in financial conditions would have affected member’s benefits by more than 5% compared with the previous year only once. This was in 2023 where the change was due to the highly unusual turmoil in the gilts market caused by the so-called “mini-budget” in September 2022.