Current proposals by the Department of Work and Pensions would mean that member consent would be needed to transfer contracted-out rights to any pension scheme which was not contracted-out on a salary related basis – which would include any pension scheme established after 6 April 2016.

Introduction

The Department for Work and Pensions (DWP) is currently consulting on changes to legislation governing pensions transfers and transfer payments to take account of the abolition of contracting-out.1 DWP’s current proposals would mean that member consent would be needed to transfer contracted-out rights to any pension scheme which was not contracted-out on a salary related basis (a COSR scheme) – which would include any pension scheme established after 6 April 2016.

Recap: abolition of contracting-out

The second-tier state pension will be abolished from 6 April 2016, and replaced with a new single-tier state pension. This means that from this date:

  • members of defined benefit pension schemes will cease to accrue contracted-out rights (i.e. the element of the state pension which has been linked to earnings); and
     
  • all defined benefit pension arrangements will cease to have contracted-out status. 

Contracting-out on a money purchase basis ceased to be possible from 6 April 2012.

Transfers of accrued rights relating to contracted-out employment

UK businesses with defined benefit pension schemes may want to arrange for accrued pension rights in those schemes to be transferred for various reasons, such as:

  • when selling a business, they may arrange for a bulk transfer to be made to another scheme; 
  • when a business is being demerged (or a demerged entity establishes a new scheme) neither part of the demerged business may be well equipped (or commercially willing) to support the entire pension liabilities of the original, combined business. Therefore, each new business may establish a new, separate scheme to receive the accrued benefits of the employees of their respective business;
     
  • they may merge pension schemes in order to save costs or rationalise or improve scheme governance; or
     
  • when de-risking a pension scheme, the trustees may agree to transfer the liabilities of that scheme to a new scheme established by an insurer, as an alternative to a buyout.

It is not usually necessary to seek members’ consent for the transfer (although this may be sought from active members).

However, members with rights which are contracted-out on a salary related basis (namely guaranteed minimum pensions and section 9(2B) rights2) raise certain issues for transfers of accrued pension benefits. Currently, it is only possible to transfer the rights to and liability for these types of contracted-out rights to another scheme without member consent if that scheme is contracted-out on a COSR scheme. If the receiving scheme is not a COSR scheme, the transfer can only take place where the member who holds those rights consents to the transfer in writing. 

Once contracting-out is abolished, no schemes will be COSR schemes. DWP therefore proposes to amend these rules to provide that transfers without consent can be made to schemes that wereCOSR schemes. 

If the DWP continues with its proposals in their current form, it will not be possible for employers to use any pension scheme which was not a COSR scheme to accept transfers of accrued rights which include contracted-out rights without the written consent of the members affected. This means that no pension scheme established after 6 April 2016 could be used for without-consent transfers which involve the transfer of contracted-out rights.

Where member consent cannot be obtained:

  • a transfer could only be made to a scheme which is not contracted-out in respect of a member’s accrued rights which exceed their contracted-out rights; and 
     
  • contracted-out liabilities must be left behind in the transferring scheme (perhaps being bought out with insurance policies). 

This would have a significant impact upon how UK businesses can address the accrued pension rights of their current (and former) employees – particularly on transactions, such as demergers, where it would be necessary to use a new pension scheme to receive accrued rights. The requirement to obtain consent for the transfer of contracted-out rights would be an obstacle to bulk transfers, scheme mergers, demergers and any other strategy which involved the transfer of such rights. 

DWP’s consultation will close on 16 November 2015.