The end of the contracting-out era is fast approaching and both trustees and employers should be thinking about reviewing their contracted-out defined benefit schemes to ensure they are compliant come 5 April 2016. On and from 6 April 2016 employers will no longer be able to opt out of the earnings-related component of the state pension on behalf of their employees.
Currently, members of contracted out defined benefit schemes are contracted out of the State Second Pension (S2P), so providing them with equivalent rights in their employer's scheme and a reduction in National Insurance Contributions (NICs) for themselves and their employer.
The reforms to the state pension, due to take effect from 6 April 2015, mean that the S2P will disappear and contracting-out of the reformed state pension will no longer be an option.
Although it will cease to be possible to contract-out of S2P from 6 April 2016, the Government nevertheless requires that benefits already earned for periods of contracted-out employment be given special protection. This is because it is necessary to ensure that the NI rebates already paid will result in earners receiving at least the specified minimum level of benefits (either guaranteed minimum pensions pre 6 April 1997 or section 9(2B) rights thereafter) which were required to be provided as a condition of contracting-out.
In response to the increase to NICs, employers can either absorb the additional NIC cost or take advantage of a statutory override under the Pensions Act 2014 allowing employers to amend the scheme rules, without trustee consent, to reduce benefits which accrue following April 2016. However, for employers with over 50 employees, this amendment may require an employee consultation exercise lasting at least 60 days - a decision on this will be addressed following a consultation on the current 2013 disclosure regulations.
It was thought that trustees would also be allowed a similar modification power as many contracted-out schemes are set up in a manner that is intended to be integrated with the state pension system and which includes, for example, pension offsets linked to the basic state pension. The Government stated view however is that as a basic state pension will continue to be paid to existing pensioners (and a figure published for the lifetime of those pensioners), there is no requirement for an override power.
For trustees and scheme administrators, the challenge now is to decide how to work with employers to register members for the state pension and how to set this in motion. For most, this will mean a reconciliation exercise of scheme records. To assist with this, HMRC is offering a free Scheme Reconciliation Service, which allows scheme administrators to reconcile their membership data against HMRC’s records. Time is of the essence if administrators wish to avail themselves of this service. HMRC will not however be publishing a revision to its contracting-out guidance to assist administrators in the post abolition world until tentatively “early 2016”.
With the deadline approaching fast, employers, trustees and scheme administrators need to act and take appropriate advice quickly - it’s a legislative and practical minefield.