On 1 October 2015 the legislation about how schemes deal with those who leave pensionable service after a short period of DC membership will change. Trustees of occupational pension schemes with DC members will therefore need to take action including to amend their scheme rules and to ensure that administrative processes and member communications are updated. In this Pensions Alert we provide an overview of the current legislation, explain what is changing and set out some key points for trustees and employers to consider.

Background - The current position

Under the legislation the position is currently as follows:

  • If members have less than three months' service, they may be entitled to an opt out refund under the automatic enrolment legislation or the scheme rules.
  • If members have at least three months' but less than two years' qualifying service they can elect to receive a refund of employee contributions (known as a short service refund) or transfer their benefits. If members do not make an election within a certain period, trustees can choose to pay the short service refund.
  • If members have at least two years' qualifying service, the scheme must make provision so that they are entitled to benefits under the scheme (this is known as 'short service benefit'). The statutory transfer rules also apply. In practice, scheme rules could provide that members become entitled to benefit under the scheme more quickly than two years and, if so, the right to a short service refund would come to an end at that earlier date. 

If a member has more than one period of service, the general principle is that these are aggregated for the purposes of assessing the length of service.

The changes from 1 October 2015

An overview

The change is part of the Government's recent focus on boosting pension saving. In summary, the period of qualifying service needed for the member to be entitled to benefits from the scheme is being changed to 30 days instead of the current two years for DC members who first join the scheme on or after 1 October 2015. This means that short service refunds are abolished for such members.

What schemes does the change apply to?

The Explanatory Notes to the updated legislation refer to the new provisions applying where all of the benefits 'to be provided by a scheme' are money purchase, which suggests that the changes are only relevant to schemes which are purely DC.

However, the updated legislation itself refers to the changes applying to members for whom all of their benefit 'would necessarily be money purchase'. In our view, this catches not only DC schemes but also cases where a scheme has a DB and a DC benefit section but the person in question has only ever been a member of the DC section. For example, this could arise where a scheme has a closed DB section and an open DC section.

The change is therefore relevant for schemes which are open to new members who will only accrue DC benefits. The changes do not have an impact for DB benefits for which the current legislation will continue to apply.

What is the position for active DC members who joined the scheme prior to 1 October 2015?

The changes will not apply to members who leave pensionable service on or after 1 October 2015 but who joined the scheme prior to that date. For these members, the existing legislation will continue to apply and therefore they will continue to be entitled to short service refunds if they leave pensionable service with at least three months' but less than two years' qualifying service. This means that short service refunds may still be payable for members leaving the scheme up to the end of September 2017.

What is the position for new DC members with a pre-1 October 2015 period of DC membership?

In summary:

  • If the member received a short service refund or made a transfer in respect of the previous period of membership of the scheme, the new rules will apply in the same way as for those who are brand new members on or after 1 October 2015
  • If the previous period of membership counts towards the member's qualification for benefits, then the new requirements will not apply. 

What is the position for members who leave with less than 30 days' qualifying service?

If the members were automatically enrolled they should be entitled to a refund under the automatic enrolment legislation. In other cases, the position will depend on the scheme rules.

Is it possible to continue to provide short service refunds for post-1 October DC members?

Yes, but it would be an unauthorised payment. In order for a refund to be an authorised payment (a 'short service refund lump sum') the member cannot be entitled to short service benefit. Because DC members who join on or after 1 October 2015 will be entitled to short service benefit after 30 days' qualifying service, after that point a refund would be an unauthorised payment (unless permitted by the automatic enrolment legislation).

How do the changes interact with automatic enrolment?

The opt out window under the automatic enrolment legislation is one month from the later of the person becoming a member of the scheme and being given enrolment information, and in some cases is extended to six weeks. This means that a right to an opt out refund may continue to apply after a member reaches 30 days' qualifying service and becomes entitled to short service benefit. The two sets of legislation are not therefore perfectly aligned, but schemes will need to continue to comply with any opt out requests that meet the requirements of the automatic enrolment legislation.

The position is less clear for cases where scheme rules provide for an opt out window of longer than 30 days, for example, if members who are contractually enrolled are given a right to opt out and be treated as though they were never a member on the same terms as apply under the automatic enrolment legislation. We recommend that trustees check to see whether their scheme rules include such a provision and, if so, seek further advice on this point.

Action points for trustees and employers 

The legislative requirement to provide short service benefit once affected members have 30 days' qualifying service is not overriding. Trustees will therefore need to consider whether their scheme rules need to be amended to reflect this, which will depend on whether, under the current drafting, the amendments to the legislation will automatically filter through to the rules.

Administrative processes will also need to be updated to ensure that the different scenarios that could arise can be identified and dealt with appropriately. For example, the administrative processes will need to take into account the differing position for active members who joined the scheme before 1 October 2015, and the impact of any previous periods of membership for those who join on or after 1 October 2015.

Trustees and employers will also need to review the communications which are sent to early leavers to ensure that these reflect the correct position and update the relevant sections of their scheme booklets.

Under the legislation short service refunds only have to relate to member contributions, and therefore the corresponding employer contributions could remain in the scheme and be used in accordance with the scheme rules, for example, to cover future employer contributions or to meet administration costs. Employers should therefore note that the abolition of short service refunds will mean less funds will be available to them in this way.

Looking ahead - automatic transfers of small pots 

Looking ahead, linked to the abolition of short service refunds, the coalition Government proposed to introduce a system in October 2016 whereby small DC pension pots will be automatically transferred when workers change employment. The intention is that the system will be introduced in two phases, and that in phase 1, the number of schemes to which the system applies will be limited and, for members, it will be operated on an opt-in basis. In February 2015 it was reported that further detail and a consultation on draft legislation would be published later this year.