Summary

With 6 April 2016 and the end of defined benefit contracting-out rapidly coming into view, the Department for Work and Pensions has recently published a response to the second part of its May 2014 consultation paper, together with a finalised set of regulations and an accompanying order.

Much of the response deals with fairly technical issues regarding the legal regime which will apply from 6 April 2016 to protect rights accrued during contracted-out employment. However, buried in between the legal niceties, there are a few more fundamental policy points on which the Government’s response may raise eyebrows within the pensions industry, plus the promise of yet more consultations to come.

Background

Although it will cease to be possible to contract-out of the state second pension from 6 April 2016, the Government requires benefits that have already been earned for periods of contracted-out employment to be given special protection. This is necessary in order 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 or section 9(2B) rights) which were required to be provided as a condition of contracting-out.

The May 2014 consultation paper therefore put forward a set of draft regulations (now finalised as The Occupational Pension Schemes (Schemes that were Contracted-out) Regulations 2015) which are intended to preserve the key provisions contained in the current contracting-out regulations. These include restrictions on matters such as alterations of scheme rules relating to contracted-out benefits, commutation of contracted-out pension rights for a lump sum, or forfeiture of such rights.

Key points

The detail of the legislation itself is likely only to be of material concern to pensions lawyers and administrators, but there are also a number of points within the DWP response which are of more general interest:

  • Perhaps the biggest surprise: having suggested in the consultation paper that it was considering providing a power to enable trustees to modify scheme rules to take account of the abolition of contracting-out, the Government has now announced that it does not intend to do so. This issue is relevant to many contracted-out schemes which are set up in a manner that is intended to be integrated with the state pension system, and which therefore include (for example) pension offsets calculated by reference to the basic state pension (BSP). The Government’s stated view – which is by no means shared by all within the pensions industry – is that since the BSP will continue to be payable to existing pensioners (and therefore a figure for the BSP will continue to be published for the lifetime of those pensioners), no override power to modify scheme rules will be needed.  
  • In response to queries as to whether employers will need to notify and/or consult with members in advance of the abolition of contracting-out, the Government has indicated that it will address these issues in a further consultation on changes to the 2013 disclosure regulations.  
  • The response promises that current HMRC guidance on contracting-out will be updated to assist scheme administrators to operate former contracted-out schemes under the post-abolition regime, with a tentative publication window for that revised guidance of “early 2016”.  
  • The DWP has had to whip up a short Order in Council to ‘save’ a number of provisions in the Pension Schemes Act 1993 for three years beyond April 2016, having reached the conclusion that merely abolishing them (which was Plan A) would have unintended consequences, and that time is too short (and the issues too complex) to come up with an appropriate Plan B before April of next year. A particular problem area here is money purchase schemes which have contracted out using a reference scheme test underpin defined by reference to the statutory provisions, where abolition of those provisions would have removed a valuable defined benefit underpin – clearly not the Government’s intention!  
  • Further consultation is promised later this year on changes to the regulations governing transfers of contracted-out rights between schemes. Interestingly, one of the purposes of those proposed changes is stated to be “to allow members to take advantage of the new flexibilities”.  
  • For the time being, the Government has reverted to the existing wording of the regulations regarding amendments to accrued contracted-out rights, having received comments from many respondents who were concerned that the draft new wording was significantly more restrictive than the current regime. However, the response document flags that the Government intends to consult again on this issue in due course (next time with a more detailed explanation of the policy intention behind the proposed changes).  
  • Whilst acknowledging that the current wording of the regulations relating to trivial commutation of contracted-out rights is “out of kilter” with HMRC rules on trivial commutation (and has been since at least 6 April 2006), the Government is carrying forward this wording for the time being, because of certain technical issues. This is another area where further consultation is to follow.  
  • Just in case anyone thought that GMP conversion and equalisation issues had fallen off the bottom of the DWP’s ‘to do’ list, the response document includes a reminder that these issues “are being explored separately”, though no timescales are offered.

Comment

No one who is embroiled in getting to grips with all the other implications of the abolition of contracting-out (think: GMP reconciliation; use of the employer override or other scheme changes) is likely to be overjoyed at the promise of a raft of further consultation papers and draft amending regulations over the coming months. However, it is useful to have (most of) the finalised provisions for the future statutory regime available, so that scheme documentation and processes can be checked for compliance.

The Government’s U-turn regarding the suggested modification power is likely to be the most controversial aspect of this response. The decision is likely to disappoint many, who will consider that it hampers their ability to maintain true integration between their scheme benefit structure and the state pension, by not expressly enabling employers to link scheme benefits to the new, higher, single tier state pension which pensioners will receive from April next year: resulting in a potential windfall for members. It is also not certain that all schemes’ rules will be framed in such a way as to allow for the application of the ‘easy’ solution which the Government suggests exists – it is likely that many schemes with integrated benefits will need to amend their scheme rules either to preserve the current position or to reflect the new state pension.