Yesterday marked the end of contracting-out for defined benefit schemes and the start of increased National Insurance contributions for employers and members. Many employers have already taken action to increase member contributions or reduce future benefits to offset this extra cost. However, one of the lesser known effects of the end of contracting-out ceasing is its potential to impact on GMP revaluation.
To counter the effects of inflation, earnings factors used for calculating GMPs must be revalued. For active members, revaluation has been based on the increase in the general level of earnings, with the amount of increase being set out in annual Government orders (known as a section 148 orders). For members whose contracted-out service has come to an end, from that time to the date on which GMP starts to be paid (age 65 for men and age 60 for women), revaluation can be applied either on the same basis or, on a fixed-rate basis – currently 4.75% pa.
Until yesterday, a member's contracted-out service generally came to an end when a member ceased active membership. However, all current active members have now ceased to be in contracted-out service. This could have the effect, under a scheme's rules, that active member's GMPs must be revalued at a fixed rate immediately, as opposed to from the end of active membership. With fixed rate revaluation being at a higher rate than that required under section 148 orders, this will increase the scheme's liabilities.
To counter this problem, trustees have a 12 month statutory power allowing them to amend their scheme rules (retrospectively from 6 April 2016) so that fixed rate revaluation only applies from the end of active membership.
The end of contracting-out and the introduction of the new state pension has the potential to impact on schemes in several ways. As well as GMP revaluation, this includes things such as the operation of state pension offsets and bridging pensions. Trustees should review their scheme's rules to see if the end of contracting-out impacts on members' benefits and engage with the scheme's employers to discuss if any changes should be made. Trustees should also be communicating with members about any impact on their benefits resulting from the end of contracting-out and the introduction of the new state pension.