The Pension Schemes Bill which is currently making its way through Parliament implements various strands of the Government’s  workplace pensions revolution. In this article we consider some of the important changes the Bill  will introduce.

Background to the Bill

The Government published its strategy document Reinvigorating Workplace Pensions in November 2012, shortly after the largest UK employers became subject to automatic enrolment.

Given the historic decline in the provision of defined benefit (DB) schemes, many eligible  jobholders who are admitted to a pension scheme through automatic enrolment will find themselves  accruing defined contribution (DC) benefits, whether in trust-based schemes or in contract-based  personal pensions.

In DB schemes, the benefits payable on retirement are fixed by the scheme rules and employers are  responsible for ensuring the cost of those benefits are met. This is now proving too volatile and  onerous a burden for many employers who, as a result, have been closing their DB schemes in recent  years.

In DC schemes, the employer usually pays a fixed percentage of its employees’ salary into the  scheme and whatever income the member gets from the scheme in future depends on the level of   contributions, the investment return and annuity rates at retirement (although changes announced by the Government and taking effect in April 2015 will give members more choice over how to access DC  benefits).

In the strategy document, the Government recognised that many people who are automatically enrolled  into a DC scheme will be uncomfortable with the fact that their future outcome is so uncertain and  that they bear all of the risk instead of the employer. As a result, the Government has been  exploring the option of a third way between DB and DC; one which gives members more certainty of  outcome than in DC schemes but without the cost and volatility for employers associated with DB  schemes.

Detail of the Bill: Defined ambition

Following a consultation in 2013 – Reshaping Workplace Pensions For Future Generations – the  Government published its Pension Schemes Bill 2014 (the “Bill”) in June 2014. Under current  legislation, pension schemes are split between those that are money purchase schemes and those  which are not. A money purchase scheme is one which provides money purchase benefits (the Pensions  Act 2011 amended the definition of money purchase benefits to mean benefits which cannot give rise  to a funding deficit).

The Bill will split private sector schemes into DB, DC and “shared risk” (or “defined ambition”)  schemes. Which category a scheme falls into will depend, broadly speaking, on the level of “pensions promise” which it provides to members. The concept of a  pensions promise is not something which has been defined in UK legislation before now.

DB schemes will be those which pay members a retirement income for life from a fixed pension age  and which include a full pensions promise in relation to the level of that income. DC schemes will  be those which provide no pensions promise at all during the accrual phase as to the level of  benefits payable on retirement (DC schemes will include those providing money purchase benefits as  described above).

Shared risk schemes will be a half-way house between DB and DC; a way of implementing the  Government’s desire to offer schemes which are less of a burden to employers than DB schemes but which offer more certainty to members than DC schemes. A scheme will be shared risk if there is a pensions promise in relation to  some of the benefits which members receive on retirement. Examples include schemes where a promise  is made about the size of the  member’s individual pension pot at retirement and schemes which  provide money purchase benefits but with a guaranteed investment return.

If a scheme provides a mix of benefits in such a way that it does not fall neatly into one of the  three categories, each benefit will be treated as being provided by a separate scheme.

The Government’s intention is not to create a separate legislative regime for each category of  scheme. Instead, requirements such as those relating to communications and governance will be  tailored depending on which category a scheme falls into.

Detail of the Bill: Collective benefits

The Government is also keen to facilitate the establishment of schemes which provide collective  benefits, whether via DC or shared risk arrangements. Collective benefit schemes feature in other  jurisdictions but are not currently possible under UK tax and pensions legislation. The Bill  therefore provides a broad framework enabling schemes to provide collective benefits.

An example of a DC scheme which provides collective benefits is one which pools all of the member  and employer contributions received into one large pot, with benefits on retirement then being paid out of that pot (i.e. members do not  have individual accounts as with traditional DC schemes). In theory, pooling contributions allows  for economies  of scale, a broader range of investment options and the smoothing of investment  returns,  with the outcome for members hopefully being more stable and certain than if they had  their own individual accounts within the scheme. At the same time, employer contributions will be  fixed, which means that if funding levels drop (for example due to poor investment performance) the  targeted level of benefits will be reduced and the employer bears no additional funding risk.

Much of the detail around the  funding and investment requirements for schemes providing collective  benefits will be set out in regulations.

Other provisions

The Bill also contains changes relating to the new flexibilities around DC benefits which the  Government is proposing to introduce from April 2015, the majority of which are covered in a  separate Taxation of Pensions Bill (see here for further details). These provisions include:

  • the framework for the guidance guarantee whereby individuals with DC arrangements will be  offered free and unbiased guidance about the range of options available to them at retirement;
  • new requirements in respect of individuals who seek to transfer out of an existing DB scheme in the private sector to take  advantage of the new flexibilities, for example, to take independent financial advice; and
  • a power to prevent people transferring benefits out of unfunded public sector pension schemes  into DC schemes in order to take advantage of the flexibilities (as the Government is concerned  about the cost to the Exchequer if there is a surge in transfer requests).

Some thoughts..

The Bill may provide opportunities for employers to develop schemes which are more attractive to  their staff than traditional DC schemes but less costly for the employer than DB schemes; this may  give them a competitive advantage in staff recruitment and retention. However, whether there is any  appetite for this amongst employers, given how far the market has already swung from DB to DC, remains to be seen.