The Department for Work and Pensions (DWP) has recently confirmed the changes it will make to pension protection on TUPE transfers, following proposals it put forward over a year ago.

The changes are due to take effect on 6 April 2014 and will only affect contributions to defined contribution schemes.  The existing requirements for defined benefit schemes remain unchanged.

A new option on TUPE transfers

In February 2013, the DWP issued a consultation document setting out its proposals to change the minimum pension protection for employees transferring to a new employer pursuant to the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE).

Currently where employees participate or have a right to participate in an occupational pension scheme, employers receiving such employees on a TUPE transfer (known as “transferee employers”) are required as a minimum to provide either:

  • Option 1:   Membership of a contracted-out defined benefit scheme which meets the reference scheme test or a defined benefit scheme under which the value of the benefits is at least 6% of pensionable pay for each year of employment OR
  • Option 2:   Membership of a defined contribution occupational pension scheme or a stakeholder scheme under which the transferee employer will pay matching contributions up to 6% of pensionable pay.

Following a lengthy consultation process, the DWP had decided to introduce a third option, namely:

  • Option 3:   Where the transferring employer has been required to make contributions, and these were solely for the purpose of producing money purchase benefits, the transferee employer can choose to contribute an amount not less than the amount the transferring employer had been required to contribute.

Reason for the new option

The primary aim behind the change is to address the perceived imbalance created by existing legislation. In particular, under Option 2, a transferee employer would as a minimum be required to provide a defined contribution scheme with 6% matching contributions to the transferring employees, even if the rate the transferring employer was required to contribute to its scheme pre-transfer was less than 6%. This could result in the transferee employer having to pay a higher rate of contributions. The introduction of Option 3 is intended to prevent transferring employees from benefitting from such an automatic uplift of contributions.

This imbalance has been exacerbated by the interaction of the pension protection requirements on TUPE transfers and automatic enrolment. The minimum level of contributions paid for existing staff of the transferee employer to comply with its auto-enrolment duties may be lower than the matching contributions the transferring employees would be entitled to receive under Option 2. 

For example, if the transferee employer has chosen to pay minimum contributions for auto-enrolment purposes for existing staff (broadly an employer contribution of 1%), it could be required to increase its contributions to 6%, post-TUPE transfer, for those individuals TUPE transferred.

However, the new Option 3 will not entirely eradicate any mismatch with auto-enrolment obligations as is explained below.

Scope of the new option

Option 3 will only be available where the transferring employer has been required to make contributions to a scheme. This could be as a function of the transferring employer having passed its staging date for auto-enrolment purposes or, for example, under a contractual obligation to make contributions to a scheme.

Also the new option can only be utilised by the transferee employer where the contributions by the transferring employer prior to the TUPE transfer were made solely for the purpose of producing money purchase benefits. The option is therefore not available where transferring employees are, or are entitled to be, members of a defined benefit scheme prior to the TUPE transfer.

From 6 April 2014 the transferee employer will need to make appropriate enquiries of the transferring employer, in order to understand whether Option 3 is available to it.

Potential issue not addressed by the new changes

Risk of creating a two-tier workforce

Even with the new Option 3 available, there could still be a discrepancy between the transferee employer’s existing auto-enrolment arrangements and the arrangement to be used for those employees being TUPE transferred.

Broadly, employers can use any of the following methods of calculating contributions in order to certify that their scheme meets the minimum auto-enrolment requirements:

  • “Qualifying Earnings” (including bonuses, commissions, overtime etc) between £5,772 and £41,865;
  • Tier 1 certification, based on “pensionable pay”, which must be at least equal to “basic pay”;
  • Tier 2 certification, based on “pensionable pay”, which must be at least 85% of total earnings; and
  • Tier 3 certification, under which all earnings are pensionable.

Importantly, the actual percentage contributions payable under each method differ from one to another.  For example, if:

  • the transferring employer uses the Tier 1 certification test as the basis of its auto-enrolment scheme, the minimum employer contribution is currently 2% of basic salary; and
  • the transferee employer uses “Qualifying Earnings”, the minimum employer contribution is currently 1% of “Qualifying Earnings”,

on the face of it there will be a discrepancy between the contributions paid for existing employees with the transferee employer and those inherited on the TUPE transfer.

Options available to transferee employers

Where such a discrepancy exists, transferee employers will have the following choices available when deciding on the pension provision for transferring employees:

  • Operate a dual certification system for auto-enrolment purposes, under which existing employees are automatically enrolled under the method already used by the transferee employer and transferring employees are automatically enrolled under the method used before their TUPE transfer.
    • This will involve additional administrative processes as a result of using two different certification methods (including the likely need to amend any auto-enrolment certificate).
    • Payroll systems will need to be adjusted to ensure the appropriate method is applied to each employee.
    • A “two-tier workforce” will still exist in respect of the pension provision being made for the existing employees and those transferring employees.
  • Make pension provision for the transferring employees on the same basis as for existing employees with the transferee employer.
    • In order to do this the transferee employer must satisfy itself that contributions in respect of transferring employees would be at least equal to the money purchase contributions made in respect of them before their TUPE transfer. This may be a relatively complex and time-consuming process and would need to be factored into the timetable for the TUPE transfer.
  • Use Option 1 or Option 2 for transferring employees.
    • This would still result in a “two-tier workforce” and would likely cost the transferee employer more when compared with using Option 3.

It may also be possible for a transferee employer to reach an agreement with transferring employees to “contract out” of the statutory requirements on pension provision by, in effect, seeking their agreement to a change in contractual terms. Legal advice should be sought if this option is being considered.