Many employers that operate defined benefit occupational pension schemes are considering ways to reduce costs relating to those schemes.

Employers often wish to make all or part of future noncontractual pay rises non-pensionable, or make the pay rise pensionable only on a restricted basis. For example:

  • only part of the increase is pensionable; 
  • it is pensionable for future service only; or
  • it is pensionable at a reduced accrual rate.

This briefing considers the approach employers may wish to take when considering making non-pensionable pay rises and suggests how some common pitfalls may be avoided.

Do the pension scheme trustees need to consent to the change?

There are two broad approaches open to employers wishing to implement changes in relation to the pensionability of pay rises:

  • obtaining the pension scheme trustees’ consent; or 
  • entering into a contractual agreement with employees outside the pension scheme (followed by a confirmatory amendment to the scheme rules).

Pension scheme trustees may be reluctant to become involved in changes relating to pay, viewing it as part of the employee’s benefits package that is more appropriately negotiated directly between the employer and its workforce. They may also be constrained by restrictions in the scheme’s amendment power

The second approach outlined above is helpful in these circumstances. This follows a principle established in the case of South West Trains v Wightman. The union had agreed with the employer as part of a collective bargaining process that only part of a pay rise would be pensionable and that it would be pensionable for future service only. An employee argued this was not binding on the pension scheme (because the definition of pensionable pay in the scheme rules included pay rises). The High Court decided that the employees could not seek pensions at a higher rate than agreed and that the trustees were obliged to amend the scheme to reflect the ‘binding pensions agreement’ between the employer and employees.

Avoiding pitfalls 

  1.  Check contracts of employment

Employees may have an express or implied contractual right to be members of the pension scheme or even that pay rises should be pensionable.

Whether a benefit is contractual will depend on the wording of the particular contract of employment. The general rule is that benefits promised to employees will be contractual, unless the employer clearly states that they are discretionary, ex gratia or merely a statement of intent.

Even if employees do not have an express right to a pay rise, it could be argued that there is an implied contractual obligation on the employer to provide a particular level of pension benefit as a result of custom and practice.

  1. Ideally, obtain express employee agreement

In terms of legal challenge, the safest option is to obtain express employee consent to the change proposed. Express agreement will be required if the employee has a contractual right to a pensionable pay increase.

The issue of whether a pay rise is pensionable may be the subject of collective bargaining. If so, it is important to ensure that there is clear evidence of agreement. The agreement does not have to be documented but it is usual and good practice to do so (and, of course, helps to avoid dispute later over the terms of any agreement). For such agreements to be binding on individuals, the individuals’ contracts of employment must incorporate the terms of the collective agreement.

  1. If express agreement is not possible, ensure there is effective implied agreement

Generally, member consent is unlikely to be implied just because employees continue to work after a pension change has been announced. However, if a pay rise is given to which the employee does not have a current contractual entitlement on the express basis that it is non-pensionable, the employee is not able to take the rise and claim that it is pensionable. There has been a decision expressly on this – NUS Superannuation v Pensions Ombudsman, which is supported by the House of Lords’ decision in Tibbals v Port of London Authority. It may be helpful to allow employees an opt-out option or offer a default position if they do not agree to the change.

  1. Ensure all communication is clear

Any communications with employees should make clear the pensionable (or otherwise) basis of future pay increases. Care should also be taken to ensure that no later communications contradict this approach. 

  1. Have good reasons for the decision (and document them)

Employers should not propose changes over pensionable pay without good reason. They owe an implied contractual duty of mutual trust and confidence to their employees. This means that they owe a duty of good faith (ie broadly a duty not to act in a way that is arbitrary or capricious or in which no reasonable employer would act).

This does not mean that an employer cannot act in its own interests but it will need to consider carefully the impact of the proposed changes and aim to be able to defend them as proportionate and reasonable. Documentation showing it has acted for valid commercial reasons and considered all available options will be helpful. Employers should also avoid giving a blanket refusal to offer pay rises.

  1. Involve trustees from an early stage

Even if the trustees are not to be asked for their formal agreement to the changes, it is sensible to involve them from an early stage in the process. This will help avoid difficulties later – for example, if they are unconvinced of the existence of the contractual agreement between the employer and employees.

Trustees are likely to seek assurances from the employer over the contractual nature of the agreement, including seeking explicit confirmations, presentations from the employer or documentary evidence. 

  1. Operate a thorough consultation process

Although it is not entirely clear whether the statutory 60-day consultation process applies to proposals to make future pay rises non-pensionable, employers are likely to want to consult as a matter of good practice.

The Occupational and Personal Pension Schemes (Consultation by Employers and Miscellaneous Amendment) Regulations 2006 (the Consultation Regulations) specify that the consultation obligations apply if an employer makes a listed change, including a proposal ‘to change, in whole or in part, the basis for determining the rate of future accrual of benefits under the scheme…’

A change in pensionable pay may arguably be a change in the determination of the rate of future accrual. Our view is that it is probably not strictly a listed change, because the Consultation Regulations refer to a change in the ‘rate’ and not, for example, the ‘amount’ of future accrual, but this has not been tested.

Although there are only very limited formal sanctions that can apply to a breach of the Consultation Regulations and they expressly confirm that the change will be effective, even if the consultation process is not followed, the pension scheme trustees may not be prepared to operate the pension scheme on the basis of the agreement between the employer and employee if they are not satisfied that a proper consultation process has been followed.

Obviously, the safest course is to consult. This may also draw out any potential concerns or even legal challenges (eg based on contractual terms or past practice). 

  1. Ensure adequate record keeping

If non-pensionable pay rises are awarded, it is essential for human resources to maintain proper records of the pensionable and non-pensionable aspects of employees’ remuneration and make them available to pension scheme administrators