The Pensions Act 2014 (PA 2014) has now received Royal Assent and will bring large innovations to the state pension system, private pension schemes and most notably the abolition of salary related contracting-out. This note reviews the main elements of the PA 2014, together with the Department for Work and Pensions’ (DWP) consultation in relation to the draft regulations relating to the introduction of the single-tier state pension.

Abolition of salary-related contracting-out

From 6 April 2016, employers who sponsor salary-related pension schemes will no longer be able to contract their employees out of the state second pension (S2P). To reduce the financial impact of the abolition (the contracted-out rebate currently reduces employer NICs by 3.4% and employee NICs by 1.4%), there will be an overriding statutory power to enable employers of contracted-out schemes to amend their scheme’s rules to alter a member’s future accrual rates or increase employee pension contributions. 

This overriding power may be used without the trustees’ consent, however, it is subject to certain restrictions and will only be available for five years from 6 April 2016. For example, it cannot be used to increase total annual employee contributions beyond the annual increase in the employer’s NICs in respect of them; to reduce the amount of the members’ benefits that accrue annually being no more than the annual increase in the employer’s NICs in respect of them; an actuary must certify that the amendments comply with the statutory requirements; and the power will only apply to future benefits and cannot be used in a way that may adversely affect members’ or survivors’ subsisting rights.

The statutory requirement to consult affected members when a proposed amendment involves a ‘listed change’ will continue to apply. The consultation regulations will, however, be amended to reflect the fact that a scheme terminating its contracting-out status is simply a necessity due to Government policy and that there is therefore no need to consult with affected employees.

It is also noteworthy that the overriding statutory amendment power may not be used in relation to public sector schemes or apply to ‘protected persons’. These being employees of private sector employers who were members of pension schemes associated with their former nationalised employers. Only employees who received legislative guarantees on privatisation, rather than solely a guarantee reflected within the scheme rules, are protected. However, the DWP has warned that these employers are often working in price-regulated industries and the costs of the increased NICs may resultantly be passed on to consumers, should there be no relaxation to permit these employers to amend the schemes.

DWP consultation on draft regulations

This month the DWP published consultation on The Occupational Pension Schemes (Power to amend schemes to reflect abolition of contracting-out) Regulations 2014 (draft), which relate to the abolition of defined benefit contracting out. 

The regulations contain detailed provisions in relation to the statutory overriding power of amendment, and specifically how the actuary is to calculate and certify the value of the proposed amendments. They provide that there will be:

  • A prescribed form of actuary’s certificate given before any proposed amendments are made;
  • The date of the actuary’s calculation may be any date from 31 December 2011 and it is envisaged that this will allow schemes to use their last triennial valuation;
  • The actuarial calculations should be based upon the statement of funding principles, however they may be adjusted to remove any prudence;
  • Schemes may be amended more than once using the statutory override if the amendments failed to fully recoup the employer’s increase in NICs;
  • The regulations do not apply to scheme contributions made by salary sacrifice;
  • The trustees have a duty to provide the employer with information requested in connection with the power within four weeks of any request; and
  • The exclusion of protected persons (as discussed above).

A second set of regulations deals with the rules which schemes that were contracted-out will need to comply with following the abolition of contracting-out in April 2016. The key issues being consulted upon in relation to The Occupational Pension Schemes (Schemes that were contracted-out) Regulations 2014 are:

  • A large proportion of the 1996 regulations will be revoked, however certain provisions will remain in order for HMRC to provide contracting-out certificates prior to the abolition of contracting-out and to deal with the variation or surrender of certificates prior to April 2016;
  • The protection of accrued contracted-out rights; and
  • The retention of the contributions equivalent premiums.

State pension reform

The single-tier state pension will be introduced from 6 April 2016 and will replace the basic state pension and the S2P. The changes will result in:

  • There being a flat-rate payment set above the basic level of means tested support, which is currently £142.70 per week and will be uprated at least by the average increase in earnings;
  • The eligibility for the full rate will require 35 qualifying years of NICs, whereas currently the full category A basic state pension is available following 30 years of contributions. Individuals with less than 35 years’ contributions will receive a pro-rated amount, however subject to meeting the minimum requirements, which will not be in excess of 10 years’ NICs;
  • It will not be possible to inherit or transfer a single-tier pension from a spouse or civil partner; and
  • The single tier state pension will apply to individuals who reach their state pension age on or after 6 April 2016, however transitional arrangements will allow individuals’ pre-implementation NICs record to be recognised on implementation, and also enable those who have been contracted-out to build up to the full single-tier weekly pension.

The increase of state pension age to 67 will also be accelerated by eight years, together with a new structured framework for periodic reviews for future increases.

Private pension scheme reform

The PA 2014 also contains a number of changes to private pension schemes, including:

  • The automatic transfer of small defined contribution pension pots of less than a specified amount, which is likely to be around £10,000, when employees change employment. This measure is a result of the Government anticipating that there will be a large number of individuals with small pension pots with disparate employers following auto-enrolment.
  • The Government was concerned that following auto-enrolment there may be a number of members who regularly change employers and will consequently take a refund of contributions if they leave with less than two years’ pensionable service. The PA 2014 effectively results in a 30-day vesting period for short-service benefits in relation to all money purchase schemes, whereas this was previously two years. It is expected that this overriding provision will come into force in the near future and it will only apply to individuals who become members of a scheme following the date of introduction. Whilst an overriding amendment, it is advisable to update scheme rules and booklets accordingly.
  • The Pensions Regulator (tPR) will have an additional statutory funding objective to “minimise any adverse impact on the sustainable growth of an employer.” This objective will be solely in respect of tPR’s functions under the scheme funding regime and will result in a new Code of Practice on scheme funding and the adoption of a new policy on defined benefit funding.
  • Incentive exercises intended to encourage members to transfer their rights from a salary-related occupational pension scheme will be prohibited under a regulation making power. If brought into force this will be wider in scope than the current restriction on cash incentives.
  • The PA 2014 provides for regulations to be passed which exclude certain categories of employee from automatic enrolment. It is unclear when these regulations will come into force, however they are likely to exclude members who have registered for tax protection from a lifetime allowance charge; those who are working a notice period with their employer; and individuals who have told their employer before their employer’s staging date that they intend to retire and take benefits from a defined contribution scheme.
  • The reforms will enact the DWP’s statement that the PPF compensation cap should be increased. The current cap will continue, however, there will be a long-service cap to apply an extra three per cent of that cap for each year of service above 20 years, with a limit to the increase to double that cap. This increase will apply to any scheme that begins to wind up or enters the PPF assessment period after the revised cap is introduced. Whilst this provision has not yet come into force, it should be considered when assessing a scheme’s liabilities for PPF or winding-up purposes.