Currently, members of occupational pension schemes who leave having completed under two years’ qualifying service may have the option of a refund of their contributions (known as a short service refund). However, from 1 October 2015, occupational money purchase pension schemes and other occupational pension schemes where all of a member’s benefits are money purchase will generally only be able to make refunds in respect of such a member within the first 30 days of qualifying service – rights will effectively vest after 30 days. Scheme rules, communications and administration processes may need to be amended to reflect this change.
In the run up to the introduction of auto-enrolment, the previous government sought to understand the factors that would influence employers’ scheme choice. Its 2011 Call for Evidence concluded that a key difference between occupational (trust based) and contract based schemes was the ability for occupational schemes to offer short service refunds, whereas personal pension schemes may not.
The DWP estimated that around 20,000 short service refunds were taken from money purchase schemes in 2013, and that number is likely to have grown significantly since the broader roll out of auto-enrolment. If a refund is taken, the member generally only receives his own contributions back (employer contributions remain in the scheme and can be used towards scheme costs).
The government considered that this ran counter to its aim of increasing pension savings and in December 2011 it announced its intention to abolish short service refunds. It passed legislation to do so (section 36 of the Pensions Act 2014) three years later. This provision, which comes into effect on 1 October 2015, reduces the two year qualifying service limit for refunds in respect of money purchase benefits to 30 days. This links with the auto-enrolment opt-out period and the FCA’s cooling off period for personal pensions. It was also designed to fit in with the “pot follows member” proposal, under which certain money purchase pots worth £10,000 or less would transfer automatically when a member switched jobs – with the first phase due in autumn 2016, it is still unclear whether the current government will take this proposal (of the previous government) forward.
What schemes and members are affected?
This is not an immediate “across the board” change. Note in particular that:
- short service refunds are not available in relation to personal pension schemes, so there is no change there,
- defined benefit occupational pension schemes (that do not provide money purchase benefits) are not affected,
- the abolition is only mandatory for members whose qualifying service starts from 1 October 2015, so members who join before that date may still be offered a short service refund (potentially up to the end of September 2017), and
- the change applies where all of a member’s benefits under the scheme are “money purchase benefits” within the new statutory definition. So where there is, for example, a defined benefit underpin or defined benefits held within another section of the same scheme, it may still be possible to pay a short service refund in respect of periods of service longer than 30 days.
Interaction with auto-enrolment opt-outs
The new maximum 30 day refund period was designed partly to tie in with the opt-out window for auto-enrolment. The interaction between the two legal regimes is not always clear, however.
Under auto-enrolment legislation, where a member is auto-enrolled into a scheme and then opts out within the one month opt-out window, he is entitled to a refund of contributions and is treated “for all purposes” as never having become an active member of the scheme. In many cases, the member will opt out within 30 days of the date he becomes an active member, which ties in neatly with the change to short service refunds. However, there could be circumstances where the opt-out window does not start running until some time after a member has more than 30 days’ qualifying service for the purposes of the short service refund test. This is because of the way in which the start of the opt-out window is triggered under the auto-enrolment legislation. The outcome here may be that the member is entitled to a refund of contributions in respect of more than 30 days’ pensionable service (since the obligation arises under separate legislation). We have raised this issue with the DWP for clarification.
Unlike some other recent pensions law developments, there has been a reasonable lead time for this change. Trustees, employers and administrators need to ensure it is not forgotten in the rush to react to other changes.
Money purchase occupational pension scheme rules and other occupational pension schemes which provide only money purchase benefits for some members should be reviewed as soon as possible because they may need to be amended. This will depend, among other things, on whether benefits provided are technically “money purchase”. This is a particularly complex area, so legal advice should be sought if there is any doubt. It will also depend on what the scheme rules say about preservation requirements (these are the benefits occupational pension schemes must by law provide for early leavers) and in particular whether the rules “hardwire” the current two year timescale for short service refunds.
Technically, the preservation laws do not override conflicting scheme rules, although trustees are obliged to comply with them (ie preserve money purchase benefits for members with more than 30 days’ qualifying service). So, failure to amend scheme rules to reflect the new law could result in an unsatisfactory conflict between what a member is entitled to under the scheme rules (ie a refund) and under the post-October 2015 preservation legislation. It could also lead to tax issues.
Member communications and administration procedures should also be reviewed. Generally, the employer contribution element of the short service refund stays in the scheme, so this could have cost implications for employers, particularly those with a high turnover of employees. Employers should therefore consider whether they can use the retained employer contribution element towards scheme costs.
Dealing with multiple small pots may lead to increased administration costs, particularly if the current government does not pursue the previous government’s “pot follows member” proposal (under which small money purchase pots would transfer out automatically when an individual moves to a new job). This will be an added incentive for affected employers to look at options, such as small pot commutation exercise, for reducing these costs.