From 6 April 2016, schemes will no longer be able to contract out of the state second pension on a defined benefit basis. In our September Pensions Newsletter we reported on a number of changes being introduced by the Government to deal with the abolition of defined benefit contracting out. Those changes include additional powers to allow employers to amend their scheme rules and the introduction of various protections in respect of contracted-out rights built up prior to 6 April 2016.
In a recent consultation, which closed on 16 November 2015, the Government set out further proposed changes dealing with issues such as transfers, changes to the disclosure requirements and a raft of consequential changes. In this article we highlight some key points from the Government’s latest instalment of proposed changes.
References in this article to a “contracted-out scheme” are references to a scheme contracted out on a defined benefit basis.
Currently, transfers of contracted-out rights are broadly permitted (subject to prescribed conditions being met):
- with the written consent of the member, to any scheme (including an overseas scheme or a scheme which is not, and has never been, a contracted-out scheme); and
- without the consent of the member, to a scheme which is or was a contracted-out scheme where:
- the transferring scheme and the receiving scheme apply to employment with the same employer or a connected employer; or
- the transfer is part of a financial transaction.
(For example, a transfer which is part of a merger or demerger of group pension schemes or part of a business sale.)
Under the proposed changes the ability to transfer contracted-out rights will largely be preserved. However, the ability to transfer without the consent of the member will be limited to transfers between schemes which were previously contracted out. This is because from 6 April 2016 it will no longer be possible to establish a new contracted-out scheme or section to receive transfers of contracted-out rights without member consent.
This may cause issues for employers involved in the restructuring of group pension provision or those looking for a pensions solution as part of a business transaction. The options available to them would appear to be:
- obtaining the consent of relevant members;
- leaving the contracted-out element of members’ rights in their existing scheme; or
- ensuring any transfer of contracted-out rights is made to a scheme which was previously contracted out on a defined benefit basis.
We await the Government’s response to these concerns. If it does recognise the need to build in an additional mechanism to facilitate transfers without consent to schemes which have never been contracted out, it is expected that such transfers would be subject to the protection of members’ contracted-out benefits in the receiving scheme.
It is proposed that with effect from 6 April 2017, a year after the abolition of contracting out, the disclosure requirements will be amended to remove the requirement to notify members and prospective members of which employments covered by the scheme are, and which are not, contracted out. This information is typically provided in scheme booklets.
A change to contracted-out employment is a material change which must be notified to members and others under the disclosure requirements either in advance of, or as soon as possible after, the change taking place but in any event within three months of the date of change. Therefore, contracted-out schemes will need to notify relevant members that their contracted-out employment will, or has, come to an end by 5 July 2016 at the latest.
Additional disclosure requirements may apply where amendments are to be made to scheme rules to take account of the abolition of contracting out (for example, where there is an increase in employee contributions or a reduction in accrual rates).
It is proposed that an employer with a scheme which currently meets the automatic-enrolment quality requirements by virtue of being a contracted-out defined benefit scheme will be required to retain a copy of its contracting-out certificate for six years after the abolition of contracting out.
Further changes and clarification
This latest set of proposed amendments is not the end of the story.
The Government has indicated that in its response to this latest consultation it will communicate the outcome of the reference scheme test underpin issue (that is, how best to preserve the position of defined contribution schemes with reference scheme underpins). There will also be further consultation in respect of protecting contracted-out rights where amendments to scheme rules are proposed and the pensions tax rules in respect of trivial commutation.
It therefore looks increasingly likely that employers and trustees of contracted-out schemes will have to consider legislative amendments and clarifications right up to the date of abolition.