From 1 December 2006, employers must ensure that pension provision for their employees does not breach age discrimination requirements. The Nabarro Pensions team is here to guide you through the minefi eld of the new legislation.
WHAT DOES THE LEGISLATION REQUIRE?
The Employment Equality (Age) Regulations 2006 came into force on 1 October 2006, implementing EU age discrimination requirements in the UK. To give the government time to carry out further consultation on exemptions for pension schemes, the implementation of the pensions aspects of the Regulations was delayed until 1 December 2006. The Regulations require employers and trustees of occupational pension schemes to refrain from unlawful discrimination on the grounds of age when exercising their functions in relation to the scheme. Discrimination can be direct or indirect. Direct discrimination occurs when someone is treated less favourably than a comparable person on grounds of age. Indirect discrimination occurs when an apparently age-neutral provision is applied which in fact disadvantages members or workers of a particular age or age group. Claims for breach of the requirements may be brought to the Employment Tribunal or Pensions Ombudsman.
The Regulations apply only to rights accrued or benefi ts payable for periods of pensionable service on or after 1 December 2006.
EXEMPTIONS FROM THE AGE DISCRIMINATION REQUIREMENTS
When the age discrimination legislation was first introduced, the government intended to allow occupational pension schemes to continue existing practices largely unaffected. The delay in the introduction of the pensions aspects of the Regulations was due largely to the diffi culty of drafting effective exemptions to cover the majority of pension scheme provisions.
The exemptions will allow some, but not all, existing discriminatory practices to continue.
Key exemptions include:
Age-related contributions to money purchase schemes. The aim of the different levels of contribution must be to give comparable members the same or similar resulting benefi ts for comparable periods of pensionable service. In practice, this means that contributions for older members may be higher than for younger members, to refl ect the shorter investment growth periods for older members’ contributions.
Maximum or minimum ages for admission.
Minimum age for drawing benefits.
Length of service conditions - any requirement of over five years must fulfil a business need.
Closure of schemes, or sections of schemes, to new entrants. Imposing an earnings cap (on benefi ts or contributions).
Enhancement of benefi ts on ill health, redundancy and death. The use of age-related factors in actuarial calculations.
Requirements imposed by the Finance Act 2004 or other statutory provisions.
There is some concern that the exemptions in the Regulations are wider than those permitted by the EU Directive. Conceivably, a successful claim could be made against the government that the Directive has not been properly implemented and the exemptions struck down. This note is based on the current form of the exemptions and we have not separately examined what may or may not be exempted under the Directive.
WHICH COMMON PRACTICES ARE NOT EXEMPT?
Many pension schemes require members to stop accruing benefi ts when they reach the scheme’s normal retirement date (often age 60 or 65). There is no exemption allowing this to continue and in our view it may be diffi cult to justify. Consideration should be given to allowing those employees still in service after the normal retirement date to continue as active members of the scheme. This will include providing them with full life cover.
There is an exemption allowing schemes to impose a maximum length of pensionable service. For example, if a scheme includes a rule restricting pensionable service to 40 years, an employee who joined at 20 could be required to cease active membership at 60, whereas an employee who joined at 30 should be allowed to continue as an active member until age 70 (or the date they leave employment, if earlier).
Other practices which may cause problems include:
Non-uniform accrual in defi ned benefi t schemes (for example, accrual at 1/80ths for those under 40 and 1/60ths for those over 40).
Groups of members with “grandfathered” benefi ts. For example, where a scheme has been closed to future accrual for those aged under 55 only.
Ceasing children’s pensions at any age below 23.
If an age-related practice/benefi t rule does not fall within one of the exemptions, it may be retained if it can be justifi ed. For a practice to be “justifi ed”, it must be shown that it is a “proportionate means of achieving a legitimate aim”. A legitimate aim might include business needs, effi ciency or reducing staff turnover. A measure will not be proportionate if an alternative way of achieving the legitimate aim exists that is less discriminatory. Employers are advised to keep records of any consultations, discussions and agreements as evidence of objective justifi cation.
EFFECT OF A NONDISCRIMINATION RULE
Where there is a discriminatory provision in a pension scheme which is not exempt or justifi ed, a non-discrimination rule will be implied into the scheme - overriding the provision and requiring trustees to refrain from doing any act which is unlawful under the Regulations. Pension scheme trustees have power, subject to employer consent where required by the scheme rules, to modify the scheme to ensure it conforms with the non-discrimination rule.
It is generally thought that the effect of the non-discrimination rule will be to make the benefi ts of the less favoured group equal to the benefi ts of the more favoured group until the discriminatory provision is eliminated. For example, if a scheme provided accrual at 1/80ths for those under 40 and 1/60ths for those over 40, all the members would have to be granted 1/60th benefi t accrual from 1 December 2006 onwards. It would be open to the trustees and employer to later modify the scheme to provide for 1/80ths accrual for all, but that change could only take effect in relation to accrual on or after the date of the modifi cation.
AGE DISCRIMINATION ANALYSIS OF BENEFIT STRUCTURE
WHAT HAPPENS IF CHANGES HAVE NOT BEEN PUT IN PLACE BY 1 DECEMBER 2006?
The general effect of missing the 1 December 2006 deadline will be that the employer/trustees will have to equalise up to the most favourable level for the period from 1 December 2006 until the equalisation date. Where non service related benefi ts are provided on a discriminatory basis, the higher benefi t may have to be provided. For example, the higher lump sum death in service benefi t. So the longer any changes are left, the more costly the problem becomes. Initially we understand that the cost implications are unlikely to be too serious, other than possibly in relation to death in service benefi ts. Actuarial advice should however be taken for an assessment of any potential costs.
In practice, failure to amend scheme rules by 1 December 2006 will not matter if the ultimate decision is to equalise up to the most favourable level of benefi ts. However, if it is intended to equalise down to the least favourable level, and this is legally possible under the rules and the Regulations, it is in the interests of the employer to equalise down as soon as possible.
HOW DOES THIS ALL FIT WITH FLEXIBLE RETIREMENT?
One of the key features of the new tax regime for pension schemes from 6 April 2006 was that it would allow fl exible retirement, where an individual may draw all or part of their pension and remain in employment with the same employer. Many employers who are currently considering this option would like to require a member taking fl exible retirement to cease accrual in that scheme, and to offer another arrangement such as a stakeholder scheme. However, this raises the possibility of an indirect age discrimination claim from the fl exible retiree, who could argue that the requirement to cease accrual impacted unfairly on members of their age. It would be open to the employer to seek to argue that as the fl exible retirement option was available only to those within a limited age group it was not discriminatory. Further, the practice might be justifi able on the basis that it would be administratively diffi cult to operate fl exible retirement if employees did not cease accrual (particularly in defi ned benefi t schemes), and that, if the only option was to allow accrual to continue, then the fl exible retirement option would not be offered at all.
However, the alternative of not offering fl exible retirement at all and continuing with existing practice could itself be discriminatory. The argument would be that requiring a member to cease working before drawing a pension would indirectly discriminate against older workers who are more likely to want to draw all or part of their pension, perhaps in conjunction with reducing their hours as they move towards full retirement. So, whether employers choose to offer fl exible retirement, or decide not to, they will have to consider potential age discrimination and carefully document their justifi cation for the arrangements they offer.
WHAT ABOUT PERSONAL PENSION SCHEMES?
The Regulations make it unlawful for employers to discriminate on the grounds of age in relation to the provision of personal pensions for their employees. There are a number of express exemptions, including:
Length of service conditions (any requirement of over fi ve years must fulfi l a business need).
Minimum age for commencement of contributions (and different ages for different groups or categories of worker).
Age-related contributions. As with occupational schemes, the aim of different levels of contribution must be that comparable employees will have the same or similar resulting benefi ts for comparable periods of pensionable service.
Application of an earnings cap on contributions.
It would be open to the employer to justify any discriminatory practices which are not expressly exempt.
HOW CAN WE HELP YOU?
We recommend that all employers and pension schemes carry out an audit of their provisions to assess the extent to which they comply with the Regulations. This will involve a detailed look at the trust deed and rules (as well as any discretionary practices or policies) or other arrangements in order to identify any potential problems. Where a problem is identifi ed, we will consider what arguments might be raised in order to justify it, or whether a modifi cation would be appropriate.