Schemes that were contracted-out on a salary-related basis until contracting-out was abolished last year may need to take action by 5 April 2017 in relation to their GMP revaluation rules.

Background

Before 6 April 2016, the state pension had two components – the basic state pension and an additional earnings-related top-up (called the state second pension). Where an employer provided membership of an occupational pension scheme that met certain minimum requirements, they could contract members out of earning the state second pension.

From 6 April 2016, a new single tier state pension was introduced, which is not separated into basic and additional pension components. As there is no longer a separate state second pension, contracting-out ceased to be an option.

Contracted-out pension rights accrued prior to 6 April 2016, including guaranteed minimum pensions (“GMPs”), remain in existence and subject to rules that are broadly equivalent to those that previously applied to contracted-out rights.

GMP revaluation for members remaining in pensionable service after 5 April 2016

Before 6 April 2016, the contracting-out legislation provided that while a member remained in contractedout service, his or her accrued GMP had to be revalued each year by the rate specified in an order made for that year under s148 Social Security Administration Act 1992. (This is known as “s148 revaluation”.) However, where a member ceased contracted-out service prior to GMP age, the scheme had a choice – it could either continue to apply s148 revaluation, or it could switch to revaluation by a fixed annual percentage which remains unchanged until the member’s GMP starts (known as “fixed rate revaluation”).

From 6 April 2016, the contracting-out legislation was changed for members whose contracted-out service ended on that date solely because contracting-out was abolished, but who remained active members of the scheme. For them:

• legislation requires s148 revaluation to continue until the member actually leaves pensionable service; and

• any switch to fixed rate revaluation can occur only when the member’s pensionable service ends.

This change to the law creates a potential problem for schemes if:

• they were contracted-out until the abolition of contracting-out;

• on 6 April 2016 they still had active members with accrued GMPs;

• they revalue deferred members’ GMPs on the fixed rate basis; and

• their rules reflect the pre-6 April 2016 statutory requirements about when fixed rate revaluation starts. (In our experience, most schemes’ rules do.) 

This is because, in those cases, the scheme rules effectively provide for those members’ GMPs to be revalued on the fixed rate basis starting from 6 April 2016 (because that is when those members’ contracted-out service ended), while legislation requires the same GMPs to be revalued on the s148 basis until the member eventually leaves pensionable service. In effect, there could be double-counting for the period from 6 April 2016 until the member leaves pensionable service, with members being entitled to whichever of fixed rate revaluation and s148 revaluation gives them the bigger benefit.

Schemes in that position should therefore amend their rules to ensure that the rules reflect only the new statutory provisions for those members who leave service after 6 April 2016 to avoid giving those members an unintended windfall.

Some schemes may be able to make those amendments using their own amendment power, but others will not. All schemes therefore have a new statutory power, exercisable by trustees, to change their rules to ensure that only the new statutory GMP revaluation rules apply to members leaving service on or after 6 April 2016. The power is exercisable by trustee resolution, and must be exercised no later than 5 April 2017. But if amendments are made by then, they can operate with retrospective effect from 6 April 2016.

Action required

Trustees of schemes that are potentially affected by this double-counting issue should:

• ask their legal advisers to confirm whether they are affected and therefore need to amend their rules; and

• if a rule amendment is required, ensure that the necessary trustee resolution is passed by 5 April 2017.