In January this year the Department for Work and Pensions published its White Paper “The single-tier pension: a simple foundation for saving”. Initial reception of the main proposals – introducing a single pension at a level higher than the current guaranteed minimum, replacing the current State Second Pension based on an individual’s contribution record over 35 years – focused, perhaps understandably, on the socio-economic impact of what is the biggest shift in State pension design in 35 years.
However, the impact that the changes may have on defined benefit occupational schemes following the abolition of contracting-out are significant and, as always, the devil is in the detail.
Those who were affected by the abolition of contracting-out by means of Protected Rights in 2011 will recall the straightforward methodology that allowed schemes to amend their rules by way of resolution to modify Protected Rights Accounts. The abolition of contracting-out by means of Guaranteed Minimum Pensions is, it appears, likely to create more challenges for schemes and seems certain to be a bumpier ride than was perhaps envisaged by trustees and employers as they followed the debate on State pension reform.
The DWP has chosen a different approach for the abolition of contracting-out through GMPs than was chosen for Protected Rights. Schemes with GMPs will, from the commencement date currently set at April 2016, be treated as having ceased to contract out. That means that accrued GMPs will remain within schemes as specifically identified elements of accrued entitlement. As a result, Schemes may face increased administrative issues presented by ongoing schemes with deferred contracted-out entitlement. In particular, dealing with revaluation, potential restriction of lump sum and transfer payments as well as ensuring that anti-franking legislation is complied with – something that the majority of trustees may not have dealt with before. There will also be particular challenges for those schemes that are integrated with the State schemes through language and definitions which will no longer be relevant after April 2016.
Perhaps of most significance will be the proposed opportunity for sponsoring employers to amend their schemes to take account of the increased employer National Insurance contributions following the cessation of contracting-out. Currently employers enjoy a National Insurance rebate of 3.4% in respect of contracted-out employees. The proposed legislation will give an employer the opportunity to amend the structure of its pension scheme to take account of the additional cost by way, for example, of a reduction in the future rate of accrual or an increase in members’ contributions.
It appears that this opportunity will be offered to employers on a “one off” basis and that it will be sanctioned by overriding legislation – thus potentially nullifying the involvement of scheme trustees regardless of how the balance of powers is held within a scheme’s amendment power. Whilst further details are to follow, it seems clear at this point that the decision to move to a single tier pension will bring about some interesting and challenging, and perhaps unexpected, issues for employers and trustees of occupational schemes.
This article was originally published by Professional Pensions.