Whilst contracting-out on a defined benefit basis will be abolished in April 2016 when the single tier state pension is introduced, accrued contracted-out rights will continue to exist. This means that in advance of April 2016 DB schemes will need to ensure that they are ready to administer those rights in accordance with the appropriate statutory requirements.

In May 2014 the DWP published a consultation about this issue, and last week the response to that consultation and the final form of the Occupational Pension Schemes (Schemes that were Contracted-out) Regulations 2015 (Regulations) were published.

An overview of the Regulations

Many provisions of the existing regulations about administering contracted-out rights - the Occupational Pension Schemes (Contracting-out) Regulations 1996 (Existing Regulations) - will be revoked and replaced by the Regulations. The Regulations aim to ensure that members' existing entitlements are preserved and make provision to ensure the appropriate operation of formerly contracted-out schemes. For example, the Regulations cover issues including the following:

  • Restrictions on the alteration of accrued rights
  • Restrictions on the circumstances in which contracted-out rights can be paid as lump sums
  • The payment of GMPs to widows, widowers and surviving civil partners
  • Revaluation of GMPs, and
  • Suspension and forfeiture of GMPs.

Whilst the general position is that the Regulations mirror certain requirements of the Existing Regulations, it will be important for schemes to ensure they have regard to any changes to the existing requirements on administering contracted-out rights.

  • For example, one of the circumstances in which the Existing Regulations state that a scheme may provide for forfeiture of any payment of a GMP is where it has been at least six years since payment became due and a claim has not been made for it, but in the Regulations the period is eight years.  
  • As reported further below, in some cases, the provisions of the Existing Regulations have been replicated for now but amendments may follow.

Savings Order

The Pensions Act 2014 (Savings) Order 2015 was also made last week. This Order preserves certain provisions of the Pension Schemes Act 1993 relating to contracting-out until 6 April 2019. The purpose of this is to require or allow schemes and HMRC to carry out necessary tasks relating to a period of contracted-out employment which occurred before 6 April 2016.

Likewise, the Regulations do not revoke all of the provisions of the Existing Regulations and some provisions will remain in force until 6 April 2019. For example, provisions relating to the issue, variation and surrender of contracting-out certificates remain in force to enable HMRC to issue certificates relating to a period before 6 April 2016 and to deal with any variation or surrender of certificates which is to take effect before that date.

Further consultation and regulations

The Regulations will not be the only legislative changes that schemes will have to consider. The response to consultation highlights some particular areas which will be the subject of further consultation and regulations.

A consultation is expected later this year on consequential changes, for example, to the regulations that deal with the transfer of contracted-out rights, and the disclosure regulations.

Some respondents thought that the wording of the draft version of the Regulations about the alteration of scheme rules in relation to post-6 April 1997 contracted-out rights provided more generous benefits and a higher level of protection than the Existing Regulations. The DWP recognises that it did not fully explain the changes proposed in the draft version and the policy behind them and therefore the terms of the Existing Regulations have been replicated in the Regulations but the DWP plans to re-consult on proposed amendments in due course.

Various issues were raised about when a GMP can be paid as a lump sum, for example, how certain provisions on trivial commutation fit with the way trivial commutation is dealt with in HMRC legislation. Given the technical nature of issues raised, this is another area in respect of which the DWP has replicated the requirements of the Existing Regulations for now, but will consider the points raised and consult on appropriate changes in due course.

There was some concern from respondents that if a DC scheme is contracted-out on a DB basis operating a Reference Scheme Test underpin and the scheme rules simply refer to the relevant legislation, that the draft version of the Regulations would not preserve this underpin. The DWP states that it initially thought that saving certain provisions of the Pension Schemes Act 1993 would be sufficient but the issue is more complex and therefore the DWP needs more time to develop a solution. For now, and until the DWP is able to resolve the matter, certain provisions of the Pension Schemes Act 1993 are being preserved but the DWP will revisit this issue.

Other rule amendments

As well as looking at the requirements for administering accrued contracted-out rights, the May 2014 consultation stated that the Government was considering whether a statutory power should be provided to enable trustees to modify their scheme rules by resolution to take account of the legislative changes. A consultation question asked what changes trustees will be obliged to make to ensure their scheme rules continue to have the same effect as a result of the abolition of contracting-out and the introduction of the single tier state pension.

The DWP reports that generally responses focused around wanting a power to modify scheme rules which make reference to Basic State Pension or integrated schemes (which the response states are also known as 'bridging pensions' or 'clawback pensions'). Respondents who have integrated their benefit structure with the State scheme wanted to ensure that members do not gain or lose out as a result of the changes to State Pension.

The DWP has concluded that a statutory power to modify scheme rules to reflect the reform of State Pension is not required. The DWP notes that:

  • For those who reach State Pension age on and after 6 April 2016 the Basic State Pension will be replaced by the new State Pension, and 
  • For those who reach State Pension age before 6 April 2016 the value of the Basic State Pension will remain and will be published each year after abolition in annual uprating orders and this will be the amount of Basic State Pension to be taken into account. 

The fact that a Basic State Pension figure will continue to be produced beyond 6 April 2016 is useful and may help to limit the extent of the amendments that need to be made to scheme rules that incorporate this definition into the benefit structure.

Conclusions and next steps

Trustees will need to consider whether any rule amendments will be needed to reflect the requirements that will apply from 6 April 2016 about administering accrued contracted-out rights, as well as the fact that no further contracted-out rights will accrue from 6 April 2016, and that for those who reach State Pension age on and after 6 April 2016 the Basic State Pension will be replaced by the new State Pension. Trustees will also need to ensure that any necessary updates are made to their administrative processes and member communications.

There are other issues that employers and trustees will also need to consider and address in advance of the end of contracting-out, such as whether any benefit changes will be made to offset the increased National Insurance cost and reconciling GMP data with HMRC records. We will be issuing a further Pensions Alert which brings together the key considerations on the different aspects of the end of contracting-out in one place.