Changes to State pensions and the abolition of contracting-out for open defined benefit schemes may result in more changes to schemes

The Government’s flagship measure of a new, flat rate, single tier pension, and changes associated with increasing the state pension age (SPA), have implications for open defined benefit pension schemes. Trustees and employers will need to assess the implication of these changes on their schemes, and possible scheme amendments.

To assist trustees and employers, the Government has introduced legislation and consulted on draft regulations.

Costs: consultation

The Pensions Act 2014 confirms that on 6 April 2016, employers will no longer have the option to contract their employees out of the additional state pension on a salary related basis.

This will have cost implications for employers who currently have a contractedout defined benefit pension scheme which is open to accrual. Employers’ national insurance contributions (NICs) will increase by 3.4% (of relevant earnings) and employees’ NICs by 1.4%. The Government has recognised the additional costs for employers, and the Act includes a power to enable employers to amend scheme rules, without trustee consent, to reduce scheme costs in order to offset the increase in NICs when contracting out ends.

The statutory modification power can be used in limited circumstances, such as to increase employee contributions or to reduce future accrual of benefits subject to certain conditions. The power will be available for a limited period of five years. However, amendments using this power can only be made to a level required to offset the increase in NICs, and an actuary must provide a certificate confirming that this is the case.

The Government has consulted on draft regulations relating to the modification power. These contained provisions regarding the calculations actuaries will be required to make, how they should do so, and what certification is required when using the power. The draft regulations provided for: • how the power applies to multi-employer schemes; • how the power can be used to amend a scheme in relation to some or all members, and in relation to current and future members; • the duty that trustees will have to provide information that employers require in order to exercise the power, within four weeks of the employer’s request.

The consultation period ended on 2 July 2014 and a response is expected. To give employers time to prepare for the cessation of contracting-out, the statutory modification power is expected to come into force in autumn 2014. Sponsors of contracted-out defined benefit schemes should start considering and planning (if they have not already done so) for the abolition of contracting-out.

SPA and bridging pensions

Some defined benefit schemes pay a higher pension initially (a “bridging pension”) and then reduce the pension at SPA, to reflect state benefits coming into payment. As SPA increases, this may have the unintended consequence of a bridging pension being paid for longer than was intended (creating funding implications), or members may experience a reduction in their total retirement income.

The specific wording of a scheme’s governing documentation should be checked to assess the terms for bridging pensions and to determine whether amendments are required. The scheme rules may refer to bridging pensions being paid to the commencement of SPA, with the result that payment of the bridging pension will be extended automatically with increased SPA.

Trustees and employers may not be able to amend their governing documents as there may be explicit restrictions in their amendment power, or because of the statutory restrictions on amendments. In recognition of this, the Government introduced legislation which gives trustees power to amend their scheme rules by resolution from 1 October 2013.

The resolution can amend the provisions to specific ages between age 60 and 65 to refer to SPA or to any age up to SPA. As an alternative, references to SPA can be changed to specific ages between 60 and 65. In addition, the regulations allow trustees to change the reductions used when calculating members’ pensions.

There are several conditions which need to be satisfied to pass such a resolution. In addition, the normal trust law duties will need to be considered before trustees take any action.

Trustees and employers will need to consider whether, and if so how, their governing provisions should be adjusted to take account of the increase in SPA, and take appropriate advice.

The Author
Colin Crocker, associate, DWF LLP
Share this article
Add To Favorites