Abolition of DC Contracting-Out: The Final Countdown

Introduction

DC contracting-out will be abolished on 6 April 2012. Employers and trustees should use the run-up to that date to check that they are prepared for its demise.

In this Alert:

• Key points
• Background
• What will happen to protected rights?
• Making amendments
• Disclosure
• Transfers

Key points

• The ability to contract-out of S2P on a DC basis will be abolished on 6 April 2012.
• Subject to transitional provisions (to allow for NI rebates due before 6 April 2012 to be paid), no further protected rights will accrue after 5 April 2012.
• Protected rights which are in payment on 6 April 2012 will retain their current status. Those not yet in payment will become ordinary scheme benefits.
• Pension schemes which are or have been contracted-out on a DC basis may need to make amendments to their trust deed and rules.
• From 6 April 2012, it will be possible to transfer contracted-out benefits to a contracted-in scheme provided certain conditions are met.

Background

In contracted-out DC schemes, employers and members pay reduced NI contributions. The employer pays the amount saved into the scheme as “minimum payments”. In addition, HMRC pays an age-related rebate into the scheme. A member’s “protected rights” are essentially a combination of those “minimum payments” and “rebates”, together with related investment return and tax relief.

Currently, protected rights are subject to certain statutory restrictions. For example:

• protected rights have to be separately identified from non-protected rights;
• annuities derived from protected rights must provide for a survivor’s benefit where the member is married or in a civil partnership; and
• an annuity securing protected rights must be provided on a unisex basis.

What will happen to protected rights?

Any protected rights which are in payment on 6 April 2012 will retain their current status. Those not yet in payment will become ordinary scheme benefits and the statutory restrictions referred to above will fall away.

HMRC will cancel DC contracting-out certificates automatically. Certificates issued for the DC section of a COMB will also be cancelled but the certificate for the DB section will remain valid.

On and from 6 April 2012, employers and members of previously contracted-out DC schemes will generally pay the full-rate of NI contributions.

Making amendments

Schemes which are currently contracted-out on a DC basis will need to consider removing protected rights provisions from their trust deed and rules, as they will not be removed automatically.

Acknowledging the difficulty that schemes face in making such amendments, the DWP has consulted on draft regulations to introduce an easement allowing trustees to amend their rules by resolution to remove “all or part of a scheme rule which relates to protected rights”. Schemes will be given until 6 April 2015 to make changes and may make amendments retrospective to 6 April 2012.

Where the protected rights provisions are set out in a separate schedule under the scheme rules, this should be a relatively straightforward task for trustees. However, this easement will be of limited use to those schemes which effectively embedded the protected rights provisions into their rules, making them an integral part of the scheme design. Employers and trustees in this position may therefore have to look to the scheme’s amendment power in order to make changes to reflect the abolition of protected rights and, in doing so, will need to consider the implications of section 67 of the Pensions Act 1995.

The DWP has indicated that the final regulations will be published later this month.

Disclosure

Trustees must notify affected members that the scheme has ceased to be contracted-out before 6 May 2012. Also, before 6 August 2012, schemes must provide such members with further prescribed details (for example a statement that, as a result of no longer being a member of a contracted-out scheme, the member may build up entitlement to an additional state pension from 6 April 2012).

However, schemes need not make further announcements if, in the year leading up to 6 April 2012, members have been informed of the changes and already provided with the required information.

Transfers

At present contracted-out benefits may only be transferred to a contracted-out scheme. To maintain members’ choice and flexibility post-abolition, the DWP has legislated to allow transfers from DB contracted-out schemes to non-contracted-out schemes from 6 April 2012, subject to certain conditions.