Consultation on draft legislation – bridging pensions

Introduction

On 4 October 2012, the DWP published a consultation on draft legislation which will introduce a limited power for trustees of schemes which provide bridging pensions to modify their rules to take account of the impact of changes to SPA.

In this Alert:

• Key points
• Bridging pensions
• Changes to SPA
• A word on tax legislation
• Why introduce a power to modify scheme rules?
• What are the options?
• Next steps

Key points

• The draft regulations introduce a limited power to enable trustees to modify their scheme rules by resolution to allow bridging pensions to be reduced at either SPA, or age 60 (women) or 65 (men).
• The consultation suggests that this power will only be available in respect of members who have not yet retired.
• The consultation also proposes various minor and technical amendments to the indexation requirements, as a consequence of the switch from RPI to CPI, which we do not cover in this Alert.

Bridging pensions

Some DB schemes pay members who retire before SPA a higher pension at the outset, which is then reduced at SPA to take account of State pension coming into payment. The aim is to allow the member to receive a similar overall level of income in retirement, regardless of when State pension actually starts.

Although often referred to as bridging pensions, these arrangements are also known by a variety of other names including “level pensions”, “step-up pensions” and “State pension offsets”. Bridging pensions may form an integral part of a scheme’s design (and therefore be payable automatically to anyone retiring before SPA) or, alternatively, they may be offered as an option.

Changes to SPA

SPA was initially due to equalise between men and women in 2020 and to increase, in increments, from 65 to 68 by 2046. However, this timetable has been accelerated by the Pensions Act 2011.1 SPA will now be equalised between men and women by 2018, and will increase to 66 for both sexes by October 2020.

When schemes introduced bridging pensions the possibility of SPA equalising or, indeed, increasing beyond age 65 may not have been contemplated. Some rules therefore tied the cessation of a bridging pension to SPA, while others stated that it would end at 60 (for women) or 65 (for men).

The potential impact of the changes to SPA on a scheme depends on the terms of its bridging pension. In some schemes, the payment of a bridging pension is intended to be cost neutral because, while the member receives a higher pension prior to SPA, the cost of this is accounted for in the level of the pension paid to the member after SPA.

Other schemes pay an amount in addition to the member’s pension, in which case paying bridging pensions for a longer period than anticipated will have an impact on the scheme’s funding.

A word on tax legislation

In order to count as an authorised payment, the FA04 generally prevents pensions being reduced once in payment. Reductions made to bridging pensions are an exception to this rule, provided that:

• the pension is reduced between the ages of 60 and 65; and
• the amount of the reduction does not exceed a specified limit set out in the FA04 (which is designed to ensure that the reduction is based on expected State pension).

In its 2012 Budget, the Government announced that it will be introducing changes in the Finance Bill 2013 to align the tax rules governing bridging pensions with the forthcoming changes in SPA.

Why introduce a power to modify scheme rules?

Restrictions in scheme rules may prevent changes being made to bridging pensions. For this reason, the DWP has published draft legislation which aims to provide trustees with a limited power to modify their rules by resolution.

The proposed power will enable trustees to change “the terms of any bridging pension offered to people who have not yet retired…which they consider to be necessary or desirable to take account of the changes to SPA and to [the FA04]”, but is not intended to allow trustees to make “wider or more general changes”. The DWP also assumes that any change using the new power would be actuarially neutral.

What are the options?

As currently drafted, there will be two options available to trustees under the new modification power:

• schemes which, as at 5 May 2010, provided for a pension to be reduced between 60 and 65 may be amended so that the reduction is made at SPA instead; or
• schemes which, as at 5 May 2010, provided for a pension to be reduced at SPA may be amended so that the reduction shall instead take effect “upon a member attaining the age at which they would have become entitled to state retirement pension had they been born on 5 May 1950” (age 60 for women, age 65 for men2).

As trustees using the above options could potentially result in increased funding costs, the sponsoring employer’s agreement is needed as a safeguard. In addition, using either power will be a “listed change” and, as such, trigger a requirement for the employer to consult with affected scheme members.

Next steps

The consultation, to which we will be responding, closes on 14 November 2012. The DWP considers a six-week period appropriate as it has already informally consulted with key stakeholders on the changes relating to bridging pensions, and the other amendments are either minor technical changes or consequential on amendments previously agreed.

1 See our Alert: “Better late than never – The Pensions Act 2011” dated 3 November 2011
2 Somewhat surprisingly, this option would seem to allow schemes to reduce bridging pensions at unequal ages between men and women, which seems at odds with the need to ensure equailty between the sexes for the purposes of EU and UK law