Abolition of DC short service refunds

Introduction

On 1 October 2015, provisions will come into force which are intended to ban DC short service refunds.

In this Alert

• Key points
• Background
• How is the change being made?
• Effect of right to refund under the rules?
• Problem of small pots
• Action to be taken

Key points

• The ban will only apply to individuals who first become active members of a DC arrangement, or who re-join an arrangement having already taken a refund or transfer, on or after 1 October 2015 (“affected individuals”).
• Rule amendments may be required and member communications should be reviewed and updated if necessary.
• Members of DB occupational schemes (and DC members who are unaffected by the change) will remain entitled to a contribution refund if they leave the scheme with less than two years’ qualifying service.

Background

Currently, individuals who leave their occupational pension scheme (DB or DC) with less than two years’ qualifying service have a statutory entitlement to a refund of contributions.

One of the key pension policies of the Coalition was to ensure that pension saving becomes the norm and that pension contributions remain in schemes to be invested to produce retirement income for members.  In addition, the then Pensions Minister, Steve Webb, was conscious that individuals saving into personal pensions never have a right to a refund.  For these reasons, provisions to remove the statutory right to short service refunds from members of occupational DC schemes were included in the Pensions Act 2014 (see our Alert).

How is the change being made?

On and from 1 October 2015, affected individuals will only be entitled to a contribution refund if they leave their occupational pension scheme with less than 30 days’ qualifying service (tying in with the period a member has to opt-out of automatic enrolment).  Those with 30 days or more qualifying service will be entitled to short service benefit, ie their benefits will vest in the scheme and will generally be payable from “normal minimum pension age” under the rules.

Effect of right to refund under the rules?

It seems that the Government intended to make the removal of the right to a refund from a DC occupational pension scheme in respect of affected members overriding.  However, depending on the wording of a scheme’s rules, a right to a (non-statutory) contribution refund may remain.  Trustees should therefore speak to their usual Sackers contact to ascertain whether a rule amendment is required.

Under the tax rules, contribution refunds (or short service refund lump sums under the FA04) are permitted only in respect of individuals who are not entitled to short service benefit.  Once the above change comes into force, if a refund was paid to an affected member it would constitute an unauthorised payment for the purposes of the tax rules, resulting in adverse tax consequences.

Many schemes contain a discretion for trustees to decide whether to make an unauthorised payment.  If there is a risk that a scheme provides a non-statutory right to a contribution refund and the trustees have a discretion not to pay an unauthorised payment, this discretion could be used to prevent short service refunds being made to affected members until such time as the rules can be amended.

Problem of small pots

The administration of small pots is a burden for occupational schemes.  With this in mind, the abolition of short service refunds was originally due to be introduced in tandem with the proposed new system of automatic transfers.  Unfortunately, this system is not now due to be implemented until autumn 2016.

Action to be taken

Trustees should ascertain, as soon as possible, whether rule amendments are required to reflect this change.  Member communications should also be reviewed as it is essential that affected members are given the correct information on contribution refunds from joining so that they have no expectation of a refund beyond 30 days’ qualifying pensionable service.