Trustees: Countdown to the abolition of DB contracting-out

Introduction

As a consequence of the introduction of the new single-tier state pension, DB contracting-out will be abolished with effect from 6 April 2016. With only six months to go, below we set out the issues which the trustees of affected schemes should have on their agendas.

Key points

Trustees should:

liaise with the sponsoring employer(s) regarding its / their plans (if any) for dealing with the loss of the National Insurance rebate with effect from 6 April 2016
work with the employer to ascertain whether any scheme rule changes are required to ensure that, on and from 6 April 2016, rules will continue to work as intended and / or that accrued contracted-out rights will be preserved
register with HMRC’s scheme reconciliation service before 5 April 2016
review and update member communications, such as joining information and the scheme booklet.

Loss of the rebate

Employers and members of schemes which are contracted-out on a DB basis currently pay reduced NICs (employer contributions are reduced by 3.4% and employee contributions by 1.4%). With effect from 6 April 2016, the participating employer(s) and their employees will pay NICs at the full rate.

Recognising that this additional cost will be a blow for the sponsoring employers of the remaining open DB schemes, the Government has provided employers with a unilateral power to amend their schemes, in relation to some or all of the members, to take account of the increase in the employer’s NICs.

Statutory modification power

An employer may only use the statutory power to recoup the increase in its NICs by either adjusting members’ future pension accrual or future contributions. The modification power may not be used in a way which would, or might, adversely affect the subsisting rights of a scheme member, or a survivor of a scheme member.

In addition, employers may not use the power to make amendments which would remove a power to determine any matter from the hands of a scheme’s trustees. For example, this is intended to prevent an employer amending the scheme rules so that it is the employer, rather than the trustees, who consents to members taking early retirement.

The statutory modification power will be complicated to administer and deliberately restricts the changes that can be made using it. For this reason, employers may wish to explore alternatives, such as:

amendments to employees’ contracts
using the scheme’s amendment power.

Depending on the method chosen, trustees could have a greater or lesser role to play. If the employer does use the modification power, trustees can be required to provide it with any information it reasonably requests and must be consulted regarding an appropriate date for the amendments to take effect. Amendments may not take effect before 6 April 2016.

GMPs

The DWP consulted on draft regulations in relation to GMP equalisation in 2012 (see our Alert). Following objections from the industry, Ministers decided to reconsider and we are awaiting the outcome of discussions on alternative approaches. We understand the DWP is considering allowing GMP equalisation to be achieved through a conversion of GMPs into ordinary scheme benefits, and it is therefore looking at whether this process can be made less complicated.

In the meantime, schemes should register with HMRC’s scheme reconciliation service. While it is not compulsory for them to do so, it is the trustees’ / scheme administrators’ responsibility to ensure records are accurate and mistakes could be costly to rectify. Requests for registration must be made before 5 April 2016.

From April 2016, HMRC intends to introduce an online self-service facility which will provide GMP and contribution / earnings information for scheme members.

Benefit design

Integration with state benefits

Certain schemes were designed to integrate with state benefits. For example, state benefits may be taken into account through:

a deduction in pensionable salary
a deduction to a pension in payment
a bridging pension.

The DWP has confirmed that the value of the basic State Pension (“BSP”) will be published in an annual Uprating Order, as it will continue to be required for those pensioners who remain entitled to BSP under the current rules, ie those who retire on or before 5 April 2016. For this reason, the DWP has decided that a power to modify scheme rules to reflect the State pension reforms will not be needed.

Although there will continue to be a notional BSP, trustees should discuss with the employer whether the scheme rules dealing with any integrated benefits will apply as intended once the new single tier pension is introduced. In addition, schemes’ actuaries should be asked to advise on the additional cost (if any) of applying such rules after the change.

Reference Scheme Test (“RST”) underpin

Since 6 April 1997, schemes contracted-out on a DB basis must provide benefits which are at least as good as those which would be provided under the statutory “reference scheme”.

Certain DC schemes contain an RST underpin. This provides members with a guaranteed minimum level of benefit at retirement. The DWP has yet to determine how best to deal with preservation of the RST for schemes that have not hardwired it into their rules. It has decided, in the interim, to preserve the provisions relating to the RST until 6 April 2019. Trustees should discuss with the employer whether a rule change is required to remove or retain the underpin for service on and from 6 April 2016.

Plan ahead!

While benefit design is basically an employer issue, trustees should engage with the process and, if necessary, start the conversation, to ensure any rule changes can be completed in good time. Remember, amendments may trigger a statutory requirement for the employer to consult with affected members for a minimum of 60 days and / or be subject to section 67 of the PA95 (protection of subsisting rights).

Communications

The DWP has devised a “State Pension toolkit” which contains guidance, a video, fact sheets, info graphics and photo case studies to help employers to communicate the April 2016 changes to the State Pension. It is encouraging employers, rather than trustees, to download and use this information to help to explain the changes to their employees.

Trustees need to ensure their benefit communications, in particular joining information and the scheme booklet are updated in time for 6 April 2016.

Next steps

Trustees should discuss and agree a plan of action. For further information and assistance, please speak to your usual Sackers’ contact.