Consultation on phasing out the default retirement age: Sackers’ Response

Background

A BIS / DWP consultation on the proposed phasing out of the DRA was published on 29 July 2010.

Having a pivot age (i.e. a fixed point at which benefits are expected to come into payment) for pension purposes is, in our view, essential for the smooth operation of occupational pension schemes.  It is usually called normal retirement age (NRA).  However, the consultation makes only very limited reference to the potential impact that the removal of the DRA may have on pension schemes.

As pensions specialists, our comments focus on this aspect of the consultation.  We outline here some of the main concerns in connection with occupational pensions and explain why, in our view, a pivot age should be maintained for pensions.

In this response:

• Pivot ages in DB schemes
  
• Pivot ages in DC schemes
  
• Retirement planning
  
• Statutory transfers and Finance Act 2004 requirements
  
• Insured benefits
  
• Changing benefits
  
• Closing comments
  

Pivot ages in DB schemes

As noted above, the removal of the DRA will be a key issue for pension schemes, as retaining a pivot age is essential for practical purposes.  By way of illustration, the following are common features of occupational DB schemes (which are permitted under the exceptions in The Equality Act (Age Exceptions for Pension Schemes) Order 2010) and in our view the use of the NRA/pivot age for these purposes (and other current permitted exceptions) should be allowed to continue.

Calculating and funding scheme benefits

Although it is becoming more common for members of DB schemes to work beyond their NRA and schemes have taken steps to address this, a retirement age in the scheme is necessary for the purpose of calculating benefits, and (vitally) the funding needed to provide these benefits.
It is necessary to distinguish here between the age at which a member becomes entitled to benefits under a scheme (i.e. the pivot age) and the age at which a member might take those benefits (which may be earlier or later than this age).  For DB Schemes, NRA is generally the age that determines when late and early retirement factors are applied.

Benefits which include prospective service

Certain benefits include an element of prospective service to NRA – for example, ill health or redundancy benefits. These benefits depend on an NRA to which to peg prospective service.

Relationship between SPA and a pension scheme’s pivot age

For many schemes, particularly DB but also to a lesser extent in DC, the pivot age is linked to existing SPA.  This helps to ensure a smooth transition for members into full retirement.  Given the proposed increases to SPA, schemes may wish to retain a pivot age that is linked to SPA, to ensure that individuals do not suffer an income gap in the first years of their retirement.

Pivot ages in DC schemes

DC schemes also benefit from an NRA or pivot age.  In particular, the vast majority of occupational DC schemes offer members an investment option under which members’ funds are switched automatically to lower risk investments as a member approaches retirement.  This is usually a phased switch over a 5 to 10 year period.  These are called “lifestyle” options and they are often a feature of the default investment fund.  For such funds to work, it is necessary to have a target retirement age as the reference point for switching.

Retirement planning

Disclosure regulations require the provision of certain information to members in the run-up to retirement, which is important to help scheme members with retirement planning.  Without an NRA, trustees will not know when to provide this information.

Furthermore, if the DRA is to be removed, there is a risk that any conversations between the employer or trustees and individual members about retirement could be considered age discriminatory.  A framework which enables pension schemes to retain an NRA (as a pivot age at which members are entitled to take benefits, rather than an age at which they must retire) is therefore required to enable employers,  as well as their employees and the trustees who operate the schemes, to plan for their employees’ eventual retirement.

In short, if the DRA is to be removed, it will be important to have an exception in the legislation to allow employers/trustees provide information to staff (and former employees) for retirement planning purposes at an appropriate point in a person’s working life, without this carrying inferences of age discrimination.

Statutory transfers and Finance Act 2004 requirements

Under section 93 of the Pension Schemes Act 1993, a member “whose pensionable service has terminated at least one year before normal pension age” has a right to request a transfer of his or her benefits out of the scheme.  Provided the transfer meets certain conditions, this is known as the cash equivalent transfer value (CETV).  This would therefore present a problem if schemes could no longer operate NRAs.

Tax legislation also currently sets a minimum age for retirement of 55 (unless someone is suffering serious ill-health), and a maximum age of 75 when an annuity must come into payment (subject to HMT consultation).  Consideration should be given to how this framework sits with the removal of the DRA.

Insured benefits

Many schemes provide death benefits by purchasing insurance policies. In practice, the cost of insuring death benefits increases with age, and our understanding is that insurance companies are permitted to continue to use age as a factor in pricing premiums.  For many businesses, there comes a point at which it ceases to be economically viable to provide these benefits, either because of the cost of premiums or the need to self insure (i.e. to provide benefits directly from the scheme), because cover cannot be obtained from an insurance provider (currently insurers will often not provide cover beyond age 70).  It is generally possible to reduce this type of death benefit without infringing section 67 of the Pensions Act 1995 or restrictions in scheme amendment powers and so there is a risk of the reduction of these benefits for all members if a cut-off age cannot be imposed legally.

Changing benefits

If the DRA is removed as proposed, as part of a general review of employers’ HR practices, we expect that many schemes will review their benefit structures in the light of this.  This is particularly likely among DB schemes which have not already closed to future accrual.  The Government should therefore be aware that one potential consequence of the removal of the DRA is the withdrawal of remaining good quality pension arrangements.

Closing comments

Pensions are designed to provide financial assistance to people later in life, when either their earnings potential is significantly reduced, or as a reward for many years of service.  They have a profound social importance in enabling people to enjoy later life with dignity and without undue pressure on state benefits.  The link between pensions and the age at which they are provided should not therefore in our view be overlooked when considering the impact that the removal of the DRA will have on businesses.

Given that age is such an intrinsic part of pension provision, our experience is that the exceptions for pension schemes originally set out in Schedule 2 to the Employment Equality (Age) Regulations (now incorporated in The Equality Act (Age Exceptions for Pension Schemes) (Amendment) Order 2010 are essential for the continued smooth operation of pension schemes.  Indeed pension provision will only continue to be workable if these exceptions continue to apply, and this includes keeping an NRA for pension provision.