The abolition of DB contracting-out – is your scheme prepared?

Written on 23 Jul 2015

Contracting-out on a defined benefit (DB) basis will be abolished from 6 April 2016, when the new state pension is implemented. This raises a number of issues that contracted-out DB schemes need to be addressing now.

The government has issued the final version of a set of regulations on this – the Occupational Pension Schemes (Schemes that were Contracted-out) Regulations 2015, as well as its response to a consultation on those regulations. The regulations provide details for schemes on how to handle accrued contracted-out rights in the scheme from 6 April 2016.

The aim of the regulations is to ensure that accrued contracting-out rights will be preserved, i.e. broadly that the existing requirements that relate to GMPs and reference scheme benefits will remain in place for benefits accrued before 6 April 2016. Although the existing contracting-out regulations will be revoked, the relevant requirements will be carried across to the new regulations.

A further Order has also been issued which preserves key contracting-out related provisions in the Pensions Schemes Act 1993 from repeal. This has been done to allow trustees of contracted-out DB schemes time to undertake any necessary tasks relating to periods of contracted-out employment prior to abolition on 6 April 2016.

These regulations bring us a step closer to understanding the details of how schemes need to respond to the abolition of DB contracting-out. A number of questions still remain unanswered and the DWP plans to consult further on various points later in 2015.

Integration with the state pension

One issue referred to in the consultation is that of how DB schemes that have some aspect of integration with the basic state pension in their benefit design should proceed. Integration with the state pension is incorporated into different schemes in different ways. Some schemes include offsets, for example the deduction of an amount equal to the basic state pension from the definition of pensionable salary. Some schemes have a bridging pension, which aims to ensure that where a member retires before state pension age, their pension is increased to take account of the fact that they are not in receipt of the basic state pension, and then drops at their state pension age when they start receiving the basic state pension.

The impact of the new state pension on these aspects of benefit design needs careful consideration, and decisions on whether benefit design changes are required need to be taken. The drafting of the rules of the scheme also needs to be reviewed, to determine whether amendments are needed to ensure that the wording still operates, and that it operates as intended.

In the recent consultation many respondents asked for an overriding power for trustees to amend the scheme, with the consent of the employer, to ensure that members do not gain or lose out in schemes that are integrated with the state pension, as a result of the introduction of the new state pension. The government has responded stating that it considers this is not necessary because it will continue to publish uprated values annually for the current basic state pension. This may be helpful for schemes that are closed to accrual, but for schemes that are open to accrual, they still need to consider whether the way their benefits integrate with the current basic state pension should be amended when the new state pension comes into force.

Without an overriding power to amend the scheme, trustees will have to make any amendments within the restrictions set out in their scheme rules and section 67 of the Pensions Act 1995 which may, in practice, make it difficult to achieve integration with the new state system in relation to benefits that have already accrued.

GMP conversion and equalisation

The regulations contain nothing new regarding either GMP conversion or equalisation. The Government has stated that these issues will be considered separately, although no timescales have been given for this. As such, the position remains uncertain.

FAQs on the abolition of DB contracting-out

Earlier this year we issued an update answering frequently asked questions on the abolition of DB contracting-out. For an explanation of the basics, and for details of the employer statutory override that employer’s may use to amend their scheme to offset increased costs arising from this development, please have a look at that update.

Action plan for employers and trustees

  • Increased costs: consider any changes to be made to the scheme to offset the increased costs arising from the abolition of DB contracting-out, and how to make any changes decided upon – i.e. whether to use the employer statutory override.
  • Integration with the state pension: review the scheme benefit design and rules to analyse if and how it integrates with the state pension. Consider and implement any benefit design changes required as a result of the new state pension, and make amendments to the trust deed and rules to ensure the drafting reflects what is intended.
  • Member communication: consider how the impact of the abolition of DB contracting-out, and any linked changes that are planned to the scheme, should be communicated to members. As part of its consultation on further points later in 2015, the DWP plans to consult on how existing disclosure legislation should be amended to include requirements on schemes to notify and consult with members about the ending of DB contracting-out.
  • Automatic enrolment: if your contracted-out DB scheme is used for automatic enrolment, consider the best test to use for it to satisfy the requirements to be used in this way. A new cost of accruals test has been introduced which can be used from 6 April 2016.
  • GMP reconciliation: make sure that the scheme administrators are undertaking the process of reconciling scheme GMP records with those held by HMRC. Requests for data must be made by April 2016. Agree the scope and cost of this exercise with them.