April 2016 and the end of contracting-out: the implications for charities

David Davison

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Many charities participate in pension schemes that are contracted-out. Participants in local government pension schemes, multi-employer schemes such as those run by the Pensions Trust, USS and many others will be impacted, as well as those charities running their own defined benefit schemes.

So what’s happening? Contracting-out of the second state pension will be abolished from 6 April 2016, to coincide with the introduction of the new state pension. This will increase the national insurance contributions (NIC) required from employers currently offering a contracted-out scheme, as well increasing the contributions required from employees. Employers will see an increase in contributions of 3.4% of band earnings (earnings between £5,824 and £43,004 for the 2016/17 tax year) on their pensionable payroll and employees an increase of 1.4% of band earnings.

Clearly organisations need to be budgeting for these increased costs and confirming the changes and their impact to staff as quickly as possible. In the case of public sector schemes, admitted bodies have no option other than just to pay the increased costs and maintain the level of benefits provided. Under other schemes, where there are options about the level of benefits provided, employers may want to consider a move to a lower benefit basis, with lower costs therefore offsetting the cost increases.

Organisations in these schemes may also see some additional correspondence from their provider, and possibly some linked additional work, as they seek to reconcile their GMP information and communicate with members on the impact of the changes.

For those charities running their own scheme there are a lot more options available which will need full consideration:-

  • Employers have been given an overriding statutory power to implement scheme amendments to offset the additional NI costs. Changes to employee contributions or future accrual are likely to require 60-day statutory consultation before they can be implemented so time is short.  This unilateral power exists for a limited time only and the relevant statutory provisions will be repealed from 2021.
  • Trustees should be communicating with members to advise them that the scheme has ceased to be contracted-out and any impact on contributions or benefits. This should be done as soon as possible after 6 April 2016 although it could be done beforehand. The DWP has produced a series of factsheets which could be highlighted to members.
  • Scheme trustees will have until December 2018 to reconcile their scheme data with HMRC and must register with the Scheme Reconciliation Service by 6 April 2016.
  • Schemes may need to take action to ensure their administrative processes reflect post 6 April 2016 practice in relation to revaluing GMPs until retirement. There is also a change to the law on forfeiture of unclaimed GMPs, extending the period after which they can be forfeited from six to eight years. Existing forfeiture clauses may be void if they are not amended.
  • Prior to 1997, members were entitled to a Guaranteed Minimum Pension (GMP) by contracting out of the State Earnings Related Pension Scheme (SERPS).  For GMP accrued prior to April 1988, no increases are awarded in payment.  For GMP accrued after April 1988 increases in payment are in line with CPI subject to a maximum of 3% p.a.  SERPS benefits however, increased in line with CPI (uncapped) and the Government agreed to top up GMP’s to ensure employees were no worse off by contracting-out.  This top up will not transfer to the new regime.  Employees with GMP’s may therefore be worse off under the new regime.  This is essentially a communication issue.  From our experience, no employers are planning to incur additional costs to retain this benefit.
  • Some schemes may operate offsets or bridging pensions by reference to the state pension. These are likely to be affected and a detailed review of any relevant scheme rules should be undertaken.
  • Scheme booklets and other member literature should be reviewed to ensure that they accurately reflect the position from 6 April 2016 both in relation to the abolition of contracting-out and the state pension changes.
  • The DWP is consulting on a transitional easement which would be likely to apply until April 2019 for employers currently using a contracted-out scheme for automatic enrolment. This will allow schemes to use a simplified cost of accruals test to confirm compliance with auto-enrolment requirements. Contracted-out status means that a scheme automatically meets the “qualifying scheme” requirement. From 6 April 2016, this automatic accreditation will no longer be available and schemes must prove that they meet the necessary standards. This must either be via the test scheme standard (broadly 120th accrual) or via an alternative requirement of either contributions being at the DC quality standard level, or the cost of providing benefits reaching a prescribed level (the “cost of accruals test”). Use of the easement is conditional on there being no scheme amendments using the overriding power to offset additional national insurance costs, nor any benefit amendments that would mean that the scheme would no longer satisfy the requirements of contracting-out (had it still existed).

So for charities participating in multi-employer schemes the impact, other than the increased cost, is likely to be limited while for those with their own schemes the options possible and therefore the actions necessary are much more material.

David Davison

Post by David Davison

Specialist consultant on pensions strategy for corporate, public sector and not for profit employers

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