Holiday pay ruling is no vacation for pension schemes

Tom Hargreaves contributed to the writing of this blog post

In early November a group of employees won a landmark case at the Employment Appeal Tribunal that means employers may now have to include an allowance for regular overtime in holiday pay. This will avoid the scenario where employees are effectively paid substantially less whilst on holiday compared to when they are working.

The cost implications in terms of increasing the salary bill for employers who offer paid overtime are obvious, but the change could also feed through to an employer’s pension provision.

Impact on pension schemes

This impact will vary from scheme to scheme – indeed there may be no change at all – and will depend on the definition of pensionable salary in scheme rules.

In some schemes, pensionable salary is defined as basic salary, in which case this ruling should not have any impact on cost. The problem may come where there are references to fluctuating elements, or where pensionable salary is based on actual earnings over the last year, both of which could be higher as a result of the ruling.

With the introduction of auto-enrolment it is also relatively common to see pensionable salary being based on “qualifying earnings” in order to better match the minimum requirements. This will generally incorporate overall earnings rather than just basic salary, so could be increased by the ruling. It could also mean that more workers are pushed over the qualifying earnings threshold and so will need to be enrolled.

For sponsors of defined contribution (DC) and defined benefit (DB) schemes this is another unwelcome increase in pension costs. For many employers the pure pension cost implications will be relatively small, but as employees may be able to claim for past holiday pay, the work involved in correcting any historic issues could be an administrative mess, particularly where automatic enrolment is concerned.

What can be done?

The immediate action for employers will be to clarify the definition of pensionable salary in the scheme rules which should help establish whether the ruling will have any impact. If there is an impact, employers could consider making changes, potentially alongside any changes being considered as a result of the cessation of contracting-out for DB schemes in 2016 where relevant.

It is worth noting that the decision may be appealed, so nothing is set in stone as yet. However, unions, in particular Unite, have been vocal in suggesting they will fight for their members to receive their full entitlements.

Key impacts of the holiday pay ruling on pension schemes:

  1. review the definition of pensionable salary in the scheme rules 
  2. consider impact on pension costs and automatic enrolment
  3. correct member benefits if necessary and consider making changes in future