The option to contract-out of the State Second Pension (S2P) will come to an end in April 2016 when the New State Pension is introduced. Regulations have recently been published permitting sponsors to make changes to the rules of contracted-out defined benefit (DB) pension schemes to mitigate the increase in National Insurance (NI) costs from 2016. Sponsors now need to decide how they will react.
Single Tier State Pension
Our recently updated note on the Single Tier State Pension sets out the background to the changes and provides further information on employers’ optionsDownload
The approach taken by employers to mitigate the increased costs will broadly fall under four options, outlined below.
- Do nothing and absorb extra NI Cost
- Make minor changes to the scheme benefit structure from April 2016
- Increase employee contribution rates to offset the extra NI cost
- Conduct a fundamental review of the scheme benefit structure
Sponsors can exercise options 2 and 3 without trustee consent. The changes (whether it is to employee contributions, scheme structure or both) must be such that the saving made is not greater than the increase in NI costs, as certified by an actuary (other than the Scheme Actuary). Members must be consulted on any changes and employers are required to consult trustees on the timing of changes.
What others are doing
Which option a sponsor will choose will depend on many factors including its financial position and the number of members still accruing benefits. We conducted a survey to gauge how scheme sponsors are planning to deal with the extra NI costs. The results are as follows:
The results show that the single most popular option among those that responded is to take no action and simply absorb the extra NI costs. This is presumably the option being taken by those companies with a relatively small number of active members left in their DB scheme. However, employers will still need to consider other relevant actions (see below) as a result of these reforms.
Nevertheless, according to our survey, the majority of sponsors will take some form of action with 25% of respondents indicating that they will take the opportunity to carry out a fundamental review of scheme benefits.
What you need to be doing
There are a number of other consequences of these reforms which employers may have to consider:
- Scheme rules should be reviewed, and amended if necessary, for references to state pension benefits to avoid an unintended increase in the benefits provided by the scheme when the Basic State Pension no longer exists.
- When a scheme ceases to contract out it is now required to reconcile its records with those held by the HM Revenue & Customs (HMRC). The mass reconciliation of Guaranteed Minimum Pensions (GMPs) and other data is likely to lead to additional administration costs for schemes.
- Employers will need to ensure that their ‘contracted-in’ scheme continues to function as a ‘qualifying scheme’ for the purposes of automatic enrolment.
- Where changes are made to benefits or contributions, the scheme’s schedule of contributions may need to be reviewed.