Spring 2015 reforms: other changes THE REFORMS AT A GLANCE y The Pension Schemes Act 2015 (the Act ) rewrites the current statutory revaluation provisions to allow for revaluation of the new benefit structures permitted by the Act. For final salary and money purchase benefits, nothing is changing. However, there will be limited changes for certain types of benefit accrued after the date on which the Act comes into force for these purposes 1 specifically flat rate benefits and some cash balance benefits. y New legislation will correct several anomalies that have emerged in the existing annual allowance legislation, including in relation to: augmentations to pre-a Day deferred pensions; and statutory increases to deferred pensions. y A new restriction will be added to s67 Pensions Act 1995 which will require member consent to any change which removes a pensions promise, which is basically a promise at a time before a benefit comes into payment about the level of benefit members will receive. y From April 2015, an additional type of family leave called shared parental leave will be available to employees in the first year after a child s birth. y Regulations will simplify the automatic enrolment process for employers from 1 April 2015. Three key simplifications will be made: an alternative quality requirement for DB schemes; simplified information requirements; and an exemption from the employer automatic enrolment duties for certain categories of worker. This Update provides a summary of some key points, but is not comprehensive. If you need legal advice or assistance in connection with any of the issues covered, please speak to your usual Mayer Brown contact. CHANGES TO REVALUATION The current position What are the statutory revaluation provisions? If a member leaves pensionable service at least a year before normal pension age, the member s benefits must be revalued over the period between leaving service and normal pension age (called the pre-pension period ) to take account of inflation. 1 It is not yet known what this date will be.
How should benefits be revalued? The revaluation takes different forms depending on what benefits the scheme provides. In general: (1) Final salary benefits and cash balance benefits based on final salary must be revalued by limited price inflation measured over the pre-pension period. Limited price inflation is CPI capped at 5% in respect of benefits accrued before 6 April 2009, and CPI capped at 2.5% in respect of benefits accrued from 6 April 2009. Special rules apply where the member left pensionable service before 1 January 1991. The legislation calls this the final salary method of revaluation. (2) Money purchase benefits must be revalued over the pre-pension period by the same method used for active members (i.e. by reference to the investment returns of the funds to which the member s account is linked). (3) Average salary benefits, flat rate benefits and cash balance benefits not based on final salary are revalued over the pre-pension period using the final salary method. However, if the trustees think it appropriate, the benefits can instead be revalued by the same method used for active members. What s changing? Benefits accrued before the Act comes into force: The changes do not affect revaluation of benefits accrued before the Act comes into force. (The only exception is where the rules of a scheme providing cash balance benefits do not provide for those benefits to be revalued in a way that is currently lawful.) Benefits accrued after the Act comes into force money purchase, average salary and final salary benefits: Similarly, for money purchase, average salary and final salary benefits accrued after the Act comes into force, nothing is changing in relation to how those benefits must be revalued. Benefits accrued after the Act comes into force flat rate benefits: The default method of accrual for these benefits is switching round. Flat rate benefits accrued after the Act comes into force will be revalued by the same method used for active members, unless the trustees decide to use the final salary method. Benefits accrued after the Act comes into force cash balance benefits: Where a scheme: y existed before the Act comes into force; and y provided cash balance benefits (other than benefits based on final salary) before the Act comes into force, benefits accrued before and after the Act comes into force can continue to be revalued in the same way that the scheme rules currently provide (assuming that method is lawful under current legislation). If a new (non-final salary-linked) cash balance arrangement is set up after the Act comes into force, benefits under that arrangement must be revalued by the same method used for active members. What should trustees be doing? Although the legislation is being rewritten, the practical effects are limited for most schemes. Trustees of schemes offering flat rate benefits should consider (having taken appropriate advice) whether to continue using the final salary revaluation method. If they do continue using that method, they should pass a resolution to this effect. CHANGES TO THE ANNUAL ALLOWANCE REGIME Augmentations to pre-a Day deferred pensions What s the current position? Current rules have an unintended impact on individuals who became deferred members before 6 April 2006 and who later receive a benefit augmentation, or who rejoin the scheme and accrue additional pension. These rules say that the total value of the member s accrued pot could count towards his or her annual allowance in the year of augmentation or rejoining, not just the increase in the value of the member s pot in that year. What s being changed? This error is being corrected with retrospective effect, from 6 April 2011, to ensure that only the increase in the value of the member s pot in any year counts towards his or her annual allowance. Statutory increases to deferred pensions What s happening? Another correction will bring the law into line with HMRC s practice of treating most forms of statutory increase to a deferred member s pension as normally invisible for annual allowance purposes. This change will apply to statutory revaluation of GMPs, statutory revaluation of non-gmp pensions, statutory increases to postponed GMPs, and increases required by the anti-franking legislation. It similarly applies retrospectively to cover increases in pension input periods ending on or after 6 April 2011. Are there any statutory increases to which this will not apply? However, this series of corrections will still not extend this sensible treatment to late retirement uplifts applied to deferred pensions which are first drawn after a scheme s normal pension age. This is despite the fact that preservation laws usually require a cost-neutral uplift where a deferred pension is postponed beyond normal pension age. The only new concession in this area is where the late retirement uplift is required by sex equalisation rules. Otherwise late retirement uplifts to deferred pensions which exceed CPI inflation will count towards the annual allowance, unless the late retirement uplift was expressly referenced in the scheme s rules as they stood on 14 October 2010. 2 mayer brown
What should trustees be doing? DB schemes: Administration processes should be updated to reflect the changes. CHANGES TO THE RULES ON AMENDING PAST SERVICE BENEFITS What s the current position? Section 67 Pensions Act 1995 ( s67 ) contains provisions to protect members against detrimental modifications to their subsisting rights. Broadly, this means that trustees and employers cannot make changes (including rule amendments) that could adversely affect the pension rights that members have built up in the past, unless certain conditions are met. The type of change determines whether member consent is required, actuarial equivalence conditions need to be met, or a combination of both these methods is required. A protected modification is the conversion of defined benefits to money purchase benefits or a change that would result in a reduction to a pension in payment. Such a change can only be made if the member agrees. What s changing? The definition of protected modification in s67 will be expanded to include a change where a right to benefits that include a pensions promise will be replaced by a right to benefits where there is no pensions promise. There is a pensions promise in relation to a benefit if the scheme provides for there to be a promise, at a time before the benefit comes into payment, about the level of the benefit. The promise can include the option of a promise from the scheme, or the option of requiring a promise to be obtained from a third party. So the focus is on the scheme benefit structure, rather than the option a member eventually takes up. A cash balance scheme and a money purchase scheme with an element of guarantee are both examples of schemes which provide a pensions promise. This change reflects the re-categorisation of pension schemes in the Act which is based on the type of promise made to members about retirement benefits during the accumulation phase: y Defined benefit (DB) scheme where there is a full pensions promise of a pension payable for life based on a fixed retirement age. y Shared risk scheme (also referred to as a defined ambition scheme) where there is a pensions promise in respect of some benefits, but it is not a DB scheme. y Defined contribution (DC) scheme where there is no pensions promise about the level of benefit. The extension of the protected modification definition in s67 puts certain changes to DC and shared risk schemes on a par with changes to DB schemes. What should trustees be doing? All schemes: Trustees should take advice on the categorisation of the benefits provided by the scheme under the new Act. When planning future benefit changes, trustees should consider whether those changes will be caught by the requirements of s67. SHARED PARENTAL LEAVE What s the current position? Employees already have a number of options for taking leave for childcare reasons maternity leave, paternity leave, adoption leave and parental leave (referred to collectively as family leave ). Each type of family leave has its own set of legal requirements in relation to the accrual of pension rights by employees while absent. What s new? The Government is introducing an additional type of family leave, called shared parental leave. At the same time it is also introducing the concept of shared parental pay. Both will be available for eligible employees whose baby is due on or after 5 April 2015. (Both will also be available on broadly similar terms for eligible employees who have a child placed with them for adoption on or after 5 April 2015, but for simplicity this note focuses on the birth of a child.) The existing types of family leave will continue to be available, apart from additional paternity leave, which will be abolished for parents to whom the new shared parental leave provisions potentially apply (ordinary paternity leave will continue to be available). Shared parental leave will be created if an eligible mother brings her statutory maternity leave to an end early. The untaken weeks of her maternity leave can be taken as shared parental leave if the mother or her partner is eligible for this up to a maximum of 50 weeks. Statutory shared parental pay will be created if an eligible mother chooses to bring her statutory maternity pay to an end early. The untaken maternity pay will become available as statutory shared parental pay up to a maximum of 37 weeks. If both the mother and her partner/the child s father are employees and both meet the eligibility criteria, they will be entitled to take shared parental leave and/or pay and will have to decide between them how they will share this leave and pay. Shared parental leave and pay must be taken during the first year after the child s birth. The new definitions are mutually exclusive categories and only apply where expressly stated in legislation. mayer brown 3
What does this mean for occupational pension schemes? The legal requirements for accrual of rights in an occupational pension scheme while a member is absent on a period of shared parental leave will be broadly consistent with those which apply to absence on existing types of family leave. The starting point is that during a period of paid shared parental leave (whether the member is receiving statutory shared parental pay, contractual shared parental pay, or both) the member continues to accrue rights in the scheme. In practice, broadly this means that during such a period: 1. For DB schemes: (a) The member continues to accrue pensionable service as if working normally. (b) If the scheme rules require the member to contribute, those contributions are calculated by reference to the pay actually being received by the member (not by reference to pay as if the member were working normally). 2. For DC schemes: (a) The contributions payable by the employer continue to be calculated by reference to pay as if the member were working normally (not by reference to the pay actually being received by the member). (b) If the scheme rules require the member to contribute, those contributions are calculated by reference to the pay actually being received by the member (not by reference to pay as if the member were working normally). Where member contributions are paid via salary sacrifice, they are treated as employer contributions, and must therefore continue to be calculated by reference to pay as if the member were working normally (not by reference to the pay actually being received by the member). What should trustees be doing? All schemes: Trustees should check the family leave absence provisions in their scheme rules to see if the wording is sufficiently broad to cover absence on shared parental leave or if they need updating. Trustees should also update their scheme rules to reflect the abolition of additional paternity leave and other minor changes made to existing types of family leave over recent years. AUTOMATIC ENROLMENT CHANGES A number of changes are being made from 1 April 2015 to simplify the automatic enrolment regime. Alternative DB quality requirement What are the current DB quality requirements? At present, employers using a DB scheme for automatic enrolment purposes can meet the minimum quality requirement by providing a contracted-out scheme or a scheme that meets a test standard set out in the automatic enrolment legislation. What s the new alternative quality requirement? With the abolition of contracting-out next year, a new alternative test will be introduced from April 2015 for DB schemes. The new test is based on the cost of future accrual under a scheme. To meet the new requirement, a scheme-level test will, for each benefit scale, require contributions equal to 10% of qualifying earnings to meet the cost of future accrual. This is reduced to 9% for schemes that do not provide survivors benefits on a member s death. Given that many schemes will pay contributions on pensionable pay based on a definition other than qualifying earnings, the following three optional variations (with a 1% reduction where no survivors benefits are provided) are allowed: y pensionable earnings are at least equal to basic pay and the cost of future accrual requires total contributions of at least 11% of pensionable earnings; y pensionable earnings are at least equal to basic pay, the cost of future accrual requires contributions of at least 10% of pensionable earnings, and the pensionable earnings of all relevant members taken together constitute at least 85% of those members earnings; or y all earnings are pensionable and the cost of future accrual requires total contributions of at least 9% of total earnings. In assessing the test, the method and assumptions to be used will be at the discretion of the scheme actuary. However, no actuarial certificate will be required. The test will be of the cost of providing all benefits, including survivors benefits. Simplified information requirements What s being changed? Regulations will reduce the current administrative complexity from April 2015 by, amongst other things: y simplifying the information that must be given when an employer uses a postponement period through the use of a standard notice for all categories of workers; y removing the requirement to send separate information notices to non-eligible jobholders or entitled workers, telling them about their rights to opt in; y abolishing the requirement to provide information to existing jobholders who are already members of a qualifying scheme at their automatic enrolment date; and y reducing the scale of information to be provided. 4 mayer brown
Exceptions to the automatic enrolment duty What s being changed? From April 2015, the statutory duty on an employer to automatically enrol a worker will be converted to a discretion for an employer to do so in the following four circumstances: y the worker is in a notice period at any point within six weeks of their automatic enrolment date; y the worker has cancelled scheme membership in the 12 months after being enrolled in a qualifying scheme; y the employer has reasonable grounds to believe that the worker has claimed lifetime allowance protection (i.e. enhanced, primary, fixed or individual protection); or y the worker has received a winding-up lump sum and, in the 12 months since the payment was made, has both ceased to be employed and subsequently been re-employed by the same employer. What should employers be doing? Automatic enrolment processes and employee communications should be updated to reflect the simplified information requirements. Employers should also decide whether to take advantage of the new option not to enrol certain categories of worker. If they decide not to enrol workers with lifetime allowance protection, they should gather evidence of the protection (e.g. see an HMRC certificate). Employers that are currently using a contracted-out DB scheme for automatic enrolment should consider whether the new alternative test will be satisfied following the abolition of contracting-out. mayer brown 5
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