Abolition of contracting-out: eight things to think about

United Kingdom

This article was produced by Nabarro LLP, which joined CMS on 1 May 2017.

Contracting-out of the second state pension is to be abolished from 6 April 2016, to coincide with the introduction of the new state pension. This will increase the national insurance contribution (NIC) liability for employers currently offering a contracted-out scheme (as well as for their employees).

Time is running short. Here is a quick summary of the main issues. More detail can be found in our September 2015 briefings for employers and trustees.

  • Consider scheme amendments to offset the additional NIC costs. Employers have been given an overriding statutory power to do this. Changes to employee contributions or future accrual are likely to require 60-day statutory consultation before they can be implemented.  
  • Reconcile GMP data. Trustees have until December 2018 to reconcile scheme data with HMRC but must register with the Scheme Reconciliation Service by 6 April 2016. Failure to take this opportunity to reconcile data could lead to benefit disputes in future.   
  • The current protections for contracted-out benefits accrued before 6 April 2016 will broadly remain in place. Schemes may need to take action to preserve their current arrangements for the revaluation of GMPs. This may require a scheme amendment to enable trustees to select the most appropriate revaluation method. 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. Detailed advice should be taken as the impact of the changes will depend on the exact scheme provisions.    
  • The treatment of increases to GMPs in payment. Currently the Government pays increases on GMPs accrued before April 1988. This will cease from 6 April 2016 and schemes will only be required (as currently) to pay increases of CPI capped at three per cent on GMPs accrued from 6 April 1988. This is essentially a communication issue and does not require any changes in the way the scheme calculates benefits.
  • Trustees should be informing members that the scheme has ceased to be contracted-out. This should be done as soon as possible after 6 April 2016 (although there is no reason why it could not be done before that date). Members will also have to be informed if any changes are made to contributions or future accrual. It would be helpful also to mention the increase in employees' NIC liability and the changes to GMP increases which are consequential on the abolition of contracting-out. The DWP has produced a series of factsheets which could be drawn to members' attention.
  • Some schemes may operate offsets or bridging pensions by reference to the state pension. These could be affected by the change to state pension provision from 6 April 2016 and we would recommend a detailed review of any relevant scheme rules.
  • 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 for employers currently using a contracted-out scheme for automatic enrolment. Contracted-out status means that a scheme automatically meets the “qualifying scheme” requirement. From 6 April 2016, employers will have to demonstrate that their scheme meets an appropriate quality standard. This must either be the test scheme standard (broadly 120th accrual) or an alternative requirement of either contributions at the DC quality standard level or the cost of providing benefits reaches a prescribed level (the “cost of accruals test”). The proposed easement (which will stand until April 2019) will allow schemes to use a simplified cost of accruals test. Reliance on the easement is conditional on there being no scheme amendments using the overriding power to offset the additional NIC cost nor any benefit amendments that would mean that the scheme would no longer satisfy the requirements of contracting-out (had it still existed).