Pensions landscape: What you need to know.

Government reform, changing actuarial assumptions and court rulings have all lead to increasing pension contributions and potential future liabilities. Here we provide finance directors an update on how this impacts management of finances and auto-enrolment arrangements.

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Are you an employer participating in a defined benefit pension scheme?

If so, you are likely to be impacted by two court rulings commonly known as GMP equalisation and McCloud. 

GMP equalisation: background

Pension scheme liabilities are impacted by a High Court decision on 26 October 2018 that confirmed the existence of a legal obligation to equalise Guaranteed Minimum Pensions (GMPs) for men and women which accrued between 1978 and 1998. In many schemes GMPs accrued at different rates for men and women. In defined benefit pension schemes GMPs had always been equal – however the method for equalising changed for employees reaching State Pension age from April 2016 with the introduction of the new State Pension.

GMP equalisation: what does this mean for you?

Following this change, the Government has only agreed an interim method for equalisation which will be in effect for LGPS employees reaching state pension age up to April 2021. Further guidance will be published by the Government once there is a more definitive stance on the impact after April 2021. 

McCloud case: background

In 2015 the Government introduced reforms to public sector pensions and as a result the majority of public sector workers were moved into new defined benefit pension schemes, with a large portion being moved into the Cabinet Office’s “alpha pension scheme”, which provides a defined benefit worked out on a career average basis meaning that a pension is built up on a percentage of earnings in a given year. The schemes that many younger judges and firefighters were enrolled into came with “transitional protection” whereby the value of historic benefits accrued are protected. It has since transpired that this scheme was not as good as equivalent schemes for older workers. The Court of Appeal therefore ruled in the McCloud case December 2018 that this amounted to unlawful discrimination. 

McCloud case: what does this mean for you?

As a result of this, there may be a significant increase in the pension liability of organisations within such schemes, especially those with a younger workforce. This is expected to cost the Treasury billions, and employers could therefore be forced to increase current contributions or make lump sum payments to fund shortfalls, although details of how the deficit is made up has not been made available yet.

Are you an employer with employees in the Teachers’ Pension Scheme (TPS)?

While the above rulings do not affect the cash position of an organisation, the forthcoming changes to the employer contribution rate of the Teachers’ Pension Scheme following its revaluation at 31 March 2016 will have an adverse impact on cash payments and accurate budgeting will become even more crucial over the next few years. 

TPS rate changes: the facts

The employer contribution rate increased to 22.8% from the current 16.48% from 1 April 2019 for a period of four years. The Department for Education has agreed that the revised rate will only be implemented from 1 September 2019 with the new contributory rate for employers being 23.6% (to make up for the six month lag). 

TPS rate changes: the impact 

Across the education sector, this increase is expected to cost £1.1 billion in 2019-20, of which around £80m is expected to impact the further education sector, and state-funded schools a further £830m. An open consultation period was commissioned to gauge the response in the sector and the results, published in April 2019, confirmed that the government will fund both further education colleges and schools for their respective 2019/20 financial years. But, their position for the funding of the 2020/21 financial year and beyond remains unclear.

The government have also confirmed that they will not fund independent schools, Universities and other organisations providing higher education, although a consultation, which closed on 3 November 2019, proposes that independent schools are allowed to make phased withdrawals from the scheme.

Are you an employer operating in a defined contribution scheme? 

For those employers operating defined contribution schemes, the minimum level of pension contributions under the auto-enrolment legislation increased to its full level from April 2019. While the Government has not officially announced any further planned contribution changes, this could happen in the future with most people currently likely to have a shortfall in retirement income.

As well as the rise in contribution levels, many changes have occurred since auto-enrolment was initially introduced in October 2012.

These changes include but are not limited to:

  • The timings of contribution increases
  • Alternative definitions to earnings periods
  • The categories of statutory letters and the prescribed wording within them
  • Declaration of compliance requirements
  • The immediate duties for new employers
  • Exemptions from the auto-enrolment duties

In the first two quarters of 2019 alone, as a result of country-wide auto-enrolment inspections instigated by the Pensions Regulator, 74% of the checks identified a breach in the legislation, with 76% of these resulting in enforcement action being taken. (Source: The Pension Regulator’s Compliance and enforcement quarterly bulletin April – June 2019).

With these points in mind, employers should aim to keep abreast of new auto-enrolment legislation changes in these areas and we would suggest that this is a good opportunity for employers to reassess their pension arrangements to ensure both compliance and best practice are met. 

Regardless of sector, all organisations are encouraged to plan ahead with their budgeting and financial management in order to continue meeting day-to-day operational needs while also meeting their longer term pension obligations, especially in an increasingly uncertain UK political and economic climate.

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