Contracting out

A new challenge to the funding of DB schemes is expected in the run up to April 2016 when the ability of salary-related pension schemes to contract out of the State Second Pension comes to an end. Employers with contracted-out schemes who benefit from a 3.4% reduction in National Insurance contributions, and members who pay 1.4% less, therefore face increased pension costs.

Employers will be tempted to change their scheme rules to recoup those costs but in general, changes to pension schemes have to be made through consultation (under sections 259-261 of the Pensions Act 2004, the Occupational and Personal Pension Schemes (Consultation by Employers and Miscellaneous Amendment) Regulations 2006 as amended, and the Occupational Pension Schemes (Consultation by Employers) (Modification for Multi-employer Schemes) Regulations 2006). Disputes can end up in the courts, with mixed results.

However, under the Pensions Act 2014 (Part 1, Section 24 and Schedule 14), sponsoring employers of contracted out schemes will be able to change the rules, using an override power that will be available for five years. The power cannot be used to change the rules of public service pension schemes (or other types of scheme to be prescribed in regulations). Nor can the increased costs be passed on to members of contracted out schemes in formerly nationalised industries (rail, Transport for London, electricity, coal and nuclear waste and decommissioning) who are “protected persons” under legislation dating back to their privatisation.