Abolition of contracting-out for Salary Related Schemes will impact on guaranteed minimum pension (GMP) increases traditionally considered to be funded by the state.
As of 6 April 2016, contracting-out on a salary related basis will be abolished. The main impact for both employers and employees will be the increase in national insurance contributions. A less well publicised consequence of the abolition of contracting-out is the impact on those guaranteed minimum pension (“GMP”) increases traditionally considered to be funded by the state.
Defined Benefit (DB) pension schemes are required to increase annually that part of a pension which represents GMP accrued between 6 April 1988 and 5 April 1997. Current increases are calculated by reference to Consumer Prices Index (CPI) capped at 3%. A defined benefit pension scheme has no statutory obligation to pay increases in respect of GMPs accrued prior to 6 April 1988.
Legislation - current
Under current legislation, GMPs and the second (additional) state pension are linked by virtue of section 46(1) of the Pension Schemes Act 1993. Under that section, when a person in contracted-out employment reaches state pension age, the state funds increases on additional state pension/GMP in respect of (1) pre-88 accrual and (2) increases on post-88 accrual in excess of 3%. Before the basic state pension, additional state pension and increases are paid over to the pensioner, however, the total amount of GMP payable in respect of the pensioner is subtracted from the amount of additional state pension built up between 1978 and 1997. This currently has the practical effect of all increases on pre-88 GMP and increases on post-88 GMP in excess of 3% being funded by the state.
Legislation – as of 6 April 2016
From 6 April 2016, all persons reaching state pension age will be subject to the single tier pension. Paragraph 55 of Schedule 12 to the Pensions Act 2014 amends section 44 of the Social Security Contributions and Benefits Act 1992, so that the state pension provisions (including increases) under that Act will not apply in respect of persons reaching state pension age on and from 6 April 2016. The legislation does not contain any mechanism for topping up the increases currently funded by the state for persons with GMPs who reach state pension age on and from 6 April 2016.
Whilst it is expected that most schemes will have standard GMP rules, such that schemes will only be required to fund increases in respect of post-88 GMP up to a maximum of 3%, employers and trustees of DB pension schemes may want to check that there is nothing in their rules that has the effect of providing that the pension scheme picks up those increases that will no longer be funded by the state.
If you have any questions or would like more information, please contact Claire Dimmock.This information is intended as a general discussion surrounding the topics covered and is for guidance purposes only. It does not constitute legal advice and should not be regarded as a substitute for taking legal advice. DWF is not responsible for any activity undertaken based on this information.