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Abolition of Protected Rights from 6 April 2012

1. Background:

1.1 In 2005, the Pensions Commission recommended abolishing the option for schemes to contract-out of the State Second Pension (‘S2P’) on the protected rights basis.  The reasons were the complexities caused by administering protected rights and the lack of member understanding.

1.2 The result is that protected rights will be abolished on 6 April 2012 and this applies to all pension schemes.   All rules and references to “protected rights” in pensions-related legislation will either be repealed, or where appropriate, amended.

1.3 On abolition, protected rights will cease to exist.  They will become ordinary money purchase scheme benefits.   

1.4 Contracting-out in final salary schemes on the reference scheme basis is not subject to change.

2. Why abolish contracting-out on the protected rights basis?

2.1 By removing the option of contracting-out of S2P, it is hoped that complexity in the pensions system will be removed.   There will no longer be the need to track protected rights separately and scheme administration will become more manageable, simplifying record keeping and the processing of benefits and transfers.

2.2 In addition, there are currently a number of restrictive rules applying to protected rights.  For example, the annuity bought with protected rights funds must include an attaching survivor’s pension of at least 50% of the member’s pension. These requirements will disappear from 6 April 2012, providing welcome flexibility for members.

3. Increased NI costs and impact on employer contributions

3.1 When contracting-out on the protected rights basis, employees and employers pay reduced NI contributions in exchange for giving up accrual of the S2P. The contracted-out scheme then invests the rebates on behalf of each employee. The current rebates mean that employees pay 1.6% lower NI contributions and employers pay 1.4% lower NI contributions. In addition, HMRC pays further age related rebates into the scheme.
 
3.2 With effect from 6 April 2012, NI contributions will revert to standard rates and the rebates from HMRC will cease. Employer and Employee contribution rates usually include the contracted-out rebate.

3.3 This means that contributions into DC schemes after 6 April 2012 will reduce, with a corresponding reduction in the rate at which funds accumulate.

3.4 For DB schemes, this which means that after 6 April 2012 employer contributions will increase. Employers are likely to wish schemes to continue contracting-out on the COSR basis after 6 April 2012 in order to maintain the rebate.

3.5 Employers may therefore wish to review contribution rates that apply to their scheme after 6 April 2012.

4. What will trustees need to do?

4.1 Where scheme rules have incorporated the protected rights provisions into the rules themselves rather than just referring to the relevant legislation, the scheme rules will have to be amended to remove any such references.  The DWP has issued draft regulations for consultation providing an amendment power under section 68 of the Pensions Act 1995 without the necessity to consider restrictions on changes affecting accrued rights under section 67 of the 1995 Act or the scheme amendment power. It is proposed that the amendment power to remove scheme rules relating to protected rights is exercised by the trustees by resolution. 

4.2 The draft amendment power is very wide but there might be cases where it is not sufficient to amend scheme rules.  Accordingly, scheme rules will need to be reviewed to determine if any changes are required, and if so, whether the statutory amendment power provided by the DWP will be sufficient.

4.3 The power provided is time limited; trustees will have until the end of a three year transitional period (6 April 2015) to make amendments to their rules.  The draft regulations permit the trustees’ resolution to be signed now or after 6 April 2012 – in each case the effective date can be 6 April 2012. 

4.4 The three year transitional period will allow for the payment of final year’s rebates and the late payment or recovery of recalculated rebates due to adjustments to individuals’ NI records.  At the end of this transitional period,  HMRC will no longer track protected rights, so trustees should ask their administrators to ensure that all records are correct prior to this date.

4.5 Under the amended Disclosure Regulations, trustees must inform members that the scheme is no longer contracted-out within one month after 6 April 2012.  Trustees will also have a period of four months following 6 April 2012 to inform members of the effect of the abolition of contracting-out, namely, the removal of protected rights and basis for future accrual of scheme benefits.  Alternatively, this information can be provided by the trustees within the year leading up to the abolition date.

4.6 Trustees may want to consider additional information to include in this announcement, for example, explaining in more detail why protected rights are no longer referred to.

4.7 Member booklets will also need to be reviewed to make sure they are appropriate following the abolition.

5. Do contracting-out certificates need to be varied or surrendered and how do schemes elect to contract-out on the COSR basis?    

5.1 For DB or DC schemes ceasing to contract-out on the COMP basis, there is no need for trustees to formally surrender their contracting-out certificate; they will all be cancelled automatically on 6 April 2012.

5.2 If a DB or DC scheme currently contracted-out on the COMP basis wants to become a COSR scheme, the normal “election” processes apply.

5.3 If a COMB scheme ceases to contract-out on a COMP basis, there is no need to surrender or vary the mixed benefit contracting-out certificate in relation to the DC section or to obtain a DB only contracting-out certificate. The existing certificate will remain valid for that section of the scheme which remains contracted-out on a COSR basis.

5.4 Practical assistance in managing the run-up to April 2012 is being publicised via HMRC’s series of ‘Countdown Bulletins’.

This note only applies to pension schemes that are currently contracted-out of the State Second Pension on the protected rights basis.

Summary and action points for trustees

• Protected rights in all schemes to be abolished from 6 April 2012; schemes will no longer be able to contract-out on a money purchase basis from that date.
• Seek legal advice as to whether the scheme rules need to be amended. If yes, pass trustees’ resolution to remove protected rights provisions from the scheme rules.
• For schemes ceasing to contract-out, inform members that the scheme will no longer be contracted-out after 6 April 2012, and the effect that this will have.
• Ask the scheme administrator to ensure that all records relating to protected rights benefits are up to date.  
• Consider the need to update the member booklet and other member literature.

We would be very happy to review your scheme rules on this issue. Please contact Pitmans Pensions team or your usual Pitmans contact.

David Hosford
Partner
T: +44 (0)118 957 0363
E: dhosford@pitmans.com

Symon Rowley
Director
T: +44 (0)118 957 0301
E: srowley@pitmans.com