With the abolition of contracting out on DC schemes just two months away, Anna Lyudvig looks at how schemes can use the reform to improve their administration
Schemes have been called to use the end of contracting out on a defined contribution (DC) basis as an opportunity to simplify their administration.
Advantages of contracting-out end
There are a few key administrative advantages to removing protected rights, said Will Wolfenden, a senior consultant at Punter Southall:
Some schemes will be able to refund small protected rights pots, which were sometimes held back for members with less than two years' service;
They will not need to separately identify-protected rights, which will simplify record-keeping in future;
There will no longer be a need to inform HMRC when a member leaves the scheme;
Communications should be simplified in no longer needing to include the different treatments of protected rights;
Members will no longer need to get two annuities – one in line with their preferences and one meeting the protected rights requirements.
The government is abolishing contracting out of the additional state pension on a DC basis from April 6.
"The removal of protected rights is likely to mean reduced record-keeping and easier-to-understand member communications," said Will Wolfenden, a senior consultant at Punter Southall.
This could lead to reduced administration costs for schemes and help members have a better understanding of their pension saving.
But schemes are warned rules may need to be amended and members would need to be communicated to over any changes in their benefit statements.
The changes will mainly affect contracted-out money purchase schemes and hybrid schemes contracted out on a DC basis, but it will have limited impact on defined benefit (DB) schemes.
Simplifying your admin
Wolfenden said the abolition should be a welcome simplification for schemes once the necessary changes had been made to scheme rules.
"It will also mean money purchase schemes will not have to retain responsibility for small pots of protected rights that may not come into payment for many years," he said.
When a scheme ceases to contract out it has to carry out a reconciliation of its contracted-out liabilities.
Protected rights are ringfenced ... this is like having a corner of your bank account over which you do not have full control
With all schemes ceasing at the same time, this process can be very slow and devilishly detailed, said Richard Butcher, managing director at Pitmans Trustees.
But abolition will ultimately make life easier, he said, because schemes will no longer have to accommodate the complexities of housing contracted-out liabilities.
He said: “At the moment protected rights are ringfenced to provide certain benefits. This is like having a corner of your bank account over which you do not have full control."
However, many final salary schemes have been exaggerating their value as a result of contracting out, he added.
“Members rarely appreciate the impact of contracting out," he said. "This means the employer will need to reduce future service accrual to maintain its costs at the same level.”
How the abolition affects your scheme
The process of amending scheme rules can vary between schemes, meaning some can make changes more easily than others.
Contracted-out deductions will still appear on individuals' state pension breakdowns and these may lead to queries levied at the scheme
Catherine Cunningham, policy adviser at the National Association of Pension Funds, said these changes could be complicated and expensive depending on how the rules are drafted.
She said: “One of the main technical challenges schemes will face is around amending their rules to take account of the lost contracted-out rebate.
"[Schemes could] choose to adjust contribution levels or accrual rates to take account of the additional income employees would receive in the future from the state pension system."
But the communication with members is vital and schemes must ensure they explain all the changes clearly.
Tony Attubato, head of dispute resolutions at the Pensions Advisory Service, said managers will have to take members through the differences in format of their benefit statements.
This may bring some schemes to continue identifying protected rights, he added.
“Some schemes may want to continue doing so because contracted-out deductions will still appear on individuals' state pension breakdowns and these may lead to queries levied at the scheme,” he said.
