The government is plotting a statutory override to help schemes remove contracting-out rules. Tesco's group pensions director tells Ian Smith how to control the cost of the changes
Employers such as Tesco and the Co-operative are confronting the cost of the end of contracting out, and how to explain state entitlement changes to their scheme members.
Abolition of contracting out
Contracting out is where individuals give up their state second pension benefits, transferring the liability to another arrangement. Both employee and employer pay a reduced rate of national insurance contributions as a result.
From April 6, 2012, contracting out on a defined contribution basis will no longer be allowed. The government is consulting until November on a statutory override for schemes to be able to remove protected rights requirements from their scheme rules.
Under the changes, schemes will have three years to make an amendment to their rules. The consultation hasinvited responses from schemes on whether the proposed statutory override would give them enough power to make the changes.
The April 2012 end of contracting out on a defined contribution basis (see box on right) is estimated to cost £4-5bn for UK schemes and members in terms of lost national insurance contribution discounts.
Schemes have been urged to consider lowering the benefits they offer to control the cost of the reform, and to encourage members to make up the difference through increased contributions.
The Department for Work and Pensions (DWP) is currently looking at introducing a statutory override to help schemes with restrictive covenants make the necessary changes to their rules.
Schemes should be active in their consultations with key stakeholders to agree benefits changes, and to encourage members to fill the gap to avoid a hit to their retirement income.
Scheme view
Ruston Smith, group pensions director at Tesco, said the £4-5bn national insurance rebate lost by abolishing contracting out was forcing schemes to make a choice between absorbing the cost and changing their benefits.
Smith was speaking at the 2011 National Association of Pension Funds conference in Manchester last week.
He said schemes wishing to make up the cost through reduced benefits could reduce the accrual rate, change the definition of pensionable pay or change the retirement age.
But then managers face a real challenge, he added, to ensure less well-paid members of staff disengage from private provision entirely due to the higher state pension.
He said: “We have heard people say they do not want to save for their retirement, because they can get it for free through means-tested benefits.”
Schemes looking to change their design to accommodate contracting out should follow the following steps:
Agree the change among trustees;
Consult with unions and members;
Change the trust deed and rules;
Communicate the changes to members.
Smith called for more time from the government to make the changes, stating five years would be a reasonable transition. This is two more years than offered in the ongoing DWP consultation.
But communication of the changes to members would be critical, he added. Managers need to use the changes to pre-empt any backlash against the scheme.
“We have got to be able to explain that to our people,” he said. “The whole point about this is to encourage people to save for retirement we have got to be proactive.”
He encouraged schemes to include in member benefit statements the state pension they are forecasted to get, as part of this communication drive.
Finney Swift, technical support manager in the pensions technical department at the Co-operative Group, voiced her concerns about the impact of the reform on lower-paid workers.
She said: “How will they understand that their take-home pay is going to be reduced? The government has to take the lead on this.”
Swift said schemes and employers’ consultation process should come “at the end” of this government-driven process of communication.
David Haigh, deputy director at the DWP, said members may well choose to increase their contributions to maintain their current benefit level.
Haigh said the department was planning to introduce a statutory override to help schemes make changes.
He added: “How can we help schemes to do that? That’s exactly what we are looking to do.”
