Govt opts for deferred choice underpin solution to McCloud

In a response published on Thursday to the ‘Public service pension schemes: changes to the transitional arrangements to the 2015 schemes’ consultation, which received hundreds of replies from individual members, trades unions and other organisations, the government stated its conclusion was in line with majority opinion.

There were two proposed remedies to the McCloud problem, the age discrimination case arising from a 2015 review of public sector pensions that moved most members to a new, reformed pension scheme, while allowing those within 10 years of retirement to stay within the legacy scheme.

Pension schemes will need to retain the ability to work out pension rights under two different arrangements for decades to come and will have to be able to explain those calculations so that members can check if they are correct

Steve Webb, LCP

This having been found by courts to be discriminatory against younger workers, the government was committed to remedying the situation by extending a choice to members as to which of the schemes they would like to be in, and so which benefits they would like to receive with respect to the remedy period covering their service between April 1 2015 and March 31 2022.

As set out in the response to the consultation, this option was deemed preferable to moving everyone back into the legacy scheme, “even though this would remove the unlawful discrimination identified”, as many members might have found themselves better off in the reformed scheme.

One solution was an immediate choice, a self-explanatory route that would have seen affected members choose immediately which of the two schemes to be in. The other option was the deferred choice underpin, under which members may opt at retirement for whichever scheme would have produced the larger pension.

In his foreword to the response, Steve Barclay, chief secretary to the Treasury, wrote: “The significant majority of responses backed the introduction of a deferred choice underpin as the way to remedy the identified discrimination. This approach will enable eligible members, when they retire with a pension, to choose whether the legacy or reformed schemes would be better for them” for the mentioned period. 

“Respondents offered strong and convincing arguments to support this view, which are set out within this consultation response. It is clear to me that the deferred choice underpin will provide greater certainty for members and is also the right approach for schemes and the government,” he continued. 

“It avoids the need for members to make assumptions around things such as their future public service career and retirement age, which would increase the risk of making an incorrect decision, particularly for younger members. It also results in a more manageable administrative challenge for schemes as the overall task will be spread over decades, rather than just a few years.” 

Govt should ‘not attempt to pass costs’ to members

The decision was widely praised by industry figures and experts. Former pensions minister Ros Altmann told Pensions Expert: “The deferred choice option is best for members as it gives them the best opportunity to get the best of both schemes for their own circumstances.

“The deferral also gives schemes more time to deal with this, but there will be difficulties in making assessments going back over many years.”

Garry Graham, deputy general secretary of the union Prospect, argued that the “public servants who have suffered from unlawful age discrimination as a result of government pension reforms deserve a fair remedy, and we welcome the Treasury’s decision today as a big step towards securing that outcome”.

But he added: “It is now essential that the government commits to funding the cost of rectifying this discrimination, and does not attempt to pass the costs on to pension scheme members.”

However, the solution will be expensive and difficult to implement. Tom Selby, senior analyst at AJ Bell, warned that McCloud will “reportedly cost an eye-watering £17bn to put right”.

Furthermore, he noted that the Treasury “says those costs will ‘feed into employer contribution rates’, meaning pension costs for public sector employers are almost certainly going to go up, placing a drain on resources at the worst possible time”.

Years of complexity ahead

The deferred choice underpin is not without its drawbacks, however. Olly Topping, senior associate at Sackers, told Pensions Expert that it will create significant administrative complexity, with schemes having to run “dual records” potentially “decades into the future, to allow the deferred choice underpin choice to be made”.

“There are also complex points about individual taxation, because the deferred choice underpin might mean that historic pension tax years need to be ‘unpicked’, both in the immediate future (as members are moved back into the legacy schemes), and at the point of retirement (if members choose to take the reformed scheme benefits),” he continued. 

“Members should be strongly urged to keep their P60s and (if applicable) tax returns to make sure they can deal with any tax issues that might arise in the future.”

Former pensions minister and LCP partner Steve Webb concurred. The deferred choice underpin option means scheme members will not know for certain what rules apply to their pension until they retire, he said. 

While opting for this solution was “understandable”, Sir Steve said: “Between now and retirement this means that members will simply not know what their pension is going to be, and will also have to hope that future governments keep this promise.

“This will make retirement planning even more uncertain. Pension schemes will need to retain the ability to work out pension rights under two different arrangements for decades to come, and will have to be able to explain those calculations so that members can check if they are correct.” 

Member communication will be a particularly important and challenging task, he said. “There is no doubt that unpicking this mess will lead to decades of complexity and uncertainty for public service pension scheme members.”