Trustees and employers offering money purchase benefits may face increased member communication and valuation requirements as a result of the government’s new statutory definition.
Under section 29 of the Pensions Act 2011, schemes capable of developing a funding deficit will be classified as defined benefit rather than money purchase. The definition came into effect from July 24 this year, with retrospective effect from January 1 1997.
The government estimates around 800 out of 40,000 schemes will be affected by the change.
Background to changes on money purchase
The government announced its intention to change the definition after the Supreme Court's July 2011 decision in Houldsworth v Bridge Trustees.
"[The court] concluded it was possible for certain benefits to be within the definition of money purchase benefits despite there being a potential mismatch between assets and liabilities," explained Sackers partner Zoë Lynch in a recent comment piece.
"The DWP immediately announced it would legislate to reverse this decision – with retrospective effect."
However transitional regulations confirm decisions taken between 1997 and the coming into force of the legislation will be validated, except in circumstances relating to winding-up and employer debt where there is a risk to member benefits.
The Pensions Regulator anticipates that schemes most affected by the change will be those offering cash balance benefits, which give a guaranteed interest rate or rate of return, those that promise a certain level of benefit, as well as those where the scheme pays retirement income directly from its own funds.
Legal experts said schemes that provide money purchase benefits should review these benefits to check whether they are reclassified.
Schemes that have been reclassified as DB will be subject to valuation requirements years as well as the Pension Protection Fund’s levy.
Kirsty Bartlett, partner at law firm Squire Sanders, said: “If there is a possibility of a funding deficit then that is going to be subject to actuarial valuations every three years; if there is a deficit that could mean a recovery plan and contributions.”
Rosalind Connor, partner at law firm Taylor Wessing, said new valuation duties would likely require schemes to carry out an administrative overhaul.
“That is going to require someone to make sure the right information is available to the right people,” said Connor.
Overhauling member comms
Members of money purchase schemes are entitled to the value of their pot in the event of a scheme winding up.
However, if their scheme has been reclassified members will be entitled to 90 per cent of their benefits at the time the scheme enters the PPF if they are below normal retirement age and 100 per cent if they are at or above that age.
Tim Smith, partner at law firm Eversheds, said trustees will need to clearly communicate the protections now afforded to members' benefits. “Trustees don’t want to be misrepresenting what the benefits are,” he said.
Money purchase additional voluntary contributions will not be affected by the redefinition unless they are converted to buy extra pension from the scheme.
These payments – which do not receive inflationary increases – involve the scheme guaranteeing to pay the member an agreed pension amount each year.
However, the transitional regulations do not cover instances where these pensions are already in payment, said Bartlett.
“Technically, under the regulations, trustees would have to go back and treat that as a [DB] pension and pay an increase on it,” said Bartlett.
Bartlett said one of her clients whose scheme has been reclassified as DB is looking to alter its benefits structure to convert it back into a money purchase arrangement.
This will require them to seek members’ permission and the scheme would need to create a separate money purchase section for those that consent, she said.
