The end of short-service refunds: Some quirks to look out for

Once a member has built up 30 days’ qualifying service, they are entitled to the short-service benefit like any other deferred member. 

The maximum period of service for a short-service refund was two years, and this is still the case for pre-October 1 joiners.  

The change in legislation for new DC members does not automatically flow through to scheme rules, and trustees and employers have been busy checking and updating scheme provisions to make sure they dovetail with the new requirements. 

Scheme administration processes and member communications have also been updated. 

A few months into the new regime, what observations can we make and what actions might trustees or employers want to take in light of these? 

Updating scheme rules

For trustees, updating scheme rules has thrown up some quirks to look out for:

• Rules might repeat the wording of the old legislation and provide a right to a refund for up to two years – but paying out a refund to a new joiner with more than 30 days’ qualifying service will be an unauthorised payment under the tax rules. A rule change is needed.

• The auto-enrolment legislation does not fit perfectly with the new 30-day rule.

Under auto-enrolment, a member has one month to opt out, and any contributions they make are returned via the employer because the employee is treated as never having been a member of the scheme.

This “one month” opt-out provision is different from getting a short-service refund for up to 30 days’ service, and trustees should check scheme rules to make sure any attempt to reflect the auto-enrolment option works with the new short-service refund requirements.

• Members with any defined benefits are unaffected by the change. 

This means that a new joiner who has built up both defined benefit and DC benefits in a hybrid scheme can still take a refund of all their benefits, including any DC, if they opt out within two years. Rules and administration processes should cater for this.

It remains to be seen whether the change to short-service refunds will push employers towards offering personal, rather than occupational, pension schemes to their employees

Small pots

For employers, the impact of the new 30-day rule is still playing out. Employers with high staff turnover or temporary employees are likely to see a build-up of small pension accounts, which will need to be administered – at a cost. 

Before October 2015, members with less than two years’ service usually took a refund of their contributions (around 20,000 refunds a year were paid out according to the government) and the ‘left behind’ employer contributions could be used to meet scheme expenses and future employer contributions. This cash flow aid for employers has been largely eliminated. 

What options do schemes have for dealing with the likely glut in small pension pots?

The April 2015 pension flexibilities mean cash sums can be paid out where previously it would have been difficult to secure an annuity with a small pot, and if ‘pot-follows-member’ is resurrected in the future, it should, as was intended, alleviate the problem of stranded small pots.

It remains to be seen whether the change to short-service refunds will push employers towards offering personal, rather than occupational, pension schemes to their employees.

Short-service refunds have never been available from personal pension schemes but, for an employer weighing up its options, this is now far less of a disadvantage than it used to be.

Adeline Chapman is an associate at law firm Sackers