Pensions World

Sarah Welling, Pinsent Masons, on the key considerations of switching from a trust based to a contract based DC scheme

As well as closing defined benefit (DB) schemes both to new entrants and to future accrual, more and more firms are also looking to close their trust based defined contribution (DC) plans and offer a contract based version instead.

Pension benefits are part of the overall remuneration package which an employer chooses to offer to its employees. Whether it is for cost reasons, for reasons of employee fairness or for pure harmonisation, companies are streamlining their pension arrangements, often ending up with a variety in place for all their employees. For example, an employer may have established a group personal pension or stakeholder scheme for new employees but longstanding employees, or those acquired on the purchase of another company, may be members of an historic DC trust based scheme.

Role of the trustees

A change in employee benefit strategy, such as the closure of a DC trust based scheme and the provision of an alternative, contract based arrangement, is a company driven process. It is for the employer to make available any other pension arrangement it chooses to its employees and deal directly with the contract based scheme provider, including any negotiation on the provider’s charges.

However, the trustees will usually have some role to play. Trustees should properly review the terms of the proposed arrangement to make sure that they do not divert too much from what is currently being provided as would make it inappropriate for them to agree to the closure of the scheme. Their focus should be on whether or not the transition from one to the other appropriately takes into account members’ interests.

Trustees should take care not to advise the members in relation to any new arrangement being proposed by the employer or any other personal pension arrangement to which they may be considering transferring their benefits. Trustees should instead recommend that members take independent financial advice in relation to these decisions.

Obligation

If scheme rules provide, as they often do, that employees will become scheme members immediately on joining service, an amendment will need to be made when the scheme is closed down. The amendment will ensure that anyone commencing employment will not be automatically eligible to join the DC scheme.

The employer contribution rule is likely to contain an obligation on the employer to contribute to the scheme in relation to the members’ benefits. If the scheme continues as a frozen scheme (ie with no-one being able to accrue further DC benefits), the employer will no longer have an obligation to contribute. The rules will need to be amended to provide for this.

In terms of fulfilling their role when exercising the amendment power, trustees should ensure that they are satisfied that any new arrangements proposed by the employer adequately protect the current members. This will involve a comparison of the DC trust based and contract based benefits as well as consideration of the employer’s reasoning. If they are satisfied, trustees can agree to the change.

Requirement to consult

Employers have a legal obligation to consult in relation to the ceasing of accrual for existing DC members. The requirement is a consultation period of not less than 60 days.

Although trustees do not take part in this process, they should be satisfied that the consultation is undertaken properly before they can agree to amend the scheme rules.

A question of consent

Members who wish to transfer their DC benefits to other arrangements have three options. The benefits can be transferred to:

• any new arrangement which the employer is considering establishing
• any other personal pension arrangement which the member has in place already or
• a s32 buyout policy in the name of the member.

For employers keen to transfer members’ benefits from one scheme to another, the burning question is can they force members to transfer their benefits? If the answer is no, can they incentivise them to do so?

Can members be forced to transfer their benefits out? Probably not. More often than not the transfer out provisions in the scheme rules will provide for members’ benefits to be transferred to another pension arrangement, or a buyout policy, but only if the member requests it.

Where the rules provide for members’ benefits to be transferred without consent, they must be read in conjunction with the statutory requirements. The preservation legislation is there to do just that – preserve members’ benefits – and so, other than in certain specific circumstances, there is a statutory prohibition on a transfer of DC benefits to another pension arrangement without the member’s consent, whether the receiving arrangement is one established by the employer or otherwise.

Where the employer wants to buy out members’ benefits without consent, this will only be possible for members who left pensionable service at least 12 months previously. This will mean that benefits of active members cannot be bought out without their consent.

The benefits of deferred members who left pensionable service at least 12 months previously could be transferred out, provided that they satisfy certain other statutory criteria (which will usually be the case).

It may prove useful to be able to transfer out benefits of deferred members without consent, if, for example, they do not respond to any communication that the employer may issue.

Can members be incentivised members to transfer out? If so, how? Since, in most cases, an employer cannot force members to transfer out their benefits, it may consider offering incentives to members. For example, if the charges incurred by the contract based scheme provider are greater than those in the trust based DC scheme, the employer may offer to meet that cost.

The Pensions Regulator (TPR) has issued guidance in relation to inducement offers. Although it relates to inducements for transferring out of DB arrangements, there are some broad principles which can be applied to transfers from trust based to contract based DC arrangements. Unsurprisingly, TPR states that it would be concerned to see members disadvantaged by inducement led transfers out. However, TPR is keen for scheme members to retain responsibility for their own financial decisions. For both these reasons, it is important that members are given enough information to be able to make an informed choice.

Trustees should review any communications between the employer and members, including information comparing the current, trust based arrangement and any alternative arrangement being proposed, in order to ensure members’ benefits and options are protected as much as possible.

Informed decisions

Any communication to members should be clear in setting out the options available. Although it is up to members to choose if they wish to transfer out their benefits and, if so, to what pension arrangement, trustees should ensure that members can make informed decisions.

Setting out the options available to members will enable them to discuss the financial implications of each option with an independent financial adviser.

Protection

Whether or not a scheme is wound up or run as a frozen scheme, if members choose to transfer their benefits, trustees must ensure that they have received a discharge from those members, confirming that they are no longer responsible for providing benefits to or in respect of those members. Often when members are sent communications explaining the options available to them, a discharge form, to be signed by the member, would be included.

Sarah Welling is an associate in the pensions team at Pinsent Masons; sarah.welling@pinsentmasons.com