Pension Protection on Transfer of Employment Provisions
Provisions in the Pensions Act 2004 and the supporting Transfer of Employment (Pension Protection) Regulations SI 2005/649 which come into effect from the 6th April 2005 ensures that for the first time transferred employees who had access to occupational pension provision with an employer contribution prior to a transfer must be offered employer pension provision following the transfer.
Transferee employers will have the flexibility to offer either an occupational or stakeholder of a prescribed level.
Background
European Directives provide for Member States to ensure employee terms and conditions of employment - as a minimum - are safeguarded where there has been a business transfer. The Transfer of Undertakings (Protection of Employment) Regulations (referred to as TUPE) implemented the directives into UK law. TUPE Regulations are the responsibility of the Department for Business, Enterprise and Regulatory Reform (DBERR).
However, as the Directives did not extend this mandatory requirement to benefits under an occupational pension scheme as relate to old age, invalidity or survivors no express requirement to protect these is included in the TUPE Regulations.
In light of new EU Directives, DBERR proposed updating the TUPE Regulations and extending them to include occupational pension provision.
In September 2001 the DBERR issued the consultation paper Government Proposals for Reform. This looked at the existing TUPE Regulations and sought views on the provision of explicit legal protection for employees’ occupational pension rights on transfer. In the DWP Green Paper Simplicity, security and choice: Working and saving for retirement the Government set out two possible options for further consideration and comment.
In June 2003 the DWP paper Working and saving for retirement: Action on occupational pensions stated the Government’s proposal for a minimum of a matched contribution of 6% to a stakeholder pension. The employer must match an employee’s contribution up to a maximum of 6%, with either party being able to contribute more at their own discretion.
Why is the change needed?
Prior to April 2005 there is no obligation for a transferee employer to offer any form of pension provision where employees previously had access to an occupational pension. Many employers already offer occupational pension provision to transferred employees as a matter of good business sense. However, business transfers are often used as a means to scrap employer pension contributions altogether.
How will pension protection on transfer of employment offer employees protection?
The Pensions Act provides a prescribed level of protection for employees, where businesses transfer, when they were either:
- active members of the transferor’s occupational pension scheme;
- eligible to be members of a transferor’s occupational pension scheme; or
- in a waiting period before becoming eligible to be a member of a transferor employer’s occupational pension scheme.
Transferee employers can offer transferred employees membership of either:
A defined benefit contribution scheme which
- meets the Reference Scheme Test
- provides benefits equal to or greater than 6% of a member’s pensionable pay for each year of service, in addition to employee contributions. Employees are not required to contribute at a rate of more than 6%
- provides for the employer to match employees contributions up to 6% of pensionable pay
A defined contribution scheme which
- provides for the employer to match employee contributions up to 6% of pensionable pay
A stakeholder pension scheme which
- provides for the employer to match employee contributions up to 6% of pensionable pay
as a condition of their contract of employment.
Why a 6% match?
- The proposal for a minimum matched contribution of up to 6% to a stakeholder pension strikes a sensible balance. It ensures that employees continue to benefit from an employer pension contribution after transfer, but offers employers a flexible range of options for how they make those contributions.
- A range of recent research reports – including surveys by the Government Actuary Department, National Association of Pension Funds and DWP survey of Employers Pension Provision – indicate that on average employers contribute between 5 and 7% towards defined contribution pension schemes and between 5 and 6% for group personal pensions and stakeholder pension scheme.
- Some employers could face significant costs if they were obliged to set up and fund an equivalent scheme from scratch. This provision ensures that these employers have a flexible alternative while still ensuring that employees benefit from employer pension contributions.
Examples – What will this achieve in terms of final pension?
- A worker who contributes 6% that is matched by his employer could attain a replacement rate of between 40% and 60% of his final salary on retirement from his private pension alone. This will be higher if state second pension benefits are included as the 6%+6% contribution is net of any contracting-out rebate put into the scheme by the employer.
- Clearly, this amount will be subject to the performance of market returns and the pattern of his career over the working life.
- By contrast a normal contracted-out defined benefit scheme may produce a replacement ratio of less than 2/3rd's final salary when taking into account losses from moving jobs.
For information – the assumptions underlying this example:
- Real wage grows at 2% a year as in Green Paper.
- Fund grows at 4% in real terms as in Green Paper to generate a 40% replacement rate, at 5% in real terms to generate a 50% replacement and 6% in real terms to generate a 60% replacement rate.
- 1% of fund goes in costs a year, as in Green Paper.
- Starting salary of £16,000 a year at 25 (the replacement ratio is independent of this figure). Final salary at 65 is £34,636.
- Present level annuity rates (0.07) applied to pot as in Green Paper. Although they will have changed in the intervening period.
- Contribution rates 12% (consisting of matched 6% contribution).
- The analysis is in real terms.
The average contribution rate to defined benefit pension schemes is 16% (GAD 2000 survey page 42).