Avoidable Headache Caused by GMP Revaluation – do you have a contracting-out hangover?
With Christmas and New Year parties well and truly over, and whilst trying to recall last year’s events, hopefully you will have remembered that contracting-out on a defined benefit basis was abolished with effect on and from 6 April 2016. Since then it has been a roller-coaster nine months (not just for pensions) so you would be forgiven for forgetting that trustees only have until 5 April 2017 to pass a resolution to prevent a GMP revaluation underpin arising.
The general position for GMP revaluation prior to 6 April 2016 was that section 148 revaluation was used whilst a member remained in contracted-out employment, and trustees of plans had a choice between using section 148 revaluation or fixed rate revaluation when an individual ceased to be in contracted-out employment prior to GMP age. Regulations now require GMP revaluation to be calculated on the section 148 basis until the member leaves pensionable service. However, many pension plan rules will not reflect the new legislation and will still provide for a switch to fixed-rate revaluation to occur at the cessation of contracted-out employment. If such a plan had active members immediately before 6 April 2016, and those active members ceased to be in contracted-out employment on that date but remained in pensionable service, there could now be a clash between the plan rules and legislative practice. In these circumstances, particularly if a plan uses fixed-rate revaluation after a member leaves, there is a risk of an underpin arising from 6 April 2016, where the affected members could potentially be entitled to GMP benefits revalued by the higher of the GMP revaluation provided by the rules and the GMP revaluation required by the revised legislation.
This is not an insurmountable headache: there is a remedy to the problem via use of a statutory power available to trustees to resolve to amend their plan’s GMP rules to prevent the underpin arising. The power allows trustees to amend rules retrospectively to 6 April 2016, but must be exercised prior to 6 April 2017. To alleviate this particular symptom, we therefore recommend that the best remedy is action before the deadline.
There are some additional hangovers from the abolition of contracting-out which trustees and employers will need to consider if they have not done so already.
First, prior to 6 April 2016, members and employers of a contracted-out plan paid a lower rate of National Insurance contributions (NICs). If members of a formerly contracted-out plan were in active pensionable service on 6 April 2016, there will now be additional liability for both those members and employers in the form of increased NICs. It is possible (under statute) for employers to unilaterally amend their plan rules to increase employee contributions to pension plans and/or adjust future benefit accrual, to offset the additional costs to employers of increased NICs. The statutory power must be used before 6 April 2021 and requires a 60-day consultation period with members.
Second, trustees should also check that their plan’s rules do not stipulate that certain increases to GMPs must be paid from the plan if they are not paid by the State. Prior to 6 April 2016, increases on pre-1988 GMPs and on post-1988 GMPs in excess of 3% p.a. were effectively covered by the State as part of the increases paid on the state second pension, but ceased to be so following the abolition of contracting-out. Generally speaking, it is rare that plan rules expressly provide that such increases must be paid from the pension plan, but trustees would be wise to check the position. Likewise, trustees may wish to check what has been told to members in communications and plan booklets about increases on pre-1988 GMPs and on post-1988 GMPs in excess of 3% p.a.