Contracting out: here's looking at you kid

Like Bogart and Bergman’s feelings for Paris, perhaps more than a few of us thought we’d always have contracting-out.  We won’t and it shouldn’t be news to you that contracting-out is being abolished from 6 April 2016.

The introduction of the single-tier state pension means there is no additional state pension to contract-out of.

Obvious implications of this move include:

First things first - GMP reconciliation

If contracting-out ends and you haven’t started reconciling, you’ll regret it; maybe not today and maybe not tomorrow, but soon… and for the rest of your life.

At the end of 2018, HMRC’s ability to track GMPs will cease.  It will then be up to the pension industry to know who has a GMP, how much it is and who is responsible for paying it.  In anticipation of that responsibility being harder to discharge than it sounds, a lot of work is needed by all of us to ensure data held by schemes is reconciled with that held by HMRC.

HMRC offer a bulk reconciliation solution to the industry; the ’Scheme Reconciliation Service‘(SRS).  Before 6 April 2016 active schemes can request details of the contracted-out data held by HMRC for preserved and pensioner members within schemes you look after.  Data for current active members will follow in 2017.  There’s also Shared Workspace which can be used for schemes which are already closed.

In early 2015 Barnett Waddingham took a decision on behalf of its clients to request this data and have since produced ’State of Play‘ reports for trustees outlining the extent of the discrepancies between the two sets of records and a reconciliation proposal.  Pleasingly, the majority of Barnett Waddingham clients are now in the process of reconciling using SRS and we are hopeful of completing these projects before the end of 2018.

What about the members - how will they COPE?

The single-tier state pension may intend to simplify benefits individuals receive in future, but it adds another layer of complexity for those who have been contracted-out and are yet to reach State Pension Age (SPA).  The Government have announced a Contracted-out Pension Equivalent (COPE) will be deducted from single-tier state pensions for these people and these are currently included on state pension forecasts.

A COPE is designed to be broadly equivalent to the additional state pension an individual gave up by contracting-out but is a complicated figure to explain.  The only definite ’benefit‘ of contracting-out that we can illustrate to members is their GMP.  How do we explain an additional deduction for those contracted-out after 1997 on a Reference Scheme Test or Money Purchase basis?

Trustees need to be prepared to answer questions from their members about new state pension entitlements; so they may want to review standard communications they send to members on leaving and/or at retirement. 

And now for something (not so) completely different - GMP rectification

Once a GMP reconciliation exercise is complete, trustees will need to consider GMP rectification.  Some members’ benefits will have been over or underpaid because an incorrect GMP figure was used to calculate benefits on leaving or retirement, so trustees should consider adjusting benefit payments accordingly.  The scope and timing of rectification exercises should be carefully considered.

What should you rectify?  I suspect trustees will find it difficult to ignore underpayments but may have more latitude with regard to non-recovery of overpayments via the use of tolerance levels and materiality limits.

When should you rectify?  A pension increase represents ideal timing to be reviewing pensions in payment as you’re already changing the amount a pensioner receives.  However, the longer an exercise is left, the bigger any current over or underpayments will become – how far away is your next pension increase (assuming you don’t have time to rectify benefits before 1 April this year!)?

But hold on a minute.  With GMP equalisation still looming large in the (hopefully not very distant) future, trustees may like to consider holding off on any rectification until the effects of equalisation are known.  We don’t want to be the ones saying 'change it again, Sam' once the GMP equalisation conundrum has been solved…

This blog was featured in the March/April 2016 edition of Engaged Investor