Pension protection for transferred staff

After several years of debate and procrastination, new regulations are now effective that give employees subject to a TUPE transfer protection for their future pension rights. Here we examine the new rights.

It is estimated that each year 145,000 to 175,000 employees are transferred from one employer to another when a business or part of a business is sold. Since 1981 these employees have had their terms and conditions of employment protected. However, occupational pension rights have always been excluded from that protection. Now new Regulations* have been made which, together with the Pensions Act 2004, extend the protection to occupational pensions in respect of transfers effected from 6 April 2005. Rights to personal and stakeholder pensions were already protected under the existing law.

The Department for Work and Pensions (DWP) estimates that every year around 19,000 employees who have access to an occupational scheme prior to a transfer will be moved to an employer with no provision, and therefore stand to benefit from the new Regulations. The total cost in the first year is assessed at £5 million.

Choice for employers

The new Regulations apply to those whose employment is transferred under the Transfer of Undertakings (Protection of Employment) Regulations (TUPE). All those who belonged to an occupational pension scheme prior to the transfer, or were eligible for membership, or were in a waiting period prior to becoming eligible will be entitled to pension scheme membership following the transfer provided that, in the case of money-purchase schemes offered by the former employer, the employer made or should have made contributions to it. (Those serving a waiting period can still be required to wait before becoming members of the new employer's scheme.)

The new employer can offer a defined-benefit (DB) plan, an occupational money-purchase scheme or a stakeholder arrangement, irrespective of the former employer's type of scheme. Offering membership of a group personal pension that is not a stakeholder arrangement would not meet the legislative requirements, although transferred staff can waive their statutory rights after the transfer.

In each case there are certain minimum standards that the new scheme must meet, but it need bear no resemblance to the scheme prior to the transfer, so the pension offered by the new employer could be more or less generous than the former employer's scheme.

Detailed options

If the new employer chooses to offer a money-purchase or stakeholder scheme, it must at least match employee contributions of up to 6% of pensionable pay.

If transferred employees are offered a DB scheme, the new employer must:

When the DWP consulted on draft Regulations, it proposed that, as an alternative to meeting the reference scheme test, DB schemes could offer transferred employees membership of a scheme that was certified as broadly equivalent in value to any DB scheme offered by the former employer, the transferor. That proposal has been dropped because concerns were raised about how the value test would be determined, what its basis would be and who would carry it out.

Except in relation to the option of meeting the reference scheme test, pensionable pay for DB schemes is "that part of remuneration payable to a member of a scheme by which the contributions and benefits are determined under the rules of the scheme". It seems this may allow a DB scheme to be integrated with the state scheme, and therefore apply a deduction. For money-purchase schemes, pensionable pay is basic pay, excluding bonus, commission, overtime and similar pay.

In the case of all money-purchase and stakeholder schemes and DB schemes to which matching contributions are made, the minimum levels of contribution required to be made by employers exclude rebate payments made because a scheme or individual is contracted out.

Problems of application

The 6% value option specifically allows employers to set a minimum employee contribution rate of not more than 6%. The legislation is silent on minimum contributions to a scheme that meets the reference scheme test, but it is probably envisaged that, as with any traditional DB scheme, a reasonable level of minimum member contributions could be required. Those options apart, the government's intention was to allow workers to contribute any amount of their choosing to a scheme. However, it is not clear whether the Regulations do prevent employers from setting a minimum level of employee contribution, say of 3%, even though this is outside the spirit of the new legislation.

According to the DWP's response^† to its consultation on the draft Regulations, the DB options that require employers to provide benefits to the value of 6% of pensionable pay or to match employee contributions up to 6% were included to meet the needs of hybrid DB schemes that provide either money-purchase or cash-balance benefits. They cannot comply with provisions intended for "normal" DB schemes.

This intention is not made clear in the Regulations. A traditional DB scheme will face difficulties in operating the value test. Given that DB schemes require higher contributions for older workers than for younger workers, and that the Regulations do not appear to permit an average contribution of 6% across all members, would a 6% contribution be needed for the youngest members and more for older members? Since DB schemes provide a specified level of benefits, the necessary contribution level will vary from year to year, but no provision is made for this. Similar problems arise if the matching 6% option were chosen by DB schemes.

It seems likely that transferees that wish to offer a traditional DB scheme to transferred employees will, therefore, have to meet the reference scheme test. It is more likely that the majority will offer a DC option.

It is unclear from the Regulations whether an employer could use part of its required contribution to fund risk benefits.

Issues for transferees

One issue highlighted in the DWP's analysis of responses to its consultation on the draft Regulations is that transferred staff could receive a higher standard of pension provision than existing employees. The DWP says "the Regulations do not allow the employer to take a streamlining approach to avoid forcing companies to have a multiplicity of schemes."

The government says transferred employees eligible for an occupational scheme prior to the transfer should be offered a minimum level of pension provision. It implies that employers can level up the pension terms for existing staff and points out that the new employer may have to address issues of potential discrimination.

Evasion provisions

Employers transferring staff under a TUPE transfer cannot avoid their obligations under the new Regulations by closing a scheme prior to the transfer. The Pensions Act contains a provision that employees will be considered to have been eligible for an occupational pension prior to the transfer if they would have been eligible "but for any action taken by the transferor".

No clarification of ECJ decisions

The Regulations deliberately do nothing to reduce the uncertainty arising from the rulings of the European Court of Justice (ECJ) in Beckmann (OP, July 2002; [2002] OPLR 289) and Martin (OP, December 2003; [2003] OPLR 317).

The EC Directive that the TUPE Regulations transposed into UK law excluded only "employees' rights to old-age, invalidity or survivors' benefits" from the protection it offered. As a consequence, the ECJ ruled that early retirement pensions were not excluded from protection and that, following a transfer, employees continue to be entitled to the same early retirement rights as they had before.

Lawyers are unclear precisely how these judgments should be applied and the government's stance leaves the question in the air.

Public sector unaffected

In the public sector, transferred staff (typically those whose work is contracted out to private sector employers) already enjoy more protection than that offered by the new Regulations, either under the Local Government Act 2003 or the Cabinet Office Statement of Practice. Staff are entitled to a pension with the new employer of a comparable value to that enjoyed before.

* Transfer of Employment (Pension Protection) Regulations 2005 (SI 2005/649), available from the Office of Public Sector Information's website (www.opsi.gov.uk ) via "Legislation", "UK" and "Statutory Instruments".

^† "The Transfer of Employment (Pension Protection) Draft Regulations 2005: Consultation on Draft Regulations - Response Analysis", available from the DWP's website (www.dwp.gov.uk ) via "Resource centre", "Consultation papers", "2004" and "Government response" following appropriate consultation paper.