Employers must consider employee pensions if they cut pay

The downturn has prompted employers to roll out measures to cut payroll costs. But the impact on the employer’s pension arrangements is sometimes overlooked – resulting in last-minute obstacles. How can those in HR, tasked with planning such projects, avoid meltdown? Emily Forrest, associate at Sacker & Partners, advises.

Where major changes to pensions are proposed – for example, closing a scheme, or moving from final salary to money purchase – most employers are aware of the issues that lie ahead, such the need to consult, perhaps changing contractual terms, and amending pension scheme rules.

However, there are other changes, particularly in the current economic climate, where pensions are not the focus but can still be impacted unintentionally. In the worst cases, this can lead to misleading employees about what the changes mean to them, or reducing the cost savings to employers.

When considering changes, it is important pensions are tackled up front. Consider what you want pensions to look like after the changes, or if you want to leave the pension scheme as it is, ask what impact the changes will have on pensions. It is easy to assume the pension scheme will accommodate whatever the employer wants to achieve. But unfortunately scheme rules don’t always co-operate. For example:

  • Pension rules can contain automatic benefit improvements for people who are made redundant, actually increasing the ongoing cost of the scheme for the employer.
  • If employees agree reduced pay in a downturn, how is this intended to affect other benefits? Pension rules nearly always base death in service benefits on a multiple of pay. This may change automatically with a change in basic pay, but not always. It may be fixed annually (for example, at a date before pay is reduced). Does the employer want to reduce death benefits or not? Knowing how the scheme rules work is essential to explaining the affect on employees.
  • In a final salary pension scheme, reducing pay will normally reduce all benefits earned to date, not just benefits earned in the future. This should be explained to employees, or, alternatively, the scheme rules will need to be changed to stop this happening.
  • An employer might encourage employees to take unpaid leave. But scheme rules are rarely designed to accommodate this. The rules will generally treat members as if they had opted-out. Re-joining won’t normally be an automatic right, and may be prohibited under the rules if the scheme has been closed. If the employer intends terms and conditions to be unchanged when employees return, scheme rules may well need to be amended to achieve this.
  • Reducing hours will impact on how a final salary pension is calculated. How this works can vary depending on the precise formula in the pension rules, and it is important to check that the result under the rules matches the intended change to the benefit.
  • Employers may need to act fast to respond to a downturn, but should remember when timetabling changes that reducing pension contributions requires a statutory consultation period of at least 60 days.
  • Where the pension scheme is run by trustees, they will normally have to agree any changes to the scheme. Where time is of the essence, arrangements may need to be made for the trustees to meet outside their normal quarterly meetings.

Forward planning is essential

Pensions’ implications often drift down the list of priorities, especially where the changes proposed do not appear on the face of things to have much to do with pensions. The good news is that with a little forward planning, the pensions impact can be factored in to the overall package of changes, or pension scheme rules can be changed to accommodate the employer’s plans. Bumping those issues back up the list can save a great deal of hassle later on.

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