Legal opinion: The end of pensions as we know them?

The abolition of the default retirement age (DRA) and the advent of flexible retirement could signal the end of pensions as we know them.

Traditionally, pension schemes have been about retirement and death benefits. In the new world of prolonged work, the key concept will no longer be “retirement”. Pension schemes will be more closely aligned to the concept of bringing benefits into payment, without the need to “retire”.

With the state pension age set to rise, continuing to work beyond the age of 65 may be an economic imperative for many employees. Retirement in the traditional sense may be a choice that they do not have.

Up until now, the DRA effectively allowed employers to call time on an employee’s working life once they reached the age of 65. It also gave employers a mechanism for cutting off benefit accrual in the pension scheme. That will soon be gone (on or around 1 October 2011). Employers will have to objectively justify not allowing employees to work on beyond the age of 65 – otherwise, it could be unlawfully discriminating against its employees on the grounds of age.

What are the pension implications for employers?

This depends on the type of pension arrangement they have:

• Defined-contribution schemes
  

  Defined-contribution schemes, in most cases, should be relatively straightforward to deal with. Contributions can continue to be paid as before.

  Defined-contribution schemes that offer tiered contributions linked to age may have to reconsider the process. It does not currently amount to unlawful discrimination if they target the same output benefit level. That will become more difficult to predict where there is no fixed retirement age.

  
  
• Defined-benefit schemes
  

  The abolition of DRA is only an issue for defined-benefit pension schemes that still have active members. In the private sector these types of schemes are diminishing rapidly. This is not the case in the public sector – but, following on from the Hutton report’s recommendations on public sector pension provision, public sector schemes are likely to undergo some fundamental benefit restructuring anyway.

Future benefit accrual and defined-benefit pension schemes

Where defined-benefit pension schemes are open to future benefit accrual, there are potential issues for the trustees, employer and actuary to consider. The most obvious one is accrual of benefits for service beyond what is currently DRA. Continued benefit accrual will be necessary unless departing from it can be objectively justified.

Switching employees from defined benefit to money purchase benefits, if they choose to work on after the defined-benefit scheme’s normal retirement age, will amount to illegal age discrimination unless it can be objectively justified.

Benefit design of defined-benefit pension schemes

Benefit design in defined-benefit pension schemes changes from scheme to scheme. Depending on the benefit structure, issues may arise for some schemes which currently rely on exemptions that prevent discrimination from being unlawful. Examples of such exemptions include:

• bridging pensions which are currently linked to state pension age of 65;
  
• pension benefits that are enhanced on redundancy for prospective service to the normal pension age;
  
• the definition of the normal retirement age;
  
• retention of Inland Revenue limits that were in place prior to the A-day pension reforms – this could effectively stop future accrual even in respect members who are still within their lifetime allowance;
  
• use of actuarial factors, as a result of the Test-Achats case – which ruled that it will be unlawful to use gender-related factors to determine insurance policy premiums and benefits; and
  
• the group-insured benefits exemption (which applies to employers only) – this may be a problem when salary-related death-in-service benefits are provided by way of a pension scheme.

It could become more difficult to ensure that the existing benefit structure still fits within the relevant exclusion.

These examples of the implications of the abolition of the DRA are not exhaustive, and are by no means the end of the story. Along with the introduction in 2012 of the new auto-enrolment regime, there is an awful lot for employers to think about over the next few years. Employment, pension and in some cases actuarial advice is an essential element in deciding how to deal with these issues.

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Mark Lindsay, associate, Brodies LLP