Resolving age discrimination in public sector pension schemes

Resolving age discrimination in public sector pension schemes

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Last year the UK government revealed that it faced a liability estimated at £17bn in connection with ‘unlawful’ age discrimination within public sector pension schemes.  The situation arises from decisions made in the early part of the last decade which were an attempt to address the expanding cost of such schemes.

The outcome of the original review was that most public sector employees were moved to new pension schemes in 2015, which offered lower benefits.  Since there were transitional arrangements for older employees close to retirement age, many of them were able to remain within the original schemes (known as ‘legacy schemes’), leaving younger staff to transfer to the new schemes (known as ‘reformed schemes’).  It is these transitional arrangements which gave rise to the court case whose judgment was announced in 2018.  It is estimated that around three million people are affected, as the ruling affects active, deferred and pensioner members of the schemes. 

The principal difference between the legacy and reformed schemes is that while the former calculated benefits based on the salary at date of retirement, the latter use a calculation of average earnings during the period of scheme membership.  For members whose final salary is substantially above the (inflation-adjusted) level of their initial salary, the legacy scheme is likely to provide higher benefits.  However, for lower paid employees, the reformed scheme could provide a better option.  Rather than move everyone wholesale back into the original schemes therefore, members will be given the option as to which benefits they receive.

Source: Bloomsbury Wealth

Those affected are members with pensionable service on or before 31st March 2012 and on or after 1st April 2015.  They will be able to choose between old and new scheme benefits for the period between 1st April 2015 and 31st March 2022, which is known as the ‘remedy period’.  After 1st April 2022, there will be no further accrual in the legacy schemes and all members will be moved to the reformed schemes.

Following a consultation which closed in October 2020, the government has now decided to proceed with the option known as deferred choice underpin (DCU) members will initially be reinstated into the old scheme.  Its report was published earlier this month.   At retirement they will then be given the option to choose to take benefits using the reformed scheme rules.  This is intended to avoid the situation in which members would have to base their decision on a number of assumptions about the future.  As those of us for whom taking assumptions about the future forms part of the day job know, there is a significant risk of such assumptions being incorrect.  Being able to defer the decision until retirement is therefore expected to lead to an increased probability of better outcomes.  At that point, they will be able to make a direct comparison between the entitlements under both schemes and select the most advantageous option.  However, they will need to choose between one scheme or the other for the remedy period; there will be no option to elect for some benefits from one scheme and some from the other.

However, with pension schemes, matters are never quite as simple as we might wish.  The complications arise, as so often, from the combination of annual allowance and lifetime allowance calculations.  While the government anticipates that the majority of members will not be affected by this, it recognises that it would be unreasonable to penalise a member at the time when they chose to revert to the reform scheme.  This is because the DCU has been designed in such a way as to accumulate the entire accrual of reformed benefits into a single tax year.  Since this would not be the case under normal circumstances, schemes will apparently compensate members affected by this particular issue.  In fact, it is anticipated that most members whose circumstances are such that they would incur an annual allowance charge will find that this is lower than it would have been.  Where members in this position used the ‘scheme pays’ facility to meet the tax charge, the scheme will receive the refund and their benefits will be adjusted accordingly.

As regards the lifetime allowance, members who revert to the legacy scheme and have taken benefits will need to have their lifetime allowance test recalculated.  This could result in higher or lower tax charges.  It could be a particular problem for members with individual protection 2016 or fixed protection 2016.  In the former case, the calculations used to determine the protected amount could become incorrect.  In the latter case, if benefits increase faster than the allowable rate (broadly the change in the consumer price index), fixed protection could be lost.  The outcome of this could be a significantly higher tax liability than originally anticipated when fixed protection was obtained.

It would therefore be wise for members to retain all of their tax-related correspondence and documentation since 1st April 2015.  The same applies to paperwork from any of their pension arrangements as either they or their advisers will need these to determine the optimal course of action.