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Short term gain; long term pain?

Pension iStock 000010217213XSmall 149x219Philip Woolham looks at incentivising employees to leave public sector pensions.

Membership of both public and private sector pension schemes is optional; although an employee may be automatically enrolled, there is nothing to stop them leaving later.  This can give rise to an issue when the significant burden of the cost of decent pension benefits is considered, for both employers and employees.

For the Local Government Pension Scheme ('LGPS'), the risks and costs increase again.  LGPS is a 'funded' scheme, meaning its assets are held in a separate pot, invested and used in time to pay benefits.  If the fund's assets are lower than needed to provide all promised benefits, the section of LGPS fund is said to be 'in deficit', and this must be funded by the employer.  In a time of ever-tightening budgets, it must be attractive to offer a financial incentive to an employee to leave a scheme. Even if it costs money up-front, long term savings and risk reduction would surely be worth it?

We are seeing increasing discussion of public bodies and other employers offering workers money or other incentives if they give up pension scheme membership.  Although there is a focus on LGPS, the same is happening in other public sector schemes. Because public sector schemes are governed by central regulations, employers don't have the ability to make small changes or, indeed, bigger ones, such as closing the scheme. The only real way to make savings is to ask workers to leave the scheme.

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However, the generous benefits of public sector pension schemes should not be given up lightly; it is extremely expensive to replicate these benefits through private pension saving.

Workers do not give up the benefits they have already built, only those which they would have received in future. In the LGPS, employers still have to fund pension promises made before the worker opts out. But for the employer, the saving is still potentially very valuable.

For younger employees, this could mean decades of lost pensions savings; and members' spouses and partners may also lose out, with no compensation whatsoever to them.

The real question is whether doing so is in the worker's best interests. Often it may not be, even if an immediate cash payment or other incentive is attractive.

And these schemes can work from an employer's perspective. There has been at least one case before the Pensions Regulator in which a health authority's offer of alternative benefits in exchange for giving up NHS Pension Scheme benefits was acceptable, and at least one other body has made a similar offer.

In the private sector, such exercises have for several years been governed by the Code of Practice on Incentive Exercises. While this document does not have the force of law, it is endorsed by, amongst others, the FCA and the Pensions Regulator. The relevant authorities, including courts, the Pensions Ombudsman and the Financial Ombudsman, are likely to consider it if anyone brings a complaint in relation to a pensions incentive exercise. This may or may not apply to public bodies, but it may well do so if a private sector employer with exposure to a public sector scheme carried out a similar exercise.

The Code sets out strict requirements in relation to pension incentive exercises, including the banning of cash rewards for giving up rights to a pension. Permanent pay rises may, however, in some cases be acceptable.

The Code does not prevent incentive exercises, although in most cases it will require the employer to pay for individual independent legal advice for each affected worker, as well as providing clear and balanced information throughout. Each worker will only be advised to agree if the offer is in some way beneficial to them, although sometimes they will go against that advice.

If an employer has followed the Code, or falls within the Pension Regulator's current approval of a public sector equivalent, then it is unlikely that any future claim by a worker will succeed. But all parties should take great care in these exercises.

From the employer's perspective, there is another potential pitfall. A worker who has left a public sector scheme can generally choose at any point to rejoin it. They may not be able to get the exact same benefits, as that particular section of the scheme may no longer be open to new members. But they could get the benefit of the offer, and then still build up pension benefits in the same or a similar scheme. The employer would have to start making contributions again.

Normally any deal would include a commitment by the worker not to rejoin the scheme, and to repay any incentive if they do. But the employer may have to pursue the worker for repayment, possibly via the courts. If the worker does not have the money to make the repayment, actions such as bankrupting the worker or making them sell the family house are not likely to attract good publicity.

But the real risk is long term – what happens if a worker realises long after the event that it was the wrong thing to do, and makes a claim then? The worker will argue that the employer persuaded or pressured them into making a change that was not in their best interests, and did not give them the information they needed to make a sensible decision. They will want to be put back in the position they would otherwise have been in – a full pension for all the time they worked with the employer. And they will want the employer to pay for it.

So both employers and workers need to carefully balance the short and indeed longer-term gains potentially on offer. Pensions are a long-term commitment on both sides, and giving them up can have equally long-term consequences.

Philip Woolham is a senior associate at Bevan Brittan. He can be contacted on 0791 727 2296 or This email address is being protected from spambots. You need JavaScript enabled to view it..

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