UK: Pension rights on business transfers

Recent legislation represents a significant change to the treatment of pension rights on business transfers.

In the past, occupational pensions have been excluded from the automatic transfer of employment rights under the Transfer of Undertakings (Protection of Employment) Regulations 1981 ("TUPE"). This is hardly surprising as it might be very onerous to replicate exactly an employee’s pension rights in a defined benefit scheme. The Government was also concerned that imposing onerous pensions obligations on TUPE transfers would stifle legitimate business transfers. However, it seemed anomalous that while other benefits had to be replicated, there appeared to be no obligation to provide any pension benefits at all. In June 2003, the Government announced that they were planning to change the pension provisions in TUPE with the aim of ensuring that: "workers who already enjoy pensions contributions will not have them withdrawn by reason of a transfer, or because a company is taken over. In achieving this we want to make sure that we do not place an excessive burden on the new employer".

On 6 April 2005, Sections 257 and 258 of the Pensions Act 2004 (the "Act") and the Transfer of Employment (Pensions Protection) Regulations 2005 (the "Regulations") came into force. This new legislation protects an employee’s pension rights in relation to an occupational pension scheme when the business in which they work transfers between employers. The new employer is not required to provide identical pension arrangements to those offered by the old employer, but it must comply with certain obligations in relation to the value of pension benefits provided by the old employer.

The legislation applies to employees:

• who become employed by a new employer as a result of a business sale under the TUPE Regulations; and

• who had actual or contingent rights in relation to an occupational pension scheme immediately before the transfer.

While the Act requires the new employer to provide a pension scheme for the transferring employees, there is no obligation for it to replicate the particular type of pension scheme offered by their old employer. Therefore, the new employer can choose which pension scheme to provide for the transferring employees (i.e. defined benefit scheme, defined contribution scheme or a stakeholder arrangement) and the obligations placed on it will depend on the type of pension scheme it chooses to provide.

Where the new employer’s scheme is a final salary scheme (or more specifically not a money purchase scheme) it must:

• comply with the contracting-out reference scheme test;

• provide for benefits of a value of at least "6% of pensionable pay for each year of employment" together with the total amount of any member contributions. Members cannot be required to contribute more than 6% of their pensionable pay. For these purposes pensionable pay means "that part of the remuneration payable to a member of a scheme by reference to which the amount of contributions and benefits are determined under the rules of the scheme"; or

• make "relevant contributions" to the scheme on behalf of its employees. To make relevant contributions, the new employer must match employee contributions subject to an upper limit of 6% of basic pay. Basic pay does not include bonus or overtime payments and no account is taken of any deductions made for tax, national insurance or pension contributions.

Where the new employer provides a money purchase or stakeholder scheme for the transferring employees, it is required to meet the same relevant contributions requirement (as set out above). A money purchase scheme is a scheme under which all the benefits that may be provided are money purchase benefits. Therefore, a hybrid scheme (i.e. a final salary scheme with a money purchase section) cannot be classed as a money purchase scheme. This means that if the new employer is providing the transferring employees with membership of the money purchase section of its final salary scheme, it may choose between the obligations set out above.

The Act actually states "it is a condition of the employee’s contract of employment" with the new employer, that from the date of the transfer, "the employee is, or is eligible to be, an active member of an occupational scheme" or that the new employer makes "relevant contributions to a stakeholder pension scheme" in respect of the employee. The employees’ contracts of employment with the old employer may only state that they are eligible to join the pension scheme subject to the terms of the trust deed and rules as amended from time to time including the terms allowing the scheme to be terminated. However, the legislation places a contractual obligation on the new employer to provide an occupational scheme or to contribute to a stakeholder scheme, in comparison to the old employer who was more than likely able to terminate its occupational pension scheme under its trust deed and rules.

Another point to note is that due to the compulsory requirement for matching contributions under the relevant contributions obligation, the Regulations may have the effect of requiring that the new employer provides higher value benefits than were originally provided under the old employer’s scheme.

In addition to the pension protection on a TUPE transfer introduced by the Act and the Regulations, there will also be changes made to the current TUPE Regulations. The DTI has published draft TUPE regulations for which the consultation process ends on 7 June 2005. The draft regulations cover issues such as "service provision changes" including outsourcing and when changes to terms and conditions of employment connected with a transfer can be effective. The new TUPE regulations are due to come into effect on 1 October 2005.

The legislation gives the new employer considerable scope in deciding how generous it chooses to be when providing a pension scheme for transferring employees. Those employees transferring from an employer with a generous final salary scheme may receive minimal protection in relation to their lucrative rights while those paying into a less generous defined contribution scheme may be better off after a transfer than before.

This article was written for Law-Now, CMS Cameron McKenna's free online information service. To register for Law-Now, please go to www.law-now.com/law-now/mondaq

The original publication date for this article was 27/06/2005.