The hidden cost of refunding pension contributions

When a member leaves a trust based pension scheme within 3 months of joining, the Scheme may require the member to receive a refund of their own contributions (net of tax and contracting out deductions). Should the member leave between 3 months and 2 years of joining the Scheme, the Trustee(s) must give them a reasonable period of time to transfer their accrued benefits to another pension provider before enforcing a refund.

In the case of defined benefit schemes, the employer contributions are not earmarked for any particular member and therefore remain in the Scheme if a member’s refund of contributions is paid. Many Defined Contribution (DC) schemes, however, allow for the employer contributions in respect of a member who is taking a refund of contributions to either be refunded to the employer, or retained within the scheme to off set against future costs.

There have been noises from the DWP and the Pensions Minister that the option of a refund of contributions will be removed and therefore schemes will be left with the cost of providing benefits that far outweigh the benefits themselves. DC schemes will be left with deferred pension pots that are too small to purchase annuities with and may prove difficult, under current regulations, to pay as a cash sum.

The justification being given for this move is to “even the playing field” with contract based schemes, under which refunds are not possible, on the assumption that employers will provide trust based “auto-enrolment” vehicles so that they can take advantage of such refunds. I wonder if such aspersions originated from insurance companies looking to drum up business.

Trust based schemes cost the employer time and money to run but, in return, they offer a level of control and ownership over employee benefits that cannot be achieved through contract based arrangements.
The contribution refunds from the vast majority of schemes would struggle to cover the cost of ongoing governance of trust based schemes, and therefore, the difference in treatment of refunds of contribution cannot possibly be the main reason to set a scheme up under trust.

Far from creating an “even playing field”, simply removing the refund option would askew the game greatly in favour of contract based arrangements. Employers looking to set up new, or with existing trust based schemes, will not want the cost or hassle associated with administering very small pension funds. However, a joined up solution involving the ability to transfer accrued benefits to NEST could be a logical compromise.

Providing defined contribution benefits under trust is never the easy option but, with the assistance of a professional trustee, it can be the best way to ensure that a scheme provides the benefits, options, flexibility and service that fulfill both the employees’ and employer’s needs.

Greig McGuinness is a trustee representative with leading independent trustee Dalriada Trustees Limited.