Employers with defined benefit pension schemes, such as final salary schemes, are increasingly looking for ways to reduce their exposure to heavy financial liability. Many such schemes are already closed to new joiners, but more and more companies are looking at closing schemes to existing members so that no more benefits can be earned under the scheme. This is also known as ceasing future accrual.
Check the rules
Every pension scheme is different. Before a scheme can be closed, an employer must check there is the legal power to do so. The power to close a pension scheme may be contained in the scheme's trust deed and rules but employers should also check the terms of the members' employment contracts, the scheme booklet and member announcements to make sure there are no obstacles.
Some scheme rules allow for closure by giving notice to members. If this option is available it is usually the simplest way to close the scheme to future accrual, but the precise wording in the scheme rules must be followed. In other cases, schemes can be closed by rule amendment. Again, the precise wording of the rule must be followed. Often, such amendments will require the consent of the trustees as well as the employer.
Even though a scheme has been closed to future accrual, in some cases members may still retain a link to final salary. This means that although they do not build up future benefits in the scheme, the pension benefit they will eventually receive will be based on their salary at the date they leave employment with the employer rather than their salary at the date of the scheme closure. Again, checking the scheme's rules is extremely important.
If the scheme rules make closure difficult, or if the employer wants to break a final salary link, then it may be possible to make the change by agreeing it directly with the scheme's members - usually done by amending the contract of employment. This can be a complicated process, and employment law advice will usually be required. Clear communication with the scheme's members is essential, as they must be able to give their fully informed consent for the changes to be enforceable.
Whichever closure method is used, check the scheme rules carefully to ensure there are no unintended consequences of the closure. In some cases, ceasing accrual may trigger a winding-up of the scheme. The employer will then become responsible for its share of any underfunding in the scheme.
The need for closure
Employers must be prepared to demonstrate the business need for the closure of a defined benefit pension scheme. The scheme's trustees, who must act to safeguard the interest of its members, are obliged to examine the commercial and financial reasons for the closure and may want to explore alternatives with the employer. They will need to be assured that the pension obligations will be met in the long term.
The duty to consult
Most employers with over 50 employees must consult with their employees for a period of at least 60 days before implementing any defined benefit scheme closure proposal.
What next?
Although a scheme may be closed to future accrual, there are still costs associated with closed schemes. In particular, the scheme actuary may recommend a higher employer contribution should the actuary feel that any funding deficit should be made good over a shorter period than had previously been agreed. The employer may want to take actuarial advice about any funding implications of ceasing future accrual.
Trustees should review the scheme's existing investment strategy if future accrual is to cease. Less risky investments may be more appropriate for a closed scheme where there are no more member contributions coming in and no new members joining.