Out-Law Guide 2 min. read

Offering financial incentives to leave a pension scheme

This guide was last updated in August 2011.

Defined benefit pension schemes promise a set level of pension once an employee reaches retirement age, no matter what happens to the stock market and the value of investments. In a defined benefit pension scheme, the employer takes on all the financial risk - which means that companies often look at ways to reduce this risk.

One option is to offer members who have left the company a financial incentive to transfer their pensions out of the scheme. This incentive could either be a cash payment to the member, or an increase in the transfer value of the member's benefits in the scheme on the condition that those benefits are transferred out to another pension arrangement – known as an enhanced transfer amount. Both would usually be funded by the employer, and any cash payment made to the member would have to be taxed.

Making enhanced transfers successfully

Initially, companies should check the rules of the pension scheme to ensure that they have the power to offer members more than what the standard transfer value payment would be. In some cases, the consent of the scheme's trustees may be necessary.

Companies should seek advice to ensure that the likely savings made from offering a financial incentive or enhanced transfer amount to members outweigh the costs involved in making the offer. Companies need to decide what incentive to offer members to encourage them to transfer out. The same incentive should be offered to all scheme members receiving the offer.

Although the company is usually the one making the offer, it will need to involve the scheme's trustees from the outset. Even if trustee consent is not required, the company will need to ask the trustees for members' contact information and details of their benefits. Trustees need to decide whether to release this information.

Trustees should ask the company for details of any proposed offer, including the company's reasons for offering such an incentive. The Pensions' Regulator, the UK body which oversees work-based pension schemes, expects trustees to take an active role where incentives are being offered. It wants them to start from the presumption that the offer is not in most members' interests and that it is likely that only a minority will benefit from accepting an offer. The Regulator wants trustees to be willing to challenge the appropriateness of any offer. Trustees will probably need to take legal and financial advice.

Both trustees and employer companies need to manage any conflicts of interest that they have. These could include a trustee also being a director or a shareholder of the employer. Any adviser conflicts of interest should also be considered.

To increase the likely level of take-up of any incentive offer, companies should check that the data which it holds on the pension scheme's members is accurate and up-to-date.

Any communication with scheme members must be clear and not misleading to ensure that members can make an informed decision before accepting or rejecting any incentive offer. The Regulator has issued guidance about what information it thinks should be included when writing to members, which is available on its website. The scheme's trustees should check any communications which are sent out.

The Regulator's guidance states that the employer should require members to take advantage of independent financial advice, paid for by the employer, unless it is confident that members are able to understand the structure and implications of the offer. This advice should be promoted to members in the strongest possible terms. The process for selecting advisers and how these are to be paid should be clearly communicated by the employer, the Regulator says.

The company should not subject scheme members to any undue pressure to come to a decision, rather giving them plenty of time to decide whether or not to accept any enhancement offer.

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