Out-Law / Your Daily Need-To-Know

Redundancy: the impact on pension schemes

Out-Law Guide | 14 Aug 2009 | 4:33 pm | 3 min. read

This guide is based on UK law. It was last updated in July 2009. Making an employee redundant can trigger significant pension scheme costs. Employers should consider this liability when contemplati...

This guide is based on UK law. It was last updated in July 2009.

Making an employee redundant can trigger significant pension scheme costs. Employers should consider this liability when contemplating a redundancy programme.

Background

It is not unusual, particularly in the manufacturing sector, for the rules of an employer's defined benefit pension scheme to provide an immediate benefit on redundancy. In times of pension scheme surplus this would have been a useful means of managing redundancy costs during a recession.

With most defined benefits schemes being in deficit today, the position is different: the trustees are likely to require a cash sum to fund the costs of providing an immediate pension and the cost can be significant, if not prohibitive. Any employer should therefore consider the pension scheme costs before implementing a redundancy programme.

Where an employer operates only a defined contribution arrangement, there are unlikely to be any significant pension liabilities arising as a result of a redundancy. However, employers need to be aware of any other contractual commitments (including so-called 'Beckmann/Martin rights' which are considered below) which might exist outside of the rules of the pension scheme and which are triggered on redundancy.

Benefits on redundancy under the pension scheme

Typically, a defined benefit pension scheme is likely to provide some form of immediate enhanced pension on redundancy so long as the member has reached a certain minimum age (probably between 50 and 55). Frequently, no reduction is made to the pension despite being paid prior to the member's normal retirement date. Alternatively, the pension is enhanced by increasing the member's pensionable service either by a fixed term or perhaps by the length of prospective service the member would have completed had he remained in the pension scheme until normal retirement date. The costs of this enhancement could be substantial.

In any case, the rules of the pension scheme should be carefully scrutinised to determine the scope of the potential benefit. In particular, the employer should consider whether the rule applies only to compulsory redundancies or would it also apply to voluntary redundancies? For example, rules providing benefits where a member "retires from service at the request of the employer" may encompass voluntary redundancy scenarios. This area is complex. Any such rule must be looked at in the context of the rules as a whole and legal advice should be sought.

Other considerations

In addition to the pension scheme considerations, an employer will also need to bear in mind the employment law considerations such as rights under the contracts of employment and employment-related legislation.

Other considerations include:

Age discrimination

It may be difficult for an employer to exclude employees who are members of the defined benefit scheme from the redundancy exercise simply because it is too expensive to provide them with an enhanced pension while, for example, members of its defined contribution scheme are included.

It is common for employers to operate two different pension arrangements for their staff because the majority of defined benefit schemes are closed to new entrants. This generally means that older employees will be members of the defined benefit arrangement and the younger ones members of a defined contribution arrangement. To exclude those in the defined benefit scheme from the redundancy exercise due to, for example, the costs of providing an enhanced pension, could lead to allegations of age discrimination from younger employees.

Early retirement rights and historic TUPE transfers

Under the Transfer of Undertakings (Protection of Employment) Regulations (commonly known as TUPE), broadly speaking, rights to occupational pension benefits do not transfer from the seller to the buyer of a business.

However, in two cases in the European Court of Justice (known respectively as the Beckmann and Martin cases) it was decided that the occupational pension scheme TUPE exemption did not extend to those pension benefits payable on early retirement, such as enhanced redundancy benefits.

As a consequence of these decisions, early retirement rights such as an enhanced pension on redundancy could transfer from the seller to the buyer on a business acquisition. Even if the current employer is operating a defined contribution arrangement, the rights could still exist.

This means that the buyer could face claims in relation to early retirement benefits if those pension benefits are not replicated by the buyer. However, whether courts will go this far is still not clear. If any of the employees could have such rights as a result of joining the employer through an historic TUPE transfer, we recommend that the employer seeks legal advice before making redundancies.

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