Pay cuts and pensions: points to watch

Helen Powell

According to recent media reports, 18% of employers have implemented pay cuts this year in response to the effects of Covid-19, and 30% more may do so in future, if they feel it’s necessary. Employers approach this objective in different ways, from a straight percentage salary reduction to reduced working hours, or arrangements involving periods of unpaid leave.

The Job Support Scheme announced in the Winter Economy statement is intended to support ‘viable jobs’, with workers being retained on shorter hours and reduced wages rather than being made redundant. It’s worth noting that under the JSS, in contrast to the Coronavirus Job Retention Scheme, the government’s expectation is that wages will not be topped up by the employer. The JSS grant does not cover pension contributions, which must be paid by the employer in addition.

All these strategies have potential pensions implications that need to be considered in structuring proposed changes, and there can be some hidden pitfalls. As always, the first rule is to check the scheme rules.

  1. Check the pensionable pay definition: it may not be correct to assume that a cut in salary feeds directly through to reduced pension contributions. Some scheme rules fix pensionable pay as at a specific annual date, so a pay cut may not reduce employer or member pension contributions until that date comes around again. An immediate reduction in the amount that the employer pays over to the scheme could mean that contributions are underpaid, which can be tricky and time-consuming to correct once the problem is discovered. A change to the rules to remove that time lag may be a listed change requiring consultation with affected members.
  2. If working hours are being reduced – for example from a five-day to a four-day working week – consider whether there is any knock-on impact for DB members in terms of calculating the length of their pensionable employment. Do the rules require pensionable employment to be reduced in proportion to the reduction in working hours (i.e. as part-time work) for this period? Is there an impact on pensionable pay for benefits purposes? If so, that should be communicated to members.
  3. Typically, no contributions are required from either members or the employer during periods of unpaid leave. Depending on how any arrangement is structured, how would this affect ongoing contributions and other benefits under the scheme rules?
  4. Check the implications of the proposal for contingent benefits such as life cover and incapacity provision. It’s possible that a proposal of this kind may create incentives for some members to take other action, such as ceasing active membership of a DB scheme before a pay cut is implemented, so it’s wise to keep scheme trustees in the loop to help identify any potential administrative hurdles that could be created.

It’s also worth considering the interaction of a pay cut with auto-enrolment requirements. For some workers, earnings may fall below the threshold of qualifying earnings for auto-enrolment purposes. That doesn’t necessarily mean that they automatically leave the scheme – this will depend on how the contributions rule is expressed – but if they do cease membership (for example, to improve their cash flow), it may affect their right to opt back in and receive contributions, as well as future re-enrolment exercises. It may also affect calculations for certifying the scheme against the quality requirements, if the employer uses the qualifying earnings test for part or all of the workforce.

Helen Powell is PSL Counsel at Allen  & Overy LLP

Comments published on Pensions Talk do not necessarily reflect the views of Allen & Overy or its clients.

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