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Age-old dilemma

Those involved in pensions 15 years ago will have the words Barber and Guardian Royal Exchange etched on their memories. This case centred on a European Court of Justice ruling that it was unlawful to prevent a man from getting his (in this case early retirement) pension at the same age as a woman.

The case spawned a rash of test cases exploring the boundaries of what did and did not amount to sex discrimination in the context of pensions. The result was a hurried move on the part of pension schemes to equalise normal retirement ages for men and women.

The shockwaves registered by Barber v GRE reverberated around the pension industry. If pensions had a Richter scale, this event would have registered about six out of 10. The reason for this brief history lesson is that another earthquake is brewing. In this case, the cause is age discrimination. More worryingly, the shockwaves from this one are likely to register eight out of 10.

From October 1, employers must not discriminate against employees based on age – at least not until they reach 65. This means employees have the right to choose when to retire up to 65, even if their normal retirement age is, say, 60. How does this impact on pensions? Take an employee in a final-salary scheme. If they choose to work after NRA, they will be entitled to another 60th or 80th for each extra year. It is also reasonable to expect that an actuarial increase will apply to benefits accrued up to NRA.

This makes things complicated for trustees and scheme managers. Some employers are already making changes to pension schemes using the new discrimination rules to justify an increase in NRA from 60 to 65 for future benefit accrual.

The tremors might also hit age-tiered contribution schemes. Although the Department of Trade and Industry tried to be super helpful to pensions when it interpreted the European anti-discrimination directive, many pension lawyers think it has gone too far. In other words, although UK law says it is OK to have age-tiered schemes, European law says otherwise. And European law overrides UK law.

In this case, the European law does permit age-tiered contributions but only if the differences are actuarially justifiable. But the question is, can contribution rates chosen arbitrarily, such as 3 per cent for those in their 20s and 7 per cent for those in their 50s, be actuarially justified? I would venture not because there must be an aim in setting different contribution rates, for example, to provide the same target level of benefits at 65.

If age-tiered schemes are declared unlawful by the ECJ, employers will be forced to make good underpayments to younger employees backdated to October 1. If this judgment happens in 2010, employers will have to make four years of underpayments in one fell swoop. If I were an employer with an age-tiered scheme, I would be seeking a swift exit strategy now.

What about personal accounts when they come along in 2012? Many employers are already considering closing existing schemes to new members and auto-enrolling new employees into personal accounts.

But if the employees in personal accounts are predominantly younger, as one might expect they would be, are they being discriminated against when compared with an employee doing the same job but who is in the better existing scheme?

There are many other issues applying to pensions resulting from this legislation. Advisers should prepare now for what is sure to be a seismic event.

John Lawson is head of pensions policy at Standard Life

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