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Set for offset

As we have discussed and confirmed in previous articles, part-time workers across Europe have for a couple of decades been (often successfully) claiming discrimination by their employers compared with their full-time counterparts.

Primarily, where within a particular firm there are substantially more females than males, then it has been decided in a number of cases that discrimination against part-tim-ers may therefore indirectly amount to discrimination against females, thus breaching Article 119 of the Treaty of Rome.

The same principle may be applied in respect of discrimination against males where they form the majority of part-time workers.

Within final-salary pension schemes, ultimate responsibility for meeting the benefit promises lies with the employer&#39s funding rate and so the higher the benefit promises become – whether voluntarily put forward by the employer/ scheme or mandatorially imposed by legislation and case law – the higher will generally become the employer&#39s funding requirement.

Little wonder then that an increasing number of schemes have looked at moving away from final-salary funding or, alternatively, ways of reduc-ing the benefit structure of the scheme.

Discrimination against the higher-paid?

In seeking to reduce the overall benefit structure, ideally, with the minimum of resistance from employees, many schemes have considered the relative pension benefits of retiring scheme members at diff- erent salary levels.

Importantly, this comparison includes not only benefits from the employer&#39s final-salary scheme but also basic state pension benefits.

The latest survey from the National Association of Pension Funds indicates that almost 50 per cent of all final- salary schemes in the private sector now have benefit structures which include the offsetting of payments from the state pension scheme.

This principle, known variously as state scheme offset, integrated state scheme benefits or clawback (the latter being the particular favourite of trade unions who are attempting to get this practice outlawed), is the main subject of our next two articles.

Expect an update in the not too distant future as we await the outcome of the Shillcock case. The implications of the principle of state scheme offset and its possible demise on many areas of pension planning will become clear over my next two articles.

Let us first of all look at a few examples of the pension benefits payable to employees retiring from a final-salary scheme which does not impose state scheme offset.

Michelle has worked for FairCo for the last 40 years and is reaching retirement age with pensionable earnings of £90,000 a year. FairCo&#39s pension scheme offers benefits on a 1/60th basis and so Michelle qualifies for a pension from the scheme of £60,000 a year, on top of which she will also clearly qualify for the full basic state pension of, let us say for the sake of simplicity of maths, £4,000 a year. This means she will receive a total pension of £64,000 a year from all sources, which is around 70 per cent of her final salary.

Compare Michelle&#39s situation with that of her colleague, David, who is also coming up to retirement with a much lower final pensionable salary of £15,000 a year.

He also has worked for FairCo for 40 years and so qualifies for a pension from the scheme of £10,000 a year plus a full basic state pension of £4,000 a year. Thus, his total pension form all sources is £14,000 a year, which is nearly 90 per cent of his final year&#39s earnings.

It is easy to sympathise (at least partly) with the claim of higher-paid workers that final-salary schemes advantage the lower-paid workers over higher-paid workers. This can be highlighted if we look at the third employee of FairCo who is reaching retirement age at the same time as Michelle and David.

Janet has also worked for FairCo for 40 years, during which time she has been a member of the pension scheme and is retiring on a final pensionable salary of £6,000 a year. Thus, her pension from FairCo&#39s scheme will be £4,000 a year, on top of which we may assume she will also qualify for the full basic state pension of £4,000 a year.

Her total pension therefore amounts to £8,000 a year – some 30 per cent higher than her income before retirement

It could therefore be suggested that final-salary scheme benefits payable in addition to the basic state pension favour lower-paid employees and unfairly “discriminate” against higher-paid employ-ees. This becomes even more pronounced against employees whose salary exceeds the earnings&#39 cap. So what could be done to correct this apparent anomaly?

How state scheme offset works

Ostensibly, in an attempt to produce fairer overall retirement incomes for lower- and higher-paid employees – as a percentage of their pre-retirement income and including allowance for the basic state pension – a large number of private sector final-salary schemes have introduced some method of SSO in their benefit structures.

State scheme offset can take a number of forms, perhaps the most basic and easily understood being the full deduction of basic state pension from the target final-salary benefit, as the following amended examples illustrate.

Michelle, with a final pensionable salary of £90,000, is due a pension of £60,000, as we already noted.

However, if her scheme benefit structure includes state scheme offset, then she will only get £56,000 from the scheme, that is, the calculated total benefit of £60,000 a year less the value of the state pension of £4,000 a year.

Her total benefit from all sources will therefore be, of course, £60,000 a year, which is two-thirds of her final earnings. The “deduction” of £4,000 a year from her scheme benefits is unwelcome for Michelle, of course, but it “only” represents about 7 per cent of the benefits she would have received if her scheme had not operated state scheme offset.

David, with a final salary of £15,000, is due a pension of £10,000 a year but, as his scheme operates state scheme offset, they will assume that £4,000 a year is to be paid by the state and so the scheme will only pay £6,000 a year.

Thus, David has, like Michelle, “lost” £4,000 a year but it could be argued that he has been disadvantaged much more than his higher-paid colleague as this £4,000 “deduction” represents 40 per cent of the benefit he would have received if state scheme offset had not been a feature of the scheme. In defence of the practice of imposing state scheme offset, it should be noted that both Michelle and David will have retirement income of two-thirds of their final earnings, taking the basic state pension into account.

This latter defence will not placate Janet, however.

With final earnings of £6,000 a year, she is due to a pension of £4,000 a year.

Her scheme knows she will receive all this payment from the state pension scheme andso no benefits will be pay-able from FairCo&#39s scheme despite Janet&#39s apparent membership of the scheme for the last 40 years. Fair? Janet does not think so.

Moreover, the trade unions think not and they are fully behind the claim in the Shillcock case to have state sch-eme offset abolished or at least put on a much fairer footing. Even the Pensions Ombudsman agreed with them.

Quite what the implications of Shillcock are likely to be for pension schemes, pension consultants and, of course, the employees themselves, we will discuss next week.


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