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State pension reform to cost councils £795m per year

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Reforms to the state pension taking effect in 2016 will cost employers paying into the Local Government Pension Scheme an extra £795m per year, according to estimates.

A paper presented to the Local Government Association’s resources board on Friday also said that an effort to reconcile HMRC records with those held by LGPS funds, which is linked to the reforms, will cost funds themselves £300m in administration and additional pension payments.

The costs relate to the introduction of the flat-rate state pension in April 2016. From then, people reaching pension age will receive a single-tier payment, which replaces the complex system of basic and additional payments in place now.

The reform will end earnings-related additional elements of the state pension, known as State Earnings Related Pensions and, in later forms, S2P.

This will also end ‘contracting out’ where employees may opt out of the state second pension and receive extra pension from their workplace scheme in exchange for lower National Insurance contributions from the employee and their employer.

LGPS employers receive an annual 3.4% National Insurance rebate to account for contracted out members. However, once the state pension comes into effect and contracting out ends in April next year, this rebate will no longer be paid. The LGA estimates this will cost employers £795m per year.

The paper said that in the last parliament Danny Alexander, the former chief secretary to the Treasury, told the association to revisit its request to have the Treasury “recycle” some of the money lost through NI rebates back to pension scheme employers as part of the 2016-17 local government financial settlement.

It has since been working with the Department for Communities & Local Government (DCLG) on a distribution method for this recycled money should the request be granted.

However, the paper from the LGA today said initial talks with Treasury officials had “not been encouraging”.

“The indications are that councils will have to shoulder the full cost of the increase in NI with no offsetting by any additional funding from the Treasury,” he added.

Further costs associated with the reforms will fall on the LGPS, the association said.

All contracted out pension schemes, including the LGPS must, by 2020, reconcile the records they hold on their members’ NI contributions and entitlements with those held by HM Revenue & Customs.

The LGA fears that during the course of reconciling the LGPS’ five million member records, which in itself will likely cost £100m, the scheme will discover discrepancies between what it believes it owes members and HMRC’s calculations.

“Subject to legal advice currently being taken by the Treasury, LGPS funds may also have to cover additional pension increases estimated at £200m per annum,” the LGA paper said.

John Hanratty, head of pensions for the north at law firm Nabarro, said the discrepancies between LGPS and HMRC records will arise as a result of employer contributions not being updated when individuals’ circumstances change. Changes to NI, staff leaving jobs and restarting them, and the computerisation of scheme records will all contribute to the gap.

“There has always been a huge issue between HMRC’s NI records and those held by contracted out schemes,” said Mr Hanratty.

“HMRC just says, ‘well, those are our records’ and schemes just have to change theirs.”

Mr Hanratty said that when schemes discover members are owed more in pension entitlement than they had calculated, they will have to pay the difference, but if they discover they owe pensioners less and decide to adjust payments accordingly, they will face complaints from members who had been relying on a certain level of income.

He added that the scheme will likely have to cover the cost of any extra payments by increasing employers’ contributions to the scheme. It cannot increase members’ contribution rates without extensive negotiations with central government, as these are set out in the 2014 scheme rules.

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