What is a short service refund?
Currently, individuals who leave their occupational pension scheme (whether defined benefit or defined contribution) with less than two years’ qualifying service, have a statutory entitlement to a refund of contributions (known as a “short service refund”). In some cases this refund is optional, but employers can insist on it being taken (or the member transferring their pension contributions to another scheme) when the employee leaves their employment.
However, with effect from 1 October 2015, the right to take a short service refund from a defined contribution (DC) occupational scheme (and other occupational schemes where all of a member’s benefits are money purchase) will be abolished. Members may then only have their contributions refunded during the 30 day ‘cooling off’ period immediately on joining the scheme.
This change will only affect members whose qualifying service starts from 1 October 2015, so members who join before that date may still be offered a short service refund if they leave with less than two years’ qualifying service.
Members of defined benefit schemes will remain entitled to a short service refund if they leave the scheme with less than two years’ qualifying service. Members of personal pension schemes are also unaffected by the change since they are not entitled to a short service refund.
Why the change?
One of the key aims of successive Governments has been to ensure that pension saving becomes the norm and that, once invested, contributions remain in schemes and are only withdrawn at retirement.
Removing the right to take a short service refund from DC schemes therefore ties in with wider reforms to broaden pension saving through the continuing roll-out of automatic enrolment and the introduction of the Government‘s “pot follows member” proposal – under which small money purchase pots will transfer automatically when an individual moves to a new job – currently scheduled for Autumn 2016.
The choice of 30 days for the refund period is intended to match the opt-out window for auto-enrolment[i] and the Financial Conduct Authority’s cooling off period for personal pensions.
Issues for employers, trustees and administrators to consider
- Depending on the wording of a scheme’s rules, the right to a non-statutory contribution refund may remain. Therefore, DC occupational pension scheme rules (and other occupational pension schemes which provide only money purchase benefits for some members) should be reviewed as soon as possible to determine whether any rule amendments are required to reflect this change. Where there is any doubt, advice may also need to be sought on whether benefits provided under a scheme are technically “money purchase” and therefore caught by this change.
- Member communications should be reviewed to ensure that affected members are given the correct information from joining so that they have no expectation that a short service refund will be payable beyond 30 days’ qualifying pensionable service.
- Administration procedures should also be reviewed to ensure short service refunds are only paid out in the correct circumstances. Once the above change comes into force, if a refund is paid incorrectly then it may constitute an unauthorised payment for the purposes of tax rules, resulting in adverse tax consequences.
- There may be a further shift in employers’ preference towards contract-based defined contribution schemes (such as group personal pensions) given that employers will no longer gain the employer contributions returned to the scheme when a short service refund is paid (previously, where a refund was taken, the employer contributions would remain in the scheme and be used to cover administration costs).
[i] Under auto-enrolment legislation, a member has a period of one month in which to opt-out of the scheme, at which point he is entitled to a refund of contributions and is treated for all purposes as never having become an active member of the scheme.