UK: Back To Basics On Pensions And Settlement Agreements: What You Need To Know To Protect Your Business

The pension terms of an employment settlement agreement are often left until the last minute. Sometimes HR or employment specialists are reluctant to draft for or advise on the pensions aspects of an individual's termination package. In turn, pensions specialists may be unaware of the wider HR related sensitives and scope of any 'deal' being reached with the individual in question.

In the fourth of our Back to Basics series the Combined Human Resources Solutions (CHRS) team seek to address some of the more frequently asked questions that arise for employers in relation to pensions and settlement agreements.

This back to basics primarily deals with settlement agreements:

  • where pension issues are not the actual subject of the potential claim - given the complexities around settling pension disputes, we recommend that specialist legal advice is taken on the particular issue; and
  • that deal with pension payments under a defined contribution (or money purchase) arrangement. These are the more common arrangements that are dealt with under such agreements. If the employee is a member of a defined benefit arrangement (such as a final salary or career average arrangement) which is still open to accrual, again, you should consider taking specialist advice early on.

Why are pensions relevant to settlement agreements?

A settlement agreement is generally intended to set out the compensation and benefits that an individual will receive from their employer in exchange for waiving potential claims they have against them, often (but not always) on termination of their employment. As pensions can form a significant part of an employee's overall benefit package, what is offered in relation to that benefit on termination will usually need to be covered off in the settlement agreement.

What pension information is useful to have before you start drafting a settlement agreement?

In order to help with drafting the pension terms of any settlement agreement, there are a number of questions you can ask which will make the drafting easier from the outset.

  1. What type of pension arrangement is it? A defined benefit or a defined contribution arrangement?
  2. Is the arrangement an occupational arrangement (usually a scheme set up by the employer for its employees and governed and administered by trustees) or a personal pension plan (e.g. contract-based and run by an insurer)?
  3. What (if anything) is the individual asking for in relation to payments into, and treatment of, their pension on termination?
  4. What does the contract say about benefits payable during notice? Are pension contributions included?
  5. Does the company have a standard or usual approach to the pensions' aspect of a settlement package?
  6. Is the employee paying any pension contributions? If so how are these being paid (e.g. as standard employee contributions or via salary sacrifice)?

Do you have to pay pension contributions during an employee's notice period?

This will depend on what contractual benefits the individual is entitled to during their notice period and whether there is a 'pay in lieu of notice' clause. If the employee is only entitled to basic pay, for example, the employer may not need to continue paying pension contributions during their notice period. There may be tax implications depending on whether there is payment in lieu of notice (PILON) clause/custom and practice of paying in lieu of notice, and also depending on whether the payments are made before or after termination of employment.

Finally, you will need to consider what statutory obligations you have under workplace pension reform in respect of the employee.

Is it OK to agree to extra payments into an employee's pension under the settlement agreement?

Often this will be OK, but you may need to check such payments are allowed under the scheme documentation. Sometimes, it will not be possible to make extra payments into a pension scheme where an employee has left employment, as they will no longer be an 'Active Member' of the scheme in question. To avoid getting into a debate on this issue, make it clear in the drafting that any obligation on the employer to make payments into an arrangement will be subject to the terms or rules of that arrangement and to the Trustees or provider (as relevant) accepting the payments.

It is not unusual for employees who have personal pension arrangements to request that their employer pays a contribution into that arrangement on their behalf pre termination. This may be a more tax efficient way of the employee to receive their settlement monies. There is no issue with the employer doing this in theory, but as above, the employer should make it subject to the insurer or trustees who administer the arrangement agreeing to receive the payments. The employer should also make it clear that it has no responsibility for the tax treatment of any such payments.

Do we need to exclude accrued pension rights from claims being settled?

Usually, yes! Wording carving out 'accrued rights' from the list of things being waived or compromised by an employee is standard. This effectively guarantees to the employee that the employer is not changing or removing any rights they have already built up in their pension scheme during their employment.

Exceptions may apply where the subject or issue of the dispute is pensions itself. In that instance specialist advice should be taken.

Can an employee keep contributing to their pension scheme after their employment has terminated?

This will depend on what type of pension arrangement they are in. Sometimes employees can only contribute to occupational pension schemes if they are Active Members (i.e. still in service with their employer). However, where an employee is a member of a group personal pension plan, depending on the rules of that plan, it may be possible for them to be able to continue to make contributions towards it. Be careful about writing into a settlement agreement anything which gives the employee a right to continue to make payments into their pension scheme unless you have checked and know that this will be possible.

Are there any particular considerations I need to have around high earners?

Yes. High earners are more likely to be subject to particular tax restrictions and allowances on their pension savings. These often result in higher tax charges where an individual's pension savings in any given year, or over their lifetime, reach a particular threshold. If you are drafting pension contributions for an individual into a settlement agreement, ensure you make it clear in the drafting that any tax consequences or considerations are the individual's responsibility.

What if an employee wants particular pension benefits writing into the settlement agreement?

The answers above have all been predicated on the assumption that the employee might be entitled to, or ask for, extra employer contributions towards their pension arrangement. If an employee is asking the employer to guarantee entitlement to a particular pension benefit, caution needs to be exercised. The employer is unlikely to know the precise cost of funding a particular benefit - agreeing to this could provide an ongoing funding risk or liability for the employer, and so both actuarial and legal advice should be taken prior to making any commitments in this respect.

For more information we have provided a top tips on pensions and settlement agreements.

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