Schools of thought

Teachers' pension scheme - schools of thought

Moira Warner 27 February 2020

If you read the material we publish on public sector pensions, you’ll know that we’ve been watching the Teachers’ Pension Schemes (TPS)/independent schools story unfold with interest and concern in equal measure.

As a quick recap, employer contributions to TPS increased from 16.4%to 23.68% of member teachers’ salaries in England and Wales effective from 1September 2019. Similarly sized increases apply in Scotland and Northern Ireland. Many independent schools simply can’t afford this hefty increase leaving them with the unenviable choice of either increasing parents’ fees, or making efficiency savings.

Shopping around for a different teachers' pension arrangement

Consultation with impacted staff has revealed that for many, the least painful way of achieving the required savings is to change teachers’ pension arrangements. Where this is the case we, like you, are above all concerned that schools shop around for the best alternative pension arrangements for their staff and don’t simply “fall” into one of the off-the-shelf options available without first understanding the needs and preferences of their particular teaching staff.

Leaving aside the choice of provider, three broad options have emerged for schools looking to make changes to teachers’ pension arrangements:

1. A longer term view - closure to new entrants

The government has recently consulted on a proposal to amend Scheme rules in England and Wales so that independent schools can opt teachers at their school out of TPS while allowing existing staff to remain in it.

Although it’s not mandatory for TPS to be made available to teaching staff in independent schools, if a school opts out, current regulations require the school to withdraw all teachers. If the government goes ahead with this option, schools choosing it are less likely to face objections from their existing staff as they won’t see any change. However, cost savings will only be realised over a longer period of time, as staff leave, and the school remains exposed to the risk of future employer contribution increases.

For many schools the urgency of the need to realise cost savings effectively rules this option out. Equally importantly, adviser feedback to date suggests that employers are reluctant to effectively create a “two tier” system.

The consultation in relation to this proposed “phased withdrawal” option closed on 3 November 2019 and a government response is expected soon. While this consultation impacts schools in England and Wales only, if the government proceeds, Scotland and Northern Ireland may follow suit.

2. School opts out of TPS and provides an alternative DC scheme

This option also has a lead time for delivery to allow time for consultation with staff, contractual changes as necessary, consideration of alternative schemes and installation.

However, once implemented the solution will deliver immediate cost savings and will protect the employer against the possibility of future employer contribution increases. In addition to providing cost certainty, and allowing a consistent approach, this option may be efficient from a National Insurance perspective for both the school and the member if operated optionally as a salary sacrifice scheme.

Where appropriate, schools may be able to extend an existing scheme in place for non-teaching staff and secure more favourable terms for all in view of the changed profile of the total membership. There’s little doubt that exiting TPS for future accrual will be unpopular with teachers, many of whom will already be feeling bruised from the significant changes to TPS which took place in 2015. So it seems to us that member engagement is key.

Of course teachers will need to understand what an alternative DC scheme can do for them, so a balanced and thorough consultation document will be essential. But that’s probably not enough. Schools should try to understand their membership and canvass affected staff on issues relevant to the selection of a new scheme.

Answers to questions ranging from current number of opt outs and (perceived) affordability issues, to the importance of responsible investment and the level of guidance/advice available to scheme members, can and should be used to inform the selection of the new arrangement.

A teacher whose opinion is sought and listened to from the outset is much less likely to be a disgruntled teacher.

3. School provides two options - teachers can stay in TPS and take a pay cut, or opt into an alternative DC scheme

The third solution we’ve encountered allows teachers to stay in TPS on the condition they agree to a pay reduction equal to the difference between the “old”, pre-increase employer contribution rate and the “new”, post-increase rate.

Alternatively, the teacher can choose to opt out of TPS and receive employer contributions at the “old” TPS rate to a DC arrangement instead. Under scheme regulations, teachers must retain the right to opt in or out of TPS at any time.

There are a number of advantages over the all or nothing solution outlined under option 2:

a) Although this solution creates a mixed economy, with some teachers in TPS and some in a DC alternative, it’s much less likely to be considered an unfair, two tier structure as the employer contribution remains the same across both schemes.

b) It allows members (if they can afford it) a mechanism of staying in TPS albeit at a cost and this may land better than proposals to close TPS to future accrual altogether.

c) If structured appropriately, individual members rather than the employer takes the risk of any future TPS employer contribution increases.

d) If teachers’ opt into the DC alternative, operating optionally on a salary sacrifice basis, they will normally benefit from NI savings.

But there are also disadvantages to this hybrid solution and you may wish to include the following in your discussions with schools considering this option:

a) The school will need to have the resources to run a minimum of two separate pension schemes for teachers, with possibly a third for non-teaching staff.

b) Impacted staff will need to understand what benefits they’d be likely to get if they stayed in TPS compared to what they might get in the proposed DC alternative. Does the school have the resources to afford guidance or financial advice for individual members to maximise the possibility of good outcomes and minimise the possibility of complaints?

c) Perhaps most importantly, this solution needs to be structured with extreme care in order to avoid inadvertently creating tax, equality or employment law issues. For example, the pay reduction for teachers staying in TPS could be structured either as a deduction from net pay or as a contractual reduction to their pay (in our opinion salary sacrifice wouldn’t work because of the requirement to allow teachers to opt in/out of TPS at any time).

The former would be horribly tax inefficient as there would be no tax relief.
The latter would result in the teacher having lower pensionable pay, with consequential negative impact on the value of any final salary benefits which retain an ongoing link to it, and on benefit accrual going forward. Teachers may struggle to understand why accrual is lower even though they’ve stayed in TPS. Moreover, contractual pay reductions for some could result in equality issues being inadvertently created.

In short this type of hybrid option is not straightforward and you should think carefully about working with any school towards this solution unless it’s willing and able to obtain legal advice.

All three of these options could potentially result in a competitive disadvantage to schools in the labour market since each of them impacts the availability of TPS. Talking to advisers at the sharp end, there’s a groundswell of opinion that says only a handful of independent schools will remain in TPS indefinitely. For all others, the question really is how and when, not if.

As pensions professionals we can hope to influence to ensure schools squaring up to this change allow themselves enough time to ensure good member engagement and a long hard look at all the options available in the marketplace.

About the author

Moira spent the early part of her career with a number of European investment banks both here in the UK and overseas with responsibility for sales of money market securities and fixed income products to institutional and Central Bank clients. In the early noughties she moved to the life insurance sector where she has held various pensions technical roles supporting both provider, product and proposition/ sales. Moira specialises in Public Sector pensions and worked closely with a number of key Public service pension schemes and the Local Government Association to help ensure the compliant overlay of pension freedoms on scheme regulations and practices. Moira moved to Royal London in August 2018 and is involved in developing adviser facing content, writing articles and commenting for the press. At weekends Moira can usually be found working in her garden but she doesn’t let her passion for plants prevent her from also indulging in her love of travel.