Updated July 2019 View full section
This chapter provides a brief overview of pensions and their relevance to housing associations. The chapter covers topics only in general terms and is intended to give a wide audience a basic understanding of the issues discussed. Therefore, it cannot be relied on to cover specific situations. Applications of the principles set out will depend on the particular circumstances involved. Housing associations should obtain professional advice before acting, or refraining from acting, on any of its contents.
CIPFA and the National Housing Federation are grateful to KPMG for writing this chapter.

Pensions have become a significant cost and risk issue for UK employers over recent years. There are two main types of pension arrangement in use in the UK: defined benefit and defined contribution.

A defined benefit scheme (also known as a DB scheme) is a pension scheme in which the benefits are defined in the scheme rules and build up independently of the contributions payable and investment returns. Most commonly, the benefits are related to members’ earnings when leaving the scheme or retiring, and the length of their service in the pension scheme.

The two most common types of defined benefit scheme are known as ‘final salary’ and ‘career average’ schemes. A final salary scheme provides a pension linked to the member’s salary at or close to retirement. A career average scheme calculates the benefit built up in each year of service based on the member’s salary in that year and then revalues each year’s benefit up to retirement at an agreed rate (usually linked to inflation).

In most defined benefit schemes the employee pays fixed contributions and the employer pays the balance of costs above this. Employers therefore take on the majority of the financial risk of ensuring that the benefit commitments are met. In recent years the costs of defined benefit provision for employers have risen significantly, mainly due to increasing life expectancy, changes in taxation, and investment returns being lower than expected.

A defined contribution scheme (also known as DC or money purchase) is where benefits are based on how much the member and employer pay into the scheme, and also on the performance of the investments made with that money. The income the member gets at retirement depends on the amount of money in their fund, the age at which they retire and also how they choose to use their fund. For example, they could take some of it as cash, buy an annuity (a guaranteed pension income for life), or leave the funds invested and draw out an amount each year.

As there is no guaranteed pension at retirement, there is significantly less financial risk to an employer in providing such arrangements for its employees.

Pensions have become a particular issue for housing associations, in common with many other organisations, due to the high level of take up of defined benefit arrangements and the increasing cost of funding these arrangements.

Transferring employees from local authorities had their pension benefits protected under the Transfer of Undertakings (Protection of Employment) Regulations (TUPE) and the best value regulations.

TUPE allows defined benefit provision to be replaced with a defined contribution arrangement. However, the best value regulations introduced in 2007 for local authorities (broadly in line with the Fair Deal policy which applies to central government employers) required that where staff are compulsorily transferred out of the public sector to an external provider, the new employer has to provide a 'broadly comparable' pension scheme for the transferred staff. Most housing associations fulfil this requirement by participating in the Local Government Pension Scheme (LGPS) on behalf of those staff transferred.

The policy also required accrued pension rights to be protected, meaning that previous employers bulk transferred arrangements for staff transferring their public service pension benefits. This has led to many housing associations to have significant defined benefit pension obligations, particularly in the LGPS.

In 2013, a revised Fair Deal policy for central government came into force whereby all staff whose employment is compulsorily transferred from central government to independent providers of public services must retain access to their previous employer’s pension arrangements. The new provider then becomes a ‘participating employer’ in the public sector arrangement.

Housing associations are not currently covered by Fair Deal because they tend to take on staff from local rather than central government. They therefore currently have the choice between participating in the LGPS and setting up a broadly comparable scheme. However, the government has completed a consultation on introducing Fair Deal to local government, which if implemented will mean housing associations will be required to offer only LGPS to those staff who have transferred from local government.

Different rules on transfer rights apply in Wales and Scotland; see the separate Wales and Scotland chapters for more detail.

Housing associations have in the past offered defined benefit pension provision when employers in other industries (particularly in the private sector) have moved towards offering defined contribution arrangements.

However, the risks and rising costs of defined benefit pension arrangements (for both the employee and the employer) and the introduction of auto enrolment mean that many housing associations have now closed defined benefit schemes to new entrants and some have closed them completely, in line with the private sector, with many now offering defined contribution arrangements, particularly to new staff.

In general, there are four main pension arrangements that are used within the social housing sector: Social Housing Pension Scheme (SHPS), the LGPS, housing associations’ own defined benefit schemes, and other defined contribution schemes. These are covered in the following sections.

Since October 2012, employers in the UK have been required to begin automatically enrolling their eligible employees into a workplace pension. Larger employers enrolled first and through a period of phasing smaller and medium sized employers will be enrolling over the following six years.

Employees are deemed to be eligible if they:

  • are not already in a qualifying pension scheme
  • are aged 22 or over (16–21 year olds have a right to opt in)
  • are under state pension age (those over state pension age but under 75 have a right to opt in)
  • earn more than £833 a month (this figure is reviewed every year), and work or usually work in the UK (those who earn between £512 and £833 have a right to opt in).

Auto enrolment has led to significant challenges in respect of establishing systems and procedures to comply with the legislation. It has also inevitably led to an increase in pensions costs, which some housing associations have had to manage.

The SHPS is the primary multi-employer pension arrangement that is used within the social housing sector in England and Wales. A separate scheme, the Scottish Housing Associations’ Pension Scheme (SHAPS), also administered by the Pensions Trust, is used in Scotland.

Housing associations can only participate in SHPS if they are members of their national federation. It is administered by the Pensions Trust and the SHPS Committee is the employer representative group for the scheme which works with the Pensions Trust to ensure that, among other things, benefits provided by the scheme comply with legislation, and to monitor the administration of the scheme.

The SHPS Committee also provides input into an appropriate investment strategy for the Scheme’s assets and the Scheme’s risks are managed and monitored on an ongoing basis.

SHPS offers employers (on behalf of their members) a range of defined benefit (final salary 1/60, 1/70 and 1/80 and career average 1/60, 1/80 and 1/120) and defined contribution benefits, and a flexible contribution structure where each employer can choose the employee contribution rate.

Auto enrolment (see below) has increased the take-up of SHPS defined contribution, partly due to housing associations having to pay an increased financial contribution if they leave SHPS defined benefit.

SHPS defined benefit is a non-segregated multi-employer scheme. Assets are combined and used for all employers and benefits are paid out of total scheme assets.

Funding valuations of defined benefit schemes are usually performed every three years and this is used to determine the contributions payments required by the participating employers. Following this valuation housing associations will need to respond to any change in the deficit, for example through a deficit reduction plan and changes to contribution rates.

The last formal valuation of SHPS at 30 September 2017 revealed an increase in the deficit to approximately £1.5bn. The next funding valuation is due on 30 September 2020. The deficit contributions payable by individual employers was, prior to 2017, based on the number of active members that employer had in the Scheme at a particular date. From 30 September 2017, this was moved to a full liability share basis, with employers paying contributions based on the level of DB liabilities held in the Scheme. This is the first time that employers have been able to see what % of the total fund is in respect of its own membership.

In 2011 the Pension Trust undertook a financial risk assessment of all of its participating employers to establish which organisations did not meet the required financial capability to sustain defined benefits. The organisations were categorised into high and low risk, with the high risk being required to drop defined benefits. These financial risk assessments continue on an annual basis.

With over 5 million members, the LGPS is one of the largest public sector pension schemes in the UK. It is a nationwide scheme and is administered locally for participating employers through 89 regional pension funds in England and Wales.

The LGPS is governed at a national level by the Ministry of Housing, Communities and Local Government (MHCLG). The MHCLG is supported by the LGPS Scheme Advisory Board whose role is to help the MHCLG fulfil its statutory duties and obligations. At a regional fund level, each fund has a local pension board that assists the administering authority with managing the governance and administration of the fund.

On the transfer of staff from local authorities, housing associations participate in the LGPS through agreements known as ‘admission agreements’. Housing associations can have a number of such agreements in place with one or more LGPS funds. These agreements (along with the transfer agreement or contract) set out the terms of pension provision and whether security such as a bond is required. Sometimes the local authority provides a guarantee for some or all of the benefits relating to transferring employees.

The LGPS provides defined benefits which have historically been based on final salary, but moved to a career average basis from 1 April 2014 (although there are final salary protections in place).

The LGPS is a segregated scheme and as such each individual participating employer has assets and liabilities allocated to it.

A funding valuation of LGPS as at 31 March 2016 revealed a decrease in the deficit to £37bn (£47bn at 31 March 2013). The 31 March 2019 funding valuation is currently underway and new contribution levels will apply from 1 April 2020.

Around 20 of the largest housing associations have their own bespoke defined benefit schemes in which only they participate. They vary in size and benefit structure but have tended to be final salary-based in the past, with recent movement to a career average basis for many.

Having a bespoke scheme rather than participating in a multi-employer scheme tends to lead to higher running expenses but gives organisations more flexibility in terms of benefit scheme design, investment strategy and the annual cost to the employer in respect of any deficit. It also makes departicipation easier (see below).

Many housing associations have a defined contribution arrangement, and employer and employee contributions into these schemes vary significantly throughout the sector.

The number of such arrangements is likely to have increased due to auto enrolment and the gradual move away from defined benefit to manage costs. However housing associations’ own defined contribution schemes remain in the minority, with many defined contribution arrangements remaining part of the SHPS defined contribution scheme. This allows them to avoid departicipation debts (see below).

The arrangements that are not SHPS defined contribution used to be relatively low-cost group personal pensions or stakeholder arrangements. Like SHPS defined contribution they represent a low risk to employers, as there is no guarantee of the level of pension benefit at retirement.

There has recently been a move to large master trusts which are subject to new guidance and regulations. These act in a similar way to SHPS DC but offer employers more scope to choose a set up that is specific to their, and their workforce’s, requirements.

If a participating employer in a multi-employer scheme (such as SHPS or LGPS) has active members then a cessation debt is triggered when the employer ceases to employ anyone who is an active member of the scheme at a time when at least one other participating employer continues to employ active members (the debt is payable under ‘Regulation 64’ of the LGPS regulations for employers exiting the LGPS, or ‘Section 75’ of legislation for SHPS).

The S75 debt payable to SHPS is calculated on a very prudent basis and is therefore often significantly higher than the funding deficit at that time. The debt is usually required to be paid immediately when it has been triggered or over a very short period of time afterwards. Under Regulation 64, the individual LGPS Fund has flexibility to set the exit debt calculation basis. It is often on a very prudent basis, but may be on a less prudent basis depending on the terms of the admission agreement and whether, for example, a guarantee is in place by the transferring Council. Alternative exit terms can sometimes be agreed with the Fund. 

SHPS is a ‘last employer standing scheme. The S75 debt payable to SHPS on exit from the scheme will include an allowance for “orphan liabilities” – ie those liabilities in the scheme which no longer have an associated employer standing behind their funding. These orphan liabilities are funded by the S75 debt paid by the previously exiting employer, with any additional funding required over and above this payable by the remaining employers. The increase in these orphan liabilities over time and the risk that these are ultimately funded by the last employer has led many employers to review and reassess the risks associated with participation in SHPS. Due to the social housing sector’s participation in multi-employer arrangements, these potential debts are a particular concern.

Under SHPS defined benefit it is possible to avoid crystallisation of departicipation debt by continuing membership of the SHPS defined contribution scheme.

Mitigation arrangements known as withdrawal arrangements are possible but require the agreement of the Pensions Trust or LGPS. Other methods of mitigating (at least part of) the payment to SHPS include:

  • transferring members out of the scheme into a bespoke defined benefit arrangement (for example six employers, including Radian have carried out a bulk transfer from SHPS and transferred its liabilities and assets into its own separate part of the Pensions Trust). Advantages can include removal of the orphan risk and control gained over funding and investment strategy, to be offset by the costs of implementation
  • putting in place an asset-backed funding arrangement
  • specific negotiation with trustees of the scheme which might involve payment of the debt over a protracted period.

The LGPS has its own regulations and the departicipation rules are similar but different. There may be more scope for mitigation.

The cost of providing benefits in the LGPS and SHPS is met through employer and employee contributions. Every three years an actuarial valuation is carried out to assess the expected cost of new benefits building up and to determine whether the assets held by the scheme cover the liabilities in respect of historic service.

If there is a shortfall then a recovery plan is put into place and additional contributions are paid by the employer, on top of the contributions for new benefits, to make up the difference.

In the LGPS, the rate at which employees contribute depends on their pensionable pay, ranging from 5.5% for those earning below £14,400 to 12.5% for those earning above £161,501. These rates are periodically reviewed to maintain an average contribution rate of 6.5%. The employer pays the balance of the cost of new benefits as well as recovery plan contributions.

Employers are assessed at an individual employer level every three years, paying rates which depend on the profile of their membership and the treatment of them by their fund actuary, which can vary considerably. New contribution rates resulting from the 31 March 2019 valuation are due to come into force from 1 April 2020.

In SHPS, the employer decides what proportion of the total contribution rate to pass on to its employees. Unlike in the LGPS, each employer on the same benefit structure is allocated the same future service contribution rate rather than being assessed on an individual employer basis. For future service this currently ranges from 11.3% for 120ths CARE to 27.2% for 60ths final salary.

In addition, employers are paying recovery plan contributions to make up the shortfall between assets and liabilities, currently amounting to over £150m per annum. This will next be reassessed at the 31 March 2020 valuation.

Housing associations should consider whether the level of pension contributions they are paying is commercially satisfactory, both compared to any defined contribution rates they are paying and compared to their competitors. Consideration of whether the pension benefit is valued by different groups of staff and how it sits within a wider reward package should form part of this.

They should understand the risk of future contribution increases associated with participating in the LGPS and SHPS, and should engage with the pension scheme at each valuation to ensure that they are paying contributions appropriate to them.

The accounting treatment of pensions depends upon the nature of the scheme. This is set out in Financial Reporting Standard 102 (FRS 102).

For segregated multi-employer defined benefit schemes (such as LGPS) and single employer defined benefit schemes, the balance sheet is required to show the surplus or deficit in the scheme. The scheme assets and liabilities are valued into the future using a corporate bond discount rate approach.

For these schemes, the income and expenditure account shows the employer cost of accruing benefits and variation of the assets and liabilities from that expected over the year.

Both the statement of financial position (formerly known as the balance sheet) and the statement of comprehensive income (formerly known as the income and expenditure statement) can be volatile from year to year.

For defined contribution schemes, only the contributions paid are accounted for, as the liabilities built up over the year are equal to the contributions payable, and there is no surplus or deficit to put on the balance sheet.

Where an employer is unable to obtain its share of the assets and liabilities of a multi-employer defined benefit pension scheme, the scheme is accounted for as a defined contribution scheme. However, where a funding agreement is in place to fund a deficit on such a scheme, FRS 102 requires the recognition of a liability in relation to the payments due under that agreement on the balance sheet. This is the approach that was taken for SHPS until recently. However, the Housing SORP Working Party has concluded that it is now possible to identify an employer’s share of SHPS assets and liabilities. Therefore full DB accounting, as currently used for LGPS, will come into place for SHPS from year end 31 March 2019. Further detail on the changes to SHPS accounting can be found here.

An association would need to consider the effect on the income and expenditure account and balance sheet, especially with regard to volatility. While the operating charge would generally increase, the overall profit and loss charge would generally become less volatile. The impact of a change in approach will depend on the individual association’s circumstances.

The tax treatment of employees’ pensions has been subject to review. An annual and lifetime allowance was introduced in April 2006. Initially this affected very few scheme members, but subsequent changes to both thresholds have made the matter more complex, and lower ‘limits’ are now affecting many more people.

The current lifetime allowance is £1.055m. With the factor for testing defined benefit pensions remaining at 20 times pension plus lump sum, this threshold can be reached with a pension of under £44,000 in an one eightieth final salary scheme that provides an automatic lump sum of three times pension or a pension of £50,000 where no lump sum is automatically provided.

For those who earn less than £110,000 a year the annual allowance is now £40,000. From April 2016, this gradually reduces down to £10,000 for those who earn between £150,000 and £210,000 a year. For those earning between £110,000 and £150,000 an annual allowance of less than £40,000 may apply, depending on the value of pension benefits accruing each year.

Defined benefit schemes are more likely to give rise to pensions tax charges and so medium to large housing associations are likely to have employees who are affected. It is likely that they will require assistance to understand the actions that they need to take.

Where pension scheme members are at or above the thresholds (either annual or lifetime allowances) they may seek to manage their tax charges. Often this may mean that they need to take action to reduce or restrict (or even remove completely) any further pension growth. The impact of this on employers could be the loss of staff (often in senior roles and with long experience) or a request from staff for alternative compensation.

Understanding who is (or could be) affected, what options exist for employers and staff, and how best to engage with affected staff will help employers to remain in a position to recruit and retain key staff and ensure that the reward package continues to work for all.