Beware the pension trap when chasing contracts

The Local Government Pension Scheme carries a number of risks for charities that decide to take on outsourced local authority provision

Pensions: both staff and employers put their money in
Pensions: both staff and employers put their money in

Securing a contract to run a service on behalf of a local council might seem like a great achievement for a charity, but such contracts can carry great risks when they involve the transferring of staff to the charity.

Employers who previously worked for a local authority would be eligible to pay into the Local Government Pension Scheme, a defined-benefit scheme funded by means of contributions from both employees and employers. Any staff who transfer from the council to another provider retain the right to earn benefits in the LGPS. There are dozens of versions of the scheme across the UK, and it is estimated that thousands of charities are members.

The LGPS is a very generous pension plan for employees, but comes with numerous potential problems for participating employers. Lee Colgate, senior associate at the law firm Charles Russell Speechlys, says awareness of these risks is crucial: "Once you're in, you're in on the terms that apply to you on the point of admission into the scheme.

"But you need to be fully aware of what those terms mean and make sure you don't expose yourself to unnecessary risk."

The Pensions and Lifetime Savings Association and the Charity Finance Group have both released briefings on the risks posed by the LGPS. The CFG's briefing warns that some LGPS funds require charities to assume responsibility for the benefits accrued by the former council staff before their transfer. This makes the charity liable for any funding shortfalls that develop as a result of those past accruals. The CFG recommends negotiating with the authority in question to ensure the charity remains liable only for accruals and shortfalls that come after the outsourced contract has begun.

One of the biggest risks is variability in the contributions made by charities. Contribution rates are re-evaluated every three years and can fluctuate wildly, depending on the fund's finances.

The CFG recommends that, before entering the LGPS, charities look into negotiating a deal that mitigates any changes in the contribution rate required from employers. It puts forward some alternatives, such as fixed-rate contributions, whereby the contribution rate does not change over the life of the contract, or a cap-and-collar arrangement, which establishes minimum and maximum contribution rates.

Another substantial risk is exit costs. These are triggered when a charity leaves the LGPS, such as when its outsourcing contract ends or the final original member of staff leaves the organisation. The CFG points out that exit payments can pose an insolvency risk for charities in the worst cases and can run into hundreds of thousands of pounds. It says charities should ensure they are not liable to pay the whole exit fee up front on departing the LGPS.

David Davison, director and head of public sector, charities and not-for-profit at the pensions consultancy Spence & Partners, says LGPS membership can also prove problematic if charities wish to merge or collaborate with others.

"Being a member of these schemes is pretty much a death knell for cooperative activity," he says. "A charity that doesn't have any LGPS or defined-benefit provision is unlikely to want to merge or take over another organisation that does. I think it seriously restricts any sensible cooperative activity."

Both the PLSA and the CFG say charities should understand the risks and each fund's terms and conditions. Most importantly, every affected charity should get specialist advice before joining the LGPS.

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