Occupational pension schemesTypes
What are the main types of private pensions and retirement plans that are provided to a broad base of employees?
Plan types available in the UK are defined benefit, defined contribution, and hybrid plans (in which the ‘pension risk’ is more fairly shared between a plan’s employer and employees on a career average (CARE) or cash balance basis). The same plan can have both defined benefit and defined contribution sections. They can be for one employer or for a group of employers.
Owing to increasing governance requirements, some employers are replacing their defined contribution plan with a defined contribution master trust. These are also often used by non-associated employers to comply with their auto-enrolment obligations - the employer’s obligation to auto-enrol all eligible workers into a qualifying pension arrangement (a workplace pension plan), to which both the employer and the employees have to pay a minimum level of contributions.
From 1 October 2018 master trusts have been given six months to apply for authorisation from The Pensions Regulator to continue operating under new legislation. This has placed the master trust regime under considerable uncertainty and it is expected that many current master trusts will cease to operate, leaving just a small number of large well-run master trusts.Restrictions
What restrictions or prohibitions limit an employer’s ability to exclude certain employees from participation in broad-based retirement plans?
An employer can exclude certain employees from its broad-based retirement plans, despite this leading to a two-tier workforce in pension terms. Often this happens for historical reasons leading to different groups of employees earning different pension benefits with the same employer. Different pension provision can arise for legal reasons owing to the transfer in of a business from another employer. Alternatively, an employer’s defined benefit plan may be closed to new joiners, who can join the employer’s defined contribution plan, while current employees still earn defined benefits.
With defined contribution plans, different employees can be entitled to different rates of employer contributions and an employer may also have, for historical reasons, different defined contribution plans for various groups of employees. There have been a series of cases challenging these types of distinctions.
An employer should not discriminate against an individual owing to, for example, sex, gender, age, sexual orientation or because the employee works part-time.
Care should be taken with defined contribution plans that have different pension provisions for different ages of employee, with older employees being entitled to a higher level of employer’s contributions.
Because of employers’ statutory auto-enrolment obligations, nearly all workers (subject to some minimal requirements) have to be given access to a minimum level of pension provision.
Can plans require employees to work for a specified period to participate in the plan or become vested in benefits they have accrued?
Employers have slightly more than three months to pay a newly auto-enrolled worker’s initial contributions over to the provider of its workplace pension plan to comply with statutory minimum pension requirements. However, employers and plans can require employees to work for a specified period before the employee can join any other plan. Benefits in these plans vest for new joiners after 30 days’ membership.Overseas employees
What are the considerations regarding employees working permanently and temporarily overseas? Are they eligible to join or remain in a plan regulated in your jurisdiction?
Employees who work permanently outside the UK should be excluded from membership of the employer’s plan.
Employees who are only working overseas on a temporary basis can continue to be members of an employer’s plan, as long as there is a reasonable expectation the employee will, in the next five years, return to work in the UK or retire.
There are serious consequences for defined benefit plans if these requirements are breached and the employee is working in another EU country as the plan has, for example, to be fully funded immediately. Employer auto-enrolment duties apply to workers who are based in the UK but work abroad.
EU Directive 2014/50/EU currently gives EU workers better pension rights when they move to another member state.Funding
Do employer and employees share in the financing of the benefits and are the benefits funded in a trust or other secure vehicle?
Occupational pension plans are set up as trusts, with trustees who hold the plan’s assets separately from the employer for the benefit of its members.
With defined benefit plans, employees usually have to contribute to the plan and the employers pay the balance of the costs of funding the plan, depending on the value of the plan’s assets and what assumptions are used to determine the plan’s liabilities.
Many defined benefit plans are closed to the future accrual of benefits, so members no longer pay contributions and cease to earn extra pension funding, although the employer must still fund the plan. Sometimes in these cases, the terms of the plan require a final salary link to be maintained for calculating benefits while the member remains employed with the plan’s employer, but no contributions are required from the member.
With defined contribution plans, the employer can match, in either a simple or more complicated form, the employee’s contributions to the plan and the plan is set up with a third-party pension provider.
With auto-enrolment, currently the minimum employer contribution has increased to 2 per cent of the worker’s qualifying earnings, with the worker paying 3 per cent. This is to increase again in April 2019 to 3 per cent employer contributions and 5 per cent employee contributions. Salary sacrifice is often used as a tax-efficient way for these contributions to be paid.
What rules apply to the level at which benefits are funded and what is the process for an employer to determine how much to fund a defined benefit pension plan annually?
Many defined benefit plans have deficits, which usually the employer has to make good over a period of years. Deficits arise because of adjustments over the years to funding assumptions, for example, over what investment returns the plan’s assets will earn, the future level of inflation and mortality rates.
The funding of defined benefit plans is controlled by the results of the plan’s triennial valuation, which values its liabilities on the following bases:
- scheme-specific funding: the plan’s own ongoing funding basis determined primarily by the trustees after taking advice from the plan’s actuary. Depending on the plan’s rules, the employer may also agree the funding rate;
- pension protection funding: the statutory basis that determines whether, if an insolvency event occurs in respect of the plan’s employer, the plan would enter and stay in the Pension Protection Fund; and
- full buyout, statutory section 75 basis: the most expensive funding basis. It is the cost of winding up the plan and securing all benefits with an insurance company, together with the trustees’ costs of doing this.
Under some plans’ rules, trustees have separate freestanding funding powers to require an employer to pay additional sums into a plan.
The UK accounting standard FRS102, which brings the UK’s accounting standards in line with the equivalent international financial reporting standards (IAS19 revised), is used to value a plan’s assets and liabilities for the employer’s accounts.
If the valuation shows the plan has a scheme-specific funding deficit the plan’s scheme needs a recovery plan, setting out what employer contributions will be paid over a set number of years to eliminate the deficit. The valuation is used to compile a statement of funding principles showing how the trustees intend to ensure the plan is appropriately funded. Contributions are paid in accordance with a schedule of contributions.
The plan’s funding position must be reconsidered annually in the light of plan and employer experiences. The plan’s actuary prepares an annual funding report comparing the plan’s actual funding position to the funding position anticipated by the plan’s valuation and its statement of funding principles. If the discrepancies are too wide, the trustees can bring forward the plan’s next valuation or formally alter the plan’s schedule of contributions to change the contribution rate.
No valuations are needed for defined contribution plans, but they must have a payment schedule that sets out what contributions are due and when.
No payment schedule is needed for auto-enrolment.Level of benefits
What are customary levels of benefits provided to employees participating in private plans?
In a defined benefit plan, the pension is based on the salary the employee was receiving at the end of his or her working life with that employer, and the number of years of the employee’s employment with the employer, with a proportion of benefits earned in the plan for each year of such work.
Typically, an employed member earns one-sixtieth of his or her final salary from that employer for each year of employment, and the plan provides a maximum pension of two-thirds of the member’s final salary after 40 years’ employment with that employer.
With defined contribution plans, employees have their own notional pension account in the plan into which employer and employee contributions are paid. The pension savings on retirement depend on how much has been contributed to the plan for the employee, investment returns achieved for that account and the charges paid. Once the employee reaches the age of 55, he or she can access his or her pension savings and decide how to use them, including buying a pension, an annuity, from an insurance company, once tax-free cash has been taken (with potentially pension increases and dependants’ pensions paid from the annuity) or taking cash or flexible drawdown (less in both cases tax), or a combination of all these to the extent these options are permitted by the plan.Pension escalation
Are there statutory provisions for the increase of pensions in payment and the revaluation of deferred pensions?
For defined benefit plans, benefits earned from 6 April 1997 must be increased when in payment by 5 per cent or price indexation, if less. This is reduced for pensions in payment to increases of 2.5 per cent or price indexation, if less, for pensions earned from 6 April 2005 onwards.
From 1 January 2011, the index used for statutory increases changed from the retail prices index to the consumer prices index. Whether plans are affected by this change depends on the plan’s rules.
There is no statutory requirement to increase pensions in payment earned before 6 April 1997, apart from guaranteed minimum pensions where special rules apply; however, many defined benefit plans do increase them. What increases are granted for these benefits depend on each plan’s rules.
Legislation requires most deferred pensions to be revalued. The precise revaluation requirements depend on each plan’s rules and when the member joined the plan.
Defined contribution benefits for employment from 6 April 1997 that came into payment before 6 April 2005 also have to increase by 5 per cent or by price indexation, if less. Apart from this, there are no statutory requirements for pension escalation or the revaluation of deferred pensions with defined contribution plans. However, the defined contribution benefit must be purely defined contribution, otherwise there may be overriding statutory requirements to provide, for example, pension increases.Death benefits
What pre-retirement death benefits are customarily provided to employees’ beneficiaries and are there any mandatory rules with respect to death benefits?
In defined benefit plans, an employee’s spouse (including a same-sex spouse or civil partner) is usually provided with a pension if the employee dies before retirement. That benefit can, but does not have to, be extended to cover a member’s dependant children up to a certain age, and other dependants.
For both defined benefit and defined contribution plans, the death of the employee usually triggers a lump-sum death benefit paid by the trustees to the employee’s nominee. These payments can be funded through separate life assurance, with the pension plans then providing a smaller benefit.Retirement
When can employees retire and receive their full plan benefits? How does early retirement affect benefit calculations?
When employees can retire and receive their full benefits depends on each plan’s rules - normal retirement age usually ranges between 60 and 65. For historical reasons, benefits in some defined benefit plans are determined on the basis of a split normal retirement age of 60 and 65. For these, members are entitled to retire as of right when they reach 60, but benefits determined by reference to a normal retirement age of 65 tend to be reduced for early payment.
Employees can usually retire at any time after 55 on a reduced pension. Often a plan’s rules require the employer’s or the trustees’ consent, or the consent of both, to early retirement. Whether consent is given in respect of a defined benefit plan usually depends on whether early retirement will result in additional costs to the plan, which depends on how the plan’s early retirement actuarial adjustment factors apply.
Early retirement is not usually an issue for defined contribution plans. An employer may have to auto-enrol employees into its statutory auto-enrolment plan if it continues to employ them after they have accessed their pension savings and their annual allowance will reduce (see question 3).Early distribution and loans
Are plans permitted to allow distributions or loans of all or some of the plan benefits to members that are still employed?
No, this is not generally permitted. However, employees can receive their pension from a plan while still employed by the plan’s employer, as long as the plan’s rules permit this.Change of employer or pension scheme
Is the sufficiency of retirement benefits affected greatly if employees change employer while they are accruing benefits?
A defined benefit plan’s funding is not immediately affected if an employee changes employment - it is picked up on the plan’s next actuarial valuation.
For a defined contribution plan, an employer ceases to pay contributions for an employee once the employee has left employment.
In what circumstances may members transfer their benefits to another pension scheme?
There is currently no requirement for an employee to transfer his or her pension benefits from one plan to another if he or she changes employer. Often employees do not transfer their pension benefits when they change jobs.
Although many members have a statutory right to transfer their benefits out of a plan, as long as they are not in receipt of their pension from that plan, they do not have the same statutory right to require a new plan to accept that transfer. The trustees of many defined benefit plans do not accept any transfers in from any other plans. So historically the transfer of benefits from one plan to another is uncommon, even for defined contribution plans. Auto-enrolment and the April 2015 pension flexibilities are gradually resulting in more employees transferring their pension benefits (defined benefit or defined contribution) to plans that allow them access to the new flexibilities.
A member of a defined benefit scheme must take specialist advice before transferring his or her benefits out of a defined benefit plan to a defined contribution plan, or to an overseas plan.Investment management
Who is responsible for the investment of plan funds and the sufficiency of investment returns?
With defined benefit plans, the plan’s trustees have overall responsibility for the investment of its assets. They decide its investment strategy, after taking written advice from an investment adviser authorised by the Financial Services and Markets Act 2000 on how to implement that strategy. The investment adviser advises the trustees on which investment or fund manager to use and how to invest the plan’s assets in the various asset classes, how to measure performance, what the performance has been and what costs have been charged. The trustees delegate the detailed implementation of their investment strategy to the investment or fund managers and sometimes appoint a fiduciary fund manager. As long as they do so in a way that satisfies the statutory requirements, the trustees are not then responsible for the actions of their managers.
The trustees’ key investment decisions are set out in the plan’s statement of investment principles, which is used by the plan’s investment managers when they manage the plan’s investments. It includes the plan’s investment objectives, its asset allocation strategy, governance, target funding levels, implementation and responsible investment. The Pensions Regulator also provides guidance for trustees. Trustees of trust -based defined contribution plans are required to produce an annual governance statement signed by their chair, called the ‘Chair’s Statement’, showing among other things, investment charges and core transaction costs. These statements are inspected by The Pensions Regulator.
With a defined contribution plan, the investment and mortality risk rests with the member. The trustees decide the range of investment options the plan provides, but the members decide which options they want to use. If they make no decision, then the default investment option or options, chosen by the trustees, is used. The default investment option of a plan used for auto-enrolment is subject to statutory charging restrictions.Reduction in force
Can plan benefits be enhanced for certain groups of employees in connection with a voluntary or involuntary reduction in workforce programme?
Whether a defined benefit plan’s benefits can be enhanced for groups of employees because of a voluntary or involuntary reduction in the workforce varies from plan to plan. There is no general statutory right to such enhancements - they form part of a plan’s rules.
Under a plan’s early retirement rules, members may be entitled to draw their pensions without reduction for early retirement, if they have reached a certain age, or the trustees or employer may agree to a member’s early retirement request in these circumstances on favourable, rather than cost-neutral, early retirement terms.
Defined contribution plans are not structured in a way that enhances benefits on a voluntary or involuntary reduction in the workforce. However, an employer can make an extra contribution to the employee’s pension account.Executive-only plans
Are non-broad-based (eg, executive-only) plans permitted and what types of benefits do they typically provide?
Non-broad-based (executive-only) plans are permitted. They can be agreed on a common basis, so all executives of a particular type obtain the same benefits, or they can be agreed on an individual basis. As the tax regime has become less favourable for executive pension arrangements, it is becoming increasingly common for employers to agree terms on an individual basis to reflect that person’s own tax position and for employers to put in place generous tax-favourable life assurance arrangements.
Executive pension plans can be defined benefit, defined contribution or hybrid. Tax changes to the annual allowance and the lifetime allowance (see question 3) make it much less tax-efficient for many executives to add to their pension savings, so many look for pension alternatives such as enhanced pay.
How do the legal requirements for non-broad-based plans differ from the requirements that apply to broad-based plans?
Some relaxations in general pension law apply to some forms of executive plans. They vary depending on the type of plan, but small self-administered schemes have the most relaxations.
The key legal concern for setting up executive plans is that they do not breach HM Revenue & Customs (HMRC) tax-avoidance rules.
Executive plans for public limited companies are subject to disclosure rules.Unionised employees
How do retirement benefits provided to employees in a trade union differ from those provided to non-unionised employees?
There is no difference in the retirement benefits provided to employees in a trade union from those provided to non-unionised employees. However, trade union involvement often results in better pension terms being negotiated for all employees of that employer.
How do the legal requirements for trade-union-sponsored arrangements differ from the requirements that apply to other broad-based arrangements?
There are no special legal requirements for trade-union-sponsored pension arrangements.