An introduction to pension schemes

This guide is based on UK law. It was last updated in September 2009.

Why have a pension scheme?

Even young companies and their personnel should think about pension provision. No one can reasonably expect to live in any comfort, let alone in the style which every successful internet entrepreneur should be able to anticipate, without putting significant sums of money into some form of pension plan in addition to what the State provides.

What sort of pension schemes are there?

Pension arrangements exist in several forms:

1. Defined benefit schemes

In these, members receive a pension based on years of service and salary at their retirement. Such schemes are expensive for the employer because the employer is responsible for meeting any shortfall in the scheme, for example if the scheme investments underperform. Both the employer and employee usually contribute to such schemes.

2. Defined contribution schemes

Otherwise known as Money Purchase Schemes, these provide a cash sum at retirement, which must then be used to buy an annuity. The amount of the cash sum depends upon how the annual contributions to the scheme have been invested and how well those investments have performed. Again, both employer and employee usually contribute as these are company wide schemes.

3. Personal pensions

As the name implies, these are pension schemes set up by an individual for his own benefit and will be with an insurance company. As these are not schemes set up by the employer there is no obligation on the employer to contribute. As only the employee will be contributing, unless an arrangement is made with an employer, the contribution burden for the employee/member to attain the same benefits is higher than under a Defined Benefit or Defined Contribution Scheme in which the employer contributes.

Like a Defined Contribution Scheme, benefits at retirement will depend upon investment performance and the annuity market.

The individual who sets up a personal pension does not need to be an employee. He can be self employed.

4. Group personal pension plans

Although set up as a company wide scheme, GPPs (as they are known) are really no more than personal pensions for employees arranged by the employer on a group basis with a single insurer/ pension provider.
However, the employer may contribute and often pays the scheme administration charge, so it would be less expensive for the employee/ member than a free standing personal pension. The ultimate pension benefits will again depend upon investment performance and the annuity market at the date of retirement.

5. Stakeholder

This is a type of money purchase scheme which the government introduced in 2001 to encourage pensions saving for those without access to an employer sponsored pension arrangement.   Anyone, whether employed or not, may contribute up to £3,600 or up to 100% of UK taxable earnings per annum to a stakeholder scheme. These schemes are usually run by insurance companies.

Every employer who employs five or more persons and who does not have a pension scheme which is open to all its employees and which provides such other benefits as are necessary to obtain exemption from the stakeholder obligation must afford access to a stakeholder scheme for its employees.

If an employee who could join a company pension scheme chooses, instead, to join a stakeholder scheme, there is no obligation on the employer to make any contribution to the stakeholder scheme.

The workforce has a right to be consulted as to which stakeholder scheme is selected by the employer.

Changes on the way – personal accounts

From 2012, there will for the first time be a statutory obligation for employers to contribute to a pension scheme.  The Government intends to establish the personal accounts scheme, a large defined contribution scheme.  Employers will have to automatically enroll all their employees into the personal accounts scheme and contribute at least 3% of qualifying earnings (earnings between approximately £5,000 and £33,500) unless their employees are already members of a qualifying scheme.  This statutory obligation will replace the stakeholder requirements set out above. For more details on personal accounts see OUT-LAW's guide to Personal accounts pension schemes: what employers need to know.

What else is important?

There are many other important points to bear in mind in relation to all pension schemes. A few of these are:

• Tax relief (subject to certain limits and restrictions) is available in respect of contributions made both by employers and employees.
• Tax relief is only available if the pension scheme or personal pension contract is registered with the Inland Revenue.
• Registration depends upon the rules of the scheme or contract satisfying a large number of strict but standard requirements.
• Pension benefits received from schemes and personal pension contracts are taxable as income, although a tax free lump sum may be taken at retirement. If a member elects to take the tax free lump sum this will result in a lower pension becoming payable because the lump sum must be deducted from the capital which would otherwise be used to purchase the pension annuity.

Contacts

Christopher Berkeley
Biography
email Christopher
+44 (0) 207 667 0147