Occupational Pension Schemes
Occupational pension schemes are pension schemes offered by employers to employees. They can provide pension and death benefits, and are run separately from an employer's business. Some occupational pensions are salary-related, which means the amount you get when you retire depends on the number of years you worked and what your earnings were. Other occupational pensions are built up using a money purchase scheme, where the contributions are invested and you use them to buy a pension when you retire. You will still get any entitlement to any State Pension that you have built up.
Does everyone get an occupational pension scheme ?
Firstly you need to be employed. If your workplace offers such a scheme, it's usually worth checking out. You will usually get tax relief on the contributions you make and you may also have extra benefits, such as a pension to your husband or wife if you die or an early pension to you if you become ill and can no longer work.
There are three types of occupational pension scheme as follows:
- Salary-related schemes
- Money purchase schemes
- Mixed-benefit schemes
By law an employer who offers an occupational pension scheme must pay a part of the cost of providing that pension. Employees can also make contributions to an occupational pension scheme. (Under an occupational money purchase scheme, the employer must pay a minimum of 10% of the employee’s contributions – although most employers match or exceed the employees contribution). Both sets of contributions are invested by the scheme manager(s) to build up a fund that is used to pay the member's pension on retirement (or to pay death benefits to a spouse).
Occupational schemes are voluntary and a person who does not join their employer's scheme can, if they wish, take out a personal pension. It is also possible to hold both an occupational scheme and a personal pension scheme, if the occupational pension only provides death benefits. Most schemes have Inland Revenue approval and so are entitled to tax relief.
Also (rather confusingly) there is another employer-sponsored alternative available, known as ‘Group Personal Pension’. These schemes are run under the less restrictive personal pension rules, and the main difference between these arrangements and occupational pension arrangements lies in the ownership of the assets / policies. Under an OPS, the assets remain under the ownership of the scheme, whilst a Group Personal Pension arrangement issues a series of individual policies that are owned by the members, to which the employer may or may not contribute to. One advantage of GPP arrangements is that if a member leaves employment, they can take the policy with them and continue contributing to it if they wish. Members of Occupational Pension schemes who leave service usually have the choice of leaving the benefits within the scheme or transferring to a new arrangement (although sometimes it is possible to have money purchase benefits assigned to the individual).
Prior to April 2012, a person could contract out of the State Earnings Related Pension Scheme (SERPS) by joining a contracted-out occupational pension, such as a contracted-out mixed-benefit scheme (COMBS). Under a COMBS, employers ran both a contracted-out salary-related and a contracted-out money purchase scheme. These are also known as final salary schemes with a money-purchase ‘underpin’ (although some schemes run as mainly money-purchase with a final-salary ‘underpin’). Schemes can no longer contract-out on this basis, and will either have restructured or ceased to operate as an active pension scheme.
Occupational Pension schemes can be set up on widely variety of basis. The way they are funded and the benefits they offer vary between schemes. Therefore, if you are uncertain about exactly what your current scheme (and any previous schemes that you have preserved benefits with) offers, then it is well worth spending a little time investigating further.
What are contracted-out money purchase schemes?
These schemes allowed members to contract out of the State Second Pension (S2P), and previously the State Earnings Related Pension Scheme (SERPS), by joining a contracted-out occupational pension scheme, such as a contracted-out money purchase scheme (COMPS).
Under a COMPS, members received a flat-rate refund of National Insurance contributions, called the minimum payment , and an age-related top-up, called the Age Related Rebate (ARR). The minimum payment was paid directly into the scheme by an employer, and the ARR is paid directly into the scheme by the Department of Social Security. Scheme members and employers generally made extra contributions to COMPS, and these receive tax relief from the Inland Revenue.
As contracting-out of S2P on a defined contribution basis ceased on 6 April 2012, these schemes have effectively come to an end, as all members are now automatically contracted back into the State Second Pension. While some schemes may carry on as a standard Occupational Money Purchase Scheme, schemes set up solely to receive rebates are now defunct, as the level of rebate in now zero.
What are contracted-out salary-related schemes?
This is the only type of pension scheme that can still contract out of the State Second Pension. Under a COSRS, the pension you receive is based on salary, length of service and annuity rates (the rate at which a pension fund is converted into a pension) at the time of your retirement. Both you and your employer make contributions. Under the Pensions Act 1995, a COSRS must meet certain legal test standards set by a reference scheme test . The test is carried out by the scheme's actuary - a person who compiles and analyses statistics in order to calculate insurance risk and premiums - who compares the benefits of the proposed COSRS against the standards set by the reference scheme. If the actuary believes that more than 10 percent of scheme members will receive benefits below the legal standard, the scheme does not pass the test.
What rules govern occupational pension schemes?
Under the Pensions Act (PA) 1995 a legal framework was set up to reinforce the most important parts of occupational pension law. Rules in trust law already covered most occupational pension schemes; PA 1995 set out new rules to ensure that occupational pension schemes were better run. These new rules included:
- Choosing trustees. Scheme members should have a say in choosing trustees. In most schemes this means members having the right to choose one third of trustees, although schemes can differ on their arrangements if they have the backing of members.
- Information to scheme members. Employers must provide new members with details of the scheme within two months of joining and members have the right to view documents about the scheme, such as annual reports, trust deeds and rules.
- New complaints system. Each pension firm must have an official complaints procedure consisting of two stages. Complaints must be dealt with first by a designated complaints person, and if a customer remains unsatisfied, he has the right to refer the matter to the scheme's trustees. If still unresolved customers can take their case to the Pensions Advisory Service (OPAS) or the Pensions Ombudsman.
- Keeping paperwork. Schemes must keep proper records.
- Making sure the contributions are paid. Schemes must keep precise records of all contributions paid into them. Trustees are also responsible for ensuring that any financial accounts needed are audited within a strict timescale.
- Investing the scheme's money. Trustees must provide a written 'statement of investment principles'. Separate accounts must be opened to keep money from the pension scheme separate from the employer's assets, ensuring that in the event of bankruptcy, money from the scheme cannot be used to pay off company debts. No more than five percent of the scheme's money can be invested into the employer's own business.
- Choosing professional advisers to the pension scheme. A scheme's trustees are responsible for choosing specialist advisers for legal and technical matters. Their appointment must be made in writing, setting out clearly their duties, and if an adviser chooses to resign they must provide the trustees with a written statement which sets out any concerns or problems.
- Minimum funding requirement. Earnings-linked (final salary) occupational pension schemes must ensure that enough money is paid into the scheme to cover everyone's pension benefits.
- Protection against inflation. From April 1997 (when PA 1995 came into force) all schemes must have protection against inflation for those parts of member's pensions which have built up after this date.
The effect of 'A-Day' and Pension Simplification
The new pension rules introduced on 06/04/2004 have substantially altered the amounts that individuals are allowed to contribute to pension schemes, and have created a standard set of rules for the taking of benefits from all types of pension schemes. See the document on Pension Simplification for more details.
However, much of the existing legislation regarding the structure and procedures of occupational pension schemes has remained intact. Employers who employ more than five employees are still required to either provide a pension scheme for their employees, or facilitate access to a pension scheme (which is usually a stakeholder-type pension arrangement). Therefore, the majority of Occupational Pension schemes in existence before April 2006 will in all likelihood carry on as normal. Whilst it will be easier for employees to make sizeable contributions if they wish to do so, the obligations upon the employer / scheme trustees with regard to the running of the scheme are pretty much the same as before.
NOTE: This document is intended to provide a brief overview of the subject. It should not be read as a recommendation to use any particular product, as it does not take into account individual circumstances and attitudes.