The UK Pension scheme is going through considerable legislative changes. It currently comprises of state and voluntary provision.
- State earnings-related basic pension
- State second earnings-related element,
- Voluntary occupational pensions
- and voluntary personal pension components.
From October 2012, every UK employer will be required by the Government to set up a workplace pension scheme for their employees. Employers who fail to comply could be jailed or face substantial penalties of up to £10,000 per day. The idea behind it is to counteract the on-going trend of decreasing coverage of supplementary pension provision.
UK Government projections anticipate that by 2030 around 29% of the population will be aged 60 or over, compared with around 22% now.
They also plan that all eligible workers, who are not already in a good quality workplace pension, will gradually be automatically enrolled into either a qualifying workplace pension scheme (QWPS) or into the NEST pension scheme. Automatic enrolment means employees will join the workplace pension scheme unless they actively decide not to be in a scheme.
Qualifying Workplace Pension Schemes (QWPS)
The amount of contributions that must be paid in order for a scheme to be treated as a QWPS is being phased in as follows:
|
Date |
Total minimum
contribution
|
Minimum employer
contribution
|
Minimum difference to be made up by employee % (gross) * |
|
October 2012 to September 2016 |
2% |
1% |
1% |
|
October 2016 to September 2017 |
5% |
2% |
3% |
|
October 2017 onwards |
8% |
3% |
5% |
* The minimum difference includes tax relief available on employee contributions.
The default retirement age of 65 is also to be phased out.
Public Pensions
The UK State Pension system is composed of:
- the Basic State Pension - a flat-rate payment that requires a National Insurance contribution record of 30 years to receive full benefits.
- the State Second Pension (S2P) - replaced the old State Earnings (Related Pension Scheme) in order to provide an additional state pension for low and moderate income earners.
- the Pension Credit.
Occupational Pensions
The UK operates until October 2012 a voluntary occupational pension system. The current reform proposals are intended to encourage savings for retirement and less reliance on the state.
Defined benefit schemes have seen a dramatic decrease in favour of defined contribution schemes due to the complex liabilities and employers aiming to contain costs. The costs are associated with risks as a result of the funding difficulties after the downturn in equity markets, accounting issues and demographic trends.
In April 2006, The Pension Protection Fund was established as a safety net against scheme employers becoming insolvent. Its role is to compensate members of Defined benefit schemes in the event there are insufficient assets in the pension scheme.
As of 2006, new Defined benefit scheme funding regulations replaced the old Minimum Funding Requirement (MFR). The Pensions Act 2004 implemented the Statutory Fund Objectives (SFO), which require that salary-related occupational pension schemes must have sufficient assets to cover their technical provisions. A pension plan is required to set up a recovery plan if it fails to meet the SFOs.
For external funding two plan types are available, namely insuranced schemes and self-administered plans.
Small self-administered Schemes (SSAS)
A SSAS requires the appointment of an investment manager and a custodian is required. Investment managers have to be authorised under the Financial Services Act 1986 and formally appointed by the trustees.
Insurance schemes
Insured schemes are arrangements provided directly by insurance companies where the benefits provided are secured by one or more insurance policies or annuity contracts. They are set up under trust and are legally treated in the same way as self-administered schemes (pension funds).
Personal Pension Plans
Personal Pensions Plans are arrangements which the employee can establish individually with a provider of their choice.
Group Personal Pensions are popular as packaged occupational schemes because of their flexibility and cost-effectiveness. Group Personal are analogous to Defined contribution schemes.
Stakeholder Pension
Employers with more than five employees are obliged to provide their employees with an access to a Stakeholder Pension. The aim was cost effective and easy access but neither the employer nor the employee has to contribute to it.
Companies may be exempt from Stakeholder pension provision by:
- already offering a comparable standard of pension scheme
- or already contribute at least 3% of basic salary to an employee’s personal pension
The employer selects the provider and all Stakeholder schemes are on a Defined contribution basis.
Unfunded schemes
Unfunded and unapproved plans. These schemes are primarily used for executives to provide enhanced benefits.
In a document on ‘disguised remuneration’, contained in the Finance Bill 2011, the Treasury confirms legislation introduced in budget to tackle arrangements using trusts and other vehicles “which seek to avoid, defer or reduce tax liabilities” will incorporate EFRBS and EBTs. As a result, from April 2011 the arrangements will be subject to income tax and national insurance.
Tax treatment of contributions and benefits
Currently there is a lifetime allowance on the total value of tax-relieved benefits, with a maximum annual allowance in every year. The lifetime allowance (LTA) is the maximum amount of pension savings that can benefit from tax relief and is currently £1.8 million. The LTA will be reduced to £1.5 million from April 2012.
From 2011-12 onwards, the annual allowance for tax relief on pension contributions for individuals will be reduced from the previous maximum level of £255,000 to £50,000.
The UK operates an Exempt, Exempt, Taxed (EET) Pension system.
An initial tax free lump sum is usually available (25% of the fund) and benefits for a UK resident will be taxed as income in full.
There are tax charges if the lifetime allowance is exceeded; Lifetime Allowance Charge (LAC).
The LAC can be applied in either of two ways or a combination of both depending on how the excess benefits value above the lifetime allowance is taken. The charge is:
- 55% if taken as a lump sum, or
- 25% if taken as income.
Benefits may be taken in a number of ways and recent changes (April 2011) introduced a new basis of capped and flexible pension drawdown to add to the traditional annuity for life pension.
Authorised and Regulated by the Financial Services Authority
