Nov 8, 2010


The governance of pension schemes is extremely (and increasingly) complex. In this section we give a brief introduction to how pension schemes are governed, the tax regime, legislation/regulation and the various parties involved.

Add a note hereHow Pension Schemes are Established

Add a note hereThe two main ways of establishing tax-approved pension schemes in the UK are under trust and under contract.

Trust-based Schemes

Add a note hereHistorically, most UK occupational pension schemes have been set up via trusts. Trusts are, in some ways, quite anachronistic, and the law governing them is mostly older case law. They are also notoriously difficult to define; however, one possible definition is that 'a trust is an equitable obligation binding a person (who is called a trustee) to deal with property over which he has control (which is called the trust property) for the benefit of persons (who are called the beneficiaries) of whom he may himself be one and any of whom may enforce the obligation' (Hewitt Bacon and Woodrow Pocket Book 2004, NTC).

Add a note hereHowever, trust law has, with a few exceptions, functioned well for many years. The reasons for using a trust are:
§  Add a note hereto ensure tax approval by the Inland Revenue;
§  Add a note hereto keep the scheme assets separate from those of the employer, thereby providing security;
§  Add a note hereto provide legal rights to beneficiaries who are not and have not been employees, such as partners and dependants.

Add a note hereTrust-based schemes are governed by a scheme trust deed and rules detailing benefit entitlements and the rights and responsibilities of the members, the sponsoring employer(s) and the trustees. It will also govern what is permissible under the scheme, including any powers of amendment.

Add a note hereTrustees may be individuals and/or the directors of a trustee company. They may or may not be members of the plan. A proportion must be member nominated and elected, with others typically nominated by the employer. Over the years, the importance role of the trustees has been emphasized at the expense of the sponsoring employer(s). For example, the trustees are now primarily responsible for investment strategy and appointing advisers.

Add a note hereThe trust deed and rules and the trustees are an important consideration when considering change - there have been cases of employers taking strategic decisions on pensions that could not be delivered under the scheme rules or else required consent from the trustees.

Contract-based Schemes

Add a note hereApproved defined benefit schemes (at least in the private sector) are invariably set up as trusts. However, defined contribution schemes may be set up as trusts ('occupational money purchase schemes') or on the basis of a contract with an external provider, such as an insurance company. These contract-based schemes include group personal pension schemes, stakeholder schemes and retirement annuity contracts (now largely superseded).

Add a note hereStakeholder schemes are a new, highly regulated, form of defined contribution schemes with very low provider charges. All employers with five or more employees must offer a stakeholder scheme unless they have another scheme with wide employee access and that meets certain criteria. There is no obligation on employers to contribute to a stakeholder arrangement.

Add a note hereThe Pensions Tax Regime

Add a note hereIn simple terms, the tax regime for approved UK pension schemes is as follows:
§  Add a note hereEmployee contributions attract income tax relief.
§  Add a note hereEmployer contributions are deductible for corporation tax purposes.
§  Add a note hereEmployer contributions are not taxable as a benefit-in-kind.
§  Add a note hereEmployer contributions are not subject to employer or employeeNICs.
§  Add a note hereIncome and capital gains on scheme investments are not subject to tax (although schemes can no longer reclaim advanced corporation tax on equity dividends).
§  Add a note herePensions in payment (including those paid to dependants) are taxed as earned income and do not attract NICs.
§  Add a note hereA proportion of the pension may be taken in the form of a tax-free lump sum at retirement.
§  Add a note hereA tax-free lump sum may be paid to dependants on death in service.

Add a note hereBecause of these tax privileges, there are restrictions on what may be provided from a tax-approved scheme. These are discussed below (see 'Executive pensions').

Add a note herePension Scheme Regulation

Add a note hereThe UK pensions field has to operate within a bewildering framework of legislation, regulation and case law. The complexity partly reflects the fact that pension schemes have to deal not just with pension law but with trust law, employment law, tax and social security laws, financial services law and EU law. It also reflects frequent government-imposed changes, which may or may not be retrospective.

Add a note hereIt should also be noted that the interaction between regulation and the pension scheme's own governing documents can be complex.

Add a note hereInterested Parties

Add a note hereOne of the many complications of pension provision is the sheer variety of interested parties. In a final salary scheme, these will typically include most of the following:
§  Add a note herethe employee;
§  Add a note herethe employee's dependants;
§  Add a note herethe sponsoring employer(s);
§  Add a note herethe employer's pensions manager;
§  Add a note herethe trustees;
§  Add a note herethe actuary (who gives advice on funding);
§  Add a note hereconsultants who may give advice on design, communication, etc;
§  Add a note hereadministrators (may be in-house or third party);
§  Add a note herelawyers (responsible for drafting the scheme rules and other advice, as required);
§  Add a note herethe scheme auditors;
§  Add a note herethe investment manager(s);
§  Add a note hereinvestment consultants (giving advice on which managers to select);
§  Add a note herethe Inland Revenue;
§  Add a note herethe Occupational Pension Regulatory Authority (OPRA);
§  Add a note herethe Pensions Ombudsman.

Add a note hereSome of the above roles may be combined. For example, a firm of consulting actuaries may provide actuarial, consultancy, administration, legal and investment consultancy advice.


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