THE FUTURE | Pension Schemes

Looking at the medium-term future of UK occupational pension provision, a number of key questions arise, as considered in the following sections.

Does the Final Salary Scheme Have a Future?

It remains to be seen whether the final salary occupational scheme has a long-term future. Its obituary has been written many times before. However, this time there is significant evidence of a move away, with more than 50 per cent of such schemes now closed to new entrants.

Where final salary provision is surviving in the private sector, one or more of the following factors may apply:

§  The scheme is still in surplus.

§  Providing a guaranteed, final salary pension is a component of a very caring and paternalistic people strategy.

§  The employer has deep pockets and/or people costs are low compare to turnover.

§  The scheme has been modified to reduce employer cost.

Will the Public Sector Move Towards Defined Contribution Schemes?

Given the huge (and rising) costs of its current schemes, this is a possibility. However, doing so would remove a significant retention lever and would cause major industrial relations problems. Any such change would probably imply a need to increase other elements of pay.

Will Defined Contribution Schemes Provide Adequate Retirement Incomes?

There is a significant risk that many defined contribution schemes will fail to deliver the standard of retirement living expected by their members. A previous generation of defined contribution schemes failed for just this reason.

Tackling this issue implies increasing employer contributions and/or providing education to employees to allow them to increase their own saving. For example, some employers pay for financial advice or offer online pension modelling through the company intranet.

There are also strong arguments for considering some of the hybrid design options outlined above. These generally involve providing at least some pension guarantees to employees, but should avoid the degree of cost fluctuation associated with traditional final salary schemes.

Can Two-tier Pensions be Sustained in one Employer?

Where an employer has scaled back pension for new employees, this creates inequalities with longer-serving staff. Some commentators have suggested a compensating increase to another part of the package. However, unless this is as part of a flexible benefits scheme, such an approach can fall foul of equal pay legislation, where comparisons are made for each element of pay separately.

Another factor to consider here is that staff in the final salary scheme, particularly any who are nearing retirement, will be unlikely to leave. This is especially true if alternative employers have also moved to defined contribution provision.

Can Pensions be Communicated Effectively?

A key and long-standing problem in the pensions field is communications. The difficulties arise because:

§  pensions are intrinsically complicated;

§  retirement feels a long way off to many people;

§  there can be a tension between effective design and ease of communication - for example, providing employees with choice may be desirable, but requires clear communication;

§  some of the language used around pensions is not always helpful to the layperson;

§  pension scandals have reduced employee confidence.

This is a field where HR, marketing and communications professionals can add value. Sadly, many pensions booklets and annual benefits statements are virtually indecipherable for most employees. In addition, communications are often very dependent on the written word.

To ensure employee engagement, pensions communications should:

§  give a clear, easily assimilated overview of the main scheme provisions;

§  allow employees to understand the likely level of pension payable;

§  encourage additional saving, where appropriate;

§  highlight where advice and clarification are available from;

§  in final salary schemes, identify how much the employer is spending on the employee's behalf.

A variety of media should be used, perhaps involving booklets, annual statements, frequently asked question sheets, workshops and interactive pension-modelling tools. Written materials should be tested on non-experts to ensure readability.

Issues and Opportunities Arising from Tax Simplification

The government's tax simplification proposals (see above, 'Executive pensions') and other changes have created some challenges and opportunities for people management looking forward, as follows:

§  Many of the restrictions on scheme design that currently exist will fall away. This should allow some more creative designs to emerge.

§  It will become possible to draw a pension while still working for the same employer. This will allow a phased approach to retirement that may suit some employees and employers.

§  Compulsory retirement on the grounds of age will disappear. This will probably mean more active performance management and a more creative approach to career management for older workers.

§  The minimum retirement age (other than on grounds of ill health) will increase from 50 to 55. Schemes will be given discretion on how to achieve this.

§  Employers may wish to help employees to make the best of the very liberal regulations for making extra voluntary contributions.

Are Final Salary Schemes Well Enough Funded?

The security of final salary pensions in a closed scheme is a complicated question well beyond the scope of this post. However, the latest government proposals are set to:

§  considerably bolster the level of financial obligation on solvent employers in respect of closed schemes;

§  introduce a levy-based scheme to fund a minimum level of benefits from under-funded schemes where the sponsoring employer is insolvent.

PENSION SCHEME GOVERNANCE

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.

How Pension Schemes are Established

The two main ways of establishing tax-approved pension schemes in the UK are under trust and under contract.

Trust-based Schemes

Historically, 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).

However, trust law has, with a few exceptions, functioned well for many years. The reasons for using a trust are:

§  to ensure tax approval by the Inland Revenue;

§  to keep the scheme assets separate from those of the employer, thereby providing security;

§  to provide legal rights to beneficiaries who are not and have not been employees, such as partners and dependants.

Trust-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.

Trustees 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.

The 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

Approved 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).

Stakeholder 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.

The Pensions Tax Regime

In simple terms, the tax regime for approved UK pension schemes is as follows:

§  Employee contributions attract income tax relief.

§  Employer contributions are deductible for corporation tax purposes.

§  Employer contributions are not taxable as a benefit-in-kind.

§  Employer contributions are not subject to employer or employeeNICs.

§  Income and capital gains on scheme investments are not subject to tax (although schemes can no longer reclaim advanced corporation tax on equity dividends).

§  Pensions in payment (including those paid to dependants) are taxed as earned income and do not attract NICs.

§  A proportion of the pension may be taken in the form of a tax-free lump sum at retirement.

§  A tax-free lump sum may be paid to dependants on death in service.

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

Pension Scheme Regulation

The 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.

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

Interested Parties

One 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:

§  the employee;

§  the employee's dependants;

§  the sponsoring employer(s);

§  the employer's pensions manager;

§  the trustees;

§  the actuary (who gives advice on funding);

§  consultants who may give advice on design, communication, etc;

§  administrators (may be in-house or third party);

§  lawyers (responsible for drafting the scheme rules and other advice, as required);

§  the scheme auditors;

§  the investment manager(s);

§  investment consultants (giving advice on which managers to select);

§  the Inland Revenue;

§  the Occupational Pension Regulatory Authority (OPRA);

§  the Pensions Ombudsman.

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