An introduction to pension schemes

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 not suitable for small companies and are expensive for the employer. Both the employer and employee usually contribute as these are company wide 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.

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, GPP s (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, 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.

5. Stakeholder

This is the new type of scheme which the government has just introduced. Anyone, whether employed or not, may contribute up to £3,600 per annum to a stakeholder scheme. These schemes will be run by insurance companies and a few other institutions, including some trade unions.

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 will have a right to be consulted as to which stakeholder scheme is selected by the employer.

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 is available in respect of contributions made both by employers and employees, but only in respect of contributions comprising a fixed percentage of relevant earnings.
• Tax relief is only available if the pension scheme or personal pension contract has been approved by the Inland Revenue.
• Inland Revenue approval depends upon the rules of the scheme or contract satisfying a large number of strict but standard requirements regarding maximum pension benefits provided for the member and surviving spouse or other dependants and ages at which pension benefits may be taken.
• Pension benefits from schemes and personal pension contracts are taxable, 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.

What should I do now?

• If your company already has a pension scheme you must seek advice as to whether or not its terms are such that you will not have to be concerned with stakeholder pension schemes.
• If your existing company pension scheme does not provide exemption or if you have no pension scheme you must decide whether or not you must provide access to a stakeholder pension for your workforce. This is a legal obligation in the circumstances mentioned above.
• If you are required to provide access to a stakeholder pension scheme there is no need to do so before 6 April 2001 but you must do so by October 2001.
• If you do not have a company pension scheme and do not have to provide access to a stakeholder pension scheme you need to consider what sort of pension arrangement you should establish for yourself and those with whom you work.

Any questions? Please contact struan.robertson@out-law.com / 0141 249 5422 or one of our other contacts.