What are contract-based defined contribution (DC) pension schemes?
Defined contribution (DC) schemes are pensions that build a monetary pot for the employee. They are referred to as contract-based because the employee has a contractual agreement with the pension provider.
What are the origins of contract-based DC pension schemes?
DC schemes were introduced in the 1980s, initially for individual pension arrangements and subsequently for workplace schemes in the form of employer money purchase schemes and group personal pensions.
Where can employers get more information and advice?
The Pensions Regulator: 0345 600 1011 or www.thepensionsregulator.gov.uk.
The Society of Pension Consultants: 020 7353 1688 or www.the-spp.co.uk.
Pensions and Lifetime Savings Association: 020 7601 1700 or plsa.co.uk.
What are the costs involved?
An annual management charge is applied to members’ funds by the provider. The government introduced a charges cap on default funds of 0.75% a year in April 2015. The cap includes not just the investment management fee but all deductions, including professional fees, member communications and website development.
What are the legal implications?
Employers are obliged to put an auto-enrolment-compliant scheme in place by their staging date, and are then required to re-enrol employees every three years.
What are the tax issues?
Tax breaks are currently available to both employers and employees. If employees pay above the basic rate of tax, they have to claim additional tax relief via their tax return.
What is the annual spend on contract-based DC schemes?
HM Revenue and Custom’s (HMRC’s) statistics show that £20.3 billion was paid into personal pensions in 2014-15, of which £11 billion was employer contributions, a substantial rise on 2013-14 when £18.4 billion was paid in, of which £10.3 billion was contributed by employers. Employers’ contributions have been rising since 1990-91 from around 9% in the early 1990s to 56% in 2013-14. However, this fell to 54% in 2014-15, as auto-enrolment reduced the average.
Which providers have the biggest market share?
Aegon, Aviva, B&CE, Fidelity, Friends Life, Legal and General, National Employment Savings Trust (Nest), Now: Pensions, Prudential, Scottish Widows and Standard Life.
Which providers have increased their market share?
Most insurance providers are targeting the mass auto-enrolment market and, because, the large employers have already staged, some providers such as Legal and General, Prudential, The People’s Pension and Nest have grown their books substantially.
The market has also seen an influx of small Sipp providers trying to capture a share of the fragmented Sipp and income drawdown market.
Defined contribution (DC) schemes are pensions that build a monetary pot for the employee, rather than being linked to salary. The employee holds a contractual agreement directly with the pension provider.
In the workplace, these schemes can be a group personal pension (GPP), a stakeholder scheme or a group self-invested personal pension (Sipp).
The attraction of the contract-based DC scheme, when it was first introduced in the 1980s, as now, was their lower cost and oversight requirements for employers compared with final salary schemes.
An annual management charge is applied to members’ funds by the provider, which is higher for actively managed funds and lower for passive, indexed funds.
Following concern that charges were too high, eroding the value of pensions, the government introduced a charges cap on default funds of 0.75% a year in April 2015. The cap includes not just the investment management fee but all deductions, including professional fees, member communications and website development. There is an exception for any charges members incur to switch funds. The charge cap is an annual cap measured over a 12-month ‘charges year’. Charges are deducted directly from the member’s pot.
Auto-enrolment responsiblities
Employers are obliged to put an auto-enrolment-compliant scheme in place by their staging date, and are then required to re-enrol employees every three years.
Many large employers are now facing the re-enrolment process. They do not have to assess all their employees to identify which ones are eligible, but only those who have opted out, ceased membership or reduced their contributions below the minimum level. This makes the re-enrolment process quite distinct from the ongoing assessment process run in each pay reference period. Employers must re-register with The Pension Regulator within two months of auto re-enrolling their schemes.
A duty to provide information such as generic guidance and risk warnings whenever a member considers a transfer, takes a lump sum, or puts benefits into a drawdown plan or an annuity, is expected following a Department for Work and Pensions (DWP) consultation on the Occupational and Personal Pension Schemes Miscellaneous Amendments Regulations 2016, which closed on 15 January.
In the Budget 2016 documentation, the government announced plans to increase the limit on income tax and national insurance relief on employer-arranged pensions advice from £150 to £500. This will come into effect from April 2017.
The government also plans to consult on the introduction of a pensions advice allowance, which would enable DC pension scheme members below the age of 55 to withdraw up to £500 from the scheme to cover the cost of financial advice. The exact age at which the pensions advice allowance can be accessed will be determined following the consultation process.
Market changes
The market has been adapting to auto-enrolment and the new freedom and choice regulations, but there is much work left to complete these twin revolutions.
In the November 2015 Autumn Statement, Chancellor George Osborne announced that the next two phases of minimum contribution rate increases will be aligned to tax years, so the planned contribution increase from 2% to 5% due in October 2017 will be postponed to April 2018, and the planned increase from 5% to 8% due in October 2018 will be postponed until April 2019.
So far, auto-enrolment has been a success, with opt-out rates of around 8%, well below the 30% expected. However, this number might rise when larger contributions become mandatory.
However, even when contributions rise to 8% in April 2019, this will only be half the amount actuaries say is required to fund a pension of two-thirds of pre-retirement income. Furthermore, that is for someone who has been saving consistently since the age of 22; for someone in their 40s it is less than one-third of the amount they would need to put aside.
The auto-enrolment market seems to be consolidating around six or seven large master trust arrangements such as National Employment Savings Trust (Nest), Prudential, Legal and General and The People’s Pension. As master trusts, these offer the benefits of economies of scale and good governance.
