What is a contract-based defined contribution (DC) pension scheme?
A contract-based DC scheme is based on contributions from both employers and staff. It can be a group personal pension (GPP), a stakeholder scheme or a group self-invested personal pension (Sipp).
What are the origins of contract-based DC pension schemes?
Most new DC schemes were set up by employers between 1980 and 1999. GPPs were introduced in 1988, when the government replaced retirement annuity plans with personal pensions. Stakeholder pensions were introduced by the government in April 2001, aimed at employees on low incomes as a means of saving for retirement.
Where can employers get more information and advice?
More information is available from:
The Pensions Regulator on 0845 600 1011
The Society of Pension Consultants on 020 7353 1688 or at: www.the-spp.co.uk
The Pensions Advisory Service on 0845 601 2923 or at: www.pensionsadvisoryservice.org.uk
What are the costs involved?
An annual management charge, which can start from around 0.25%, is applied to members’ funds, with a lower charge for passive funds. In March 2014, the government announced it would set a charges cap of 0.75% for workplace pensions with effect from April 2015.
Under auto-enrolment legislation, contribution levels will rise incrementally, with the full employer contribution of 3% of banded earnings due from October 2018.
What are the legal implications?
Employers are obliged to put an auto-enrolment-compliant scheme in place by their staging date, although they can request to postpone the date at which they enrol employees. Employers are then required to re-enrol employees who opt out every three years. Organisations with more than 50 employees have now passed their auto-enrolment staging dates.
What are the tax issues?
Tax breaks are 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?
According to the Association of British Insurers (ABI), the total workplace pension premiums in 2013 were £11,545m, of which group personal pensions totalled £10,680m and employer stakeholder pension totalled £866m.
Which providers have the biggest market share?
The main providers in this market include Aegon, Aviva, B&CE, Fidelity, Friends Life, Legal and General, MetLife, National Employment Savings Trust (Nest), Now:Pensions, Prudential, Scottish Widows, Standard Life and Zurich Life.
Which providers have increased their market share?
There are no figures available, but some providers are concentrating their focus on the pensions they provide for auto-enrolment provision, including Legal and General, Standard Life and Scottish Widows.
There are three types of contract-based DC pension: group personal pension plans (GPPs), stakeholder schemes and self-invested personal pensions (Sipps). GPPs and stakeholder schemes are aimed at the majority of an organisation’s workforce, offering a limited range of investment funds for scheme providers to track on their behalf.
Sipps are essentially DC schemes that offer greater investment choice. In addition to the equities and bonds on offer with a GPP or stakeholder plan, Sipps offer wider asset choice, including commercial property. The plans are typically targeted at higher-earning employees.
Contract-based DC arrangements involve a contract between scheme members and the insurance provider offering the scheme.
The DC contract-based pensions market is going through another period of change due to the pension freedoms announced in the Budget in March 2014. These will affect how employees access their pension fund from 6 April 2015, enabling them to choose to take their pension savings in the form of a cash lump sum, drawdown or annuity.
Members will be able to take a tax-free lump sum of up to 25% of the value of their pension pot; however, any cash taken over the 25% tax-free amount will be taxed at the person’s marginal tax rate and no longer at 55%.
The amount a member can draw down each year will be increased from 120% to 150% of an equivalent annuity, which means the amount an annuity would have paid out in that year. DC members must earn at least £12,000 a year on order to be allowed to draw down from their pension, less than the current £20,000-a-year income limit.
It is expected that most pension providers will offer the ability for employees to use any of the three options once these come into effect this month.
The new freedoms bring with them greater choice for members, but this could cause confusion for staff in an auto-enrolment environment.
Auto-enrolment relies on the apathy of members to stay in a pension scheme and not opt out. Staff may spend their working life contributing to a pension scheme, but they may struggle with the complex choices they need to make when nearing retirement, particularly if they have not been given any workplace support.
If not already a recognised element of a benefits package, financial education, particularly focused around the at-retirement phase, could become even more important for staff after April. Employees should be supported throughout their working lives, so that at the point of retirement they will be confident in making critical decisions that afford them a comfortable retirement.
To help provide this, the government has guaranteed that all DC scheme members will be offered free, impartial, face-to-face guidance on their choices at the point of retirement. Face-to-face guidance will be provided by the Citizens Advice Bureau, telephone guidance by the Pensions Advisory Service and online support by its Pension Wise website.
The other change dominating the market is the new governance requirement, which means contract-based pension schemes will have to set up independent governance committees from April 2015. This follows the publication of the Office of Fair Trading’s Defined contribution workplace pension market study, published by in September 2013.
Traditionally, a collection of pension contracts was sold through the workplace and provided to employees, which risked a misalignment of interest between the desires and needs of employers and their staff. This also risked poor governance outcomes.
From April, pensions providers will need to have independent governance committees in place that will hold pension providers to account, and ensure they are acting in the members’ best interests. Their primary role will be to assess a scheme’s value for money and make sure that members are being protected.
Many pension providers are now well versed in providing contract-based DC schemes to meet auto-enrolment requirements, but product development rumbles on.
For example, in March, Standard Life announced that it was removing its minimum eligibility criteria for its auto-enrolment provision and opening its scheme up to all employers left to stage. Its criteria was: a minimum of five members, a minimum average contribution level and a limit on the proportion of members on short-term contracts.
96% – the number of employers that think that the new pension flexibilities create a need for more financial education in the workplace
(Jelf Employee Benefits, published in February 2015)
34% – the number of employees that will think about their retirement plans sooner because of the Budget changes
(Nest insight 2015 report, published in January 2015 by the National Employment Savings Trust, or Nest)
48% – the number of employees that are aware of the new pension flexibilities available to defined contribution scheme members, which come into force in April
(Nest insight 2015 report, published in January 2015 by Nest)
65% – the number of pension scheme members that cited the level of costs and charges as the most important factors for employers when choosing a pension provider
(What do pension scheme members expect of how their savings are invested? published by the National Association of Pension Funds, or NAPF, in July 2014)
11.7% – the average contribution rate: 7.6% from the employer and 4.1% from the employee (The NAPF’s 40th annual survey of workplace pensions, published in December 2014)
67% – the number of schemes that operate on a matching contribution basis (The NAPF’s 40th annual survey of workplace pensions, published in December 2014)
33% – the number of employees that receive the minimum employer contribution, and 43% of employees received the maximum employer contribution
(The NAPF’s 40th annual survey of workplace pensions, published in December 2014)