Liz Wood: Contract-based pension schemes versus master trusts

With auto-enrolment well and truly upon us, many employers have chosen to fulfil their duties by making use of either a defined contribution (DC) contract-based pension scheme or a master trust. But which one is better from an employer’s perspective?


Contract-based DC schemes and master trusts have both been around for years, despite the recent rebranding of master trusts. Both types of scheme are seeing a surge in popularity, spurred on by the arrival of auto-enrolment. 

The obvious appeal of both contract-based schemes and master trusts for employers is the ability to choose an off-the-peg plan administered by an external provider.

The key differences between the two arise from how they are regulated, both internally and externally, and how this affects employers.

Internal regulation

Master trusts have the advantage of being administered by trustees that have fiduciary duties to act in the best interests of scheme beneficiaries. This tangible layer of governance appeals to many employers, which can distance themselves from the day-to-day mechanics of the scheme in the knowledge that a body of custodians is looking after members’ benefits.

By comparison, contract-based schemes, run entirely by a pension provider, can appear relatively governance ‘light’. But this would be an oversimplification.

External regulation

Although master trusts have an in-built safety mechanism through the role of the trustees, this does not necessarily mean they are always bastions of good governance. The Pensions Regulator, responsible for regulating all workplace pension schemes, is broadly supportive of master trusts, but it does have some words of caution.

For a start, it remains surprisingly easy to set up master trusts. The Pensions Regulator has expressed concern about the quality of the 70-odd master trusts currently available in the UK and hopes for the market to be slimmed down in favour of a smaller number of larger, quality schemes, such as the National Employment Savings Trust (Nest), Now: Pensions and The People’s Pension.

The regulator is also critical of the close relationship between trustee boards and master trust providers, suggesting that conflicts of interest resulting from commercial relationships are a real risk unless they are managed properly. One proposed solution has been the voluntary master trust assurance framework, proposed by The Pensions Regulator last month.

Meanwhile, contract-based schemes are regulated by the Financial Conduct Authority (FCA), which places duties on providers to treat their customers fairly, in accordance with the Financial Services and Markets Act 2000, as a regulated investment. Also, contract-based schemes do not escape the scrutiny of The Pensions Regulator, even though primary responsibility for their regulation lies with the FCA.

Regulation of the future?

The direction of travel for both master trusts and contract-based schemes is for more, not less, regulation, whether in the form of hard compliance requirements or softer voluntary compliance. This is high on the regulator’s agenda, particularly taking into account the thousands of new members that auto-enrolment has pushed into both types of scheme, often for the first time.

The Pensions Regulator and the FCA are working together to highlight commonalities in their approaches. For example, the regulator is considering whether the voluntary assurance framework proposed for master trusts might also be rolled out for contract-based schemes. Many current government initiatives around good governance will also affect DC schemes, regardless of whether they are trust- or contract-based, for example the planned cap on charges.

How do regulatory frameworks affect employers?

The increased scrutiny of both master trusts and contract-based schemes by The Pensions Regulator, the FCA and the government is unlikely to have an immediate impact on employers. The various regulators are focusing on ensuring good governance in DC schemes, and the onus for compliance will be on the providers of those schemes.

However, the regulator has a clear expectation that, in the DC space, employers will put in place well-governed schemes, whether a group personal pension or a master trust.

At present, it will be the more engaged, paternalistic employers that will respond to this trend. But, in time, as expectations on providers increase, employers will need to keep alert to these expectations and requirements, and ensure the scheme they have in place is, and remains, fit for purpose.

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One way of doing this, which is appropriate for both master trusts and contract-based schemes, would be for organisations to set up employer-led governance committees to monitor, on an ongoing basis, their chosen workplace pension scheme.

Liz Wood is an associate at Wragge Lawrence Graham