Regulation of state and supplementary pension schemes in UK (England and Wales): overview
A Q&A guide to pensions law in the UK (England and Wales).
The Q&A gives a high level overview of the key practical issues including: state pensions; supplementary pensions; funding and solvency requirements; tax on pensions; business transfers; participation in pension schemes; and employer insolvency and overall scheme solvency.
To compare answers across multiple jurisdictions, visit the Pensions: Country Q&A tool.
The Q&A is part of the global guide to pensions law. For a full list of jurisdictional Q&As visit www.practicallaw.com/pensions-guide.
Contributions paid to the government
Contributions toward the state pension are made by employers and employees by way of National Insurance (NI) contributions.
Taxation of contributions
Employer NI contributions are deductible for corporation tax purposes.
Monthly amount of the government pension
The state pension is currently made up of two elements:
Basic State Pension.
Additional State Pension.
However, for people who reach their state pension age on or after 6 April 2016, these will be replaced by the new, single tier State Pension. State Pension age was historically 65 for men and 60 for women. However, women's state pension age has been increasing gradually since 2010 and will reach 65 in November 2018. Thereafter, State Pension age will rise to 68 by 2046 (or possibly earlier).
The Basic State Pension will be GB£119.30 per week for the year 2016/17 and increases each year in line with the "triple lock" system, being the lower of earnings growth, prices and 2.5%.
The Additional State Pension was up to GB£164.36 per week for 2015/16 depending on an individual's earnings and contribution history. An amount in respect of the Additional State Pension can be provided by a private pension scheme if the scheme fulfils certain requirements and is "contracted-out". Where a scheme is contracted-out, the employer and employee pay lower NI contributions. Contracting-out will be abolished from April 2016.
The initial amount of the new single tier State Pension will be GB£155.65 per week and it will also be subject to triple lock increases.
Occupational (that is, linked to an employment or professional relationship between the plan member and the entity that establishes the plan)?
Personal (that is, not linked to an employment relationship, established and administered directly by a pension fund or a financial institution acting as pension provider, where individuals independently purchase and select material aspects of the arrangements, though the employer may make contributions)?
Both occupational and personal pension schemes exist within the UK. Occupational pension schemes are set up by a sponsoring employer. The assets are held under trust and invested by scheme trustees. Such schemes may provide benefits on either a defined benefit or a defined contribution basis.
Personal pension schemes are typically individual agreements with insurance companies and provide benefits on a defined contribution basis. Group Personal Pensions are personal pension arrangements for employees of a particular employer. Whilst the legal agreement is between the employees and the provider, the employer may negotiate special terms for its employees and receive regular reports from the provider.
An employer might contribute to a single personal pension arrangement for an employee but that is rare and would usually only apply where a high earner had negotiated that as part of a package. The personal pension might be a Self Invested Personal Pension (SIPP) which allows the employee greater scope in investing than an alternative arrangement.
2012 saw the introduction of a regime of compulsory enrolment of employees into a pension arrangement called Auto-Enrolment. Auto-Enrolment was originally applicable only to the largest companies but is being rolled out to cover all employers by 2018, even employers of a single person. Since the introduction of Auto-Enrolment, defined contribution occupational pension schemes for employers who are not associated with each other are becoming increasingly popular. These are called Mastertrusts. Auto-enrolment obligations may also be satisfied though a personal pension or the National Employment Savings Trust (NEST), which is the arrangement set up by the government to ensure that all employers had access to an Auto-Enrolment scheme.
Where the employee has been auto-enrolled, a minimum level of employer and employee contributions is required which is currently 1% of relevant earnings for each, rising to a total of 8% by April 2019 (3% employer, 5% employee). Alternatively, a defined benefit scheme can be used for auto-enrolment if it satisfies certain requirements as to emerging benefits. Employees who have been auto-enrolled may opt-out of the pension arrangement but must be auto-enrolled again after three years.
Is linked to the employee's salary (defined benefit)?
Is linked to employer and/or employee contributions and investment return on those contributions (defined contribution)?
Linked to the employee's salary
Defined benefit schemes exist in the UK but are increasingly closing to new members and future benefit accrual. Defined benefit schemes are almost exclusively provided through a trust arrangement where the assets are held separately to their employer's assets. Hybrid schemes, where both defined benefit and defined contribution benefits are provided are not uncommon as well as, particularly in older schemes, defined benefit benefits underpinned by defined contribution benefits or vice versa.
Defined benefit schemes traditionally provided benefits based on an individual's final salary, but alternative schemes where benefits are based on career average salary are also common. In career average schemes, annual salary for each year of service is usually revalued up to the year of retirement (or leaving service) to provide protection against inflation, and pension is based on the average of a member's revalued salary over the entire period of pensionable service.
Linked to employer and/or employee contributions
Newer schemes in the UK tend to be defined contribution schemes, particularly if they have been established for Auto Enrolment purposes. Defined contribution schemes can be occupational pension schemes set up under trust or contract based, where the individual employee will have a personal pension contract direct with a pension provider.
Defined contribution schemes will usually offer members a choice of investments with a "default" fund for members who do not make a choice. Some schemes will also offer "life-styling" arrangements where, as the member approaches a designated retirement age, their investments will automaticall be re-allocated from equities to gilts and cash. Life-styling has become less straightforward since the introduction of pension flexibility for defined contribution members from April 2015.
Some (older) schemes will provide a guaranteed rate of return on investments or otherwise "target" a particular level of benefits, without guaranteeing it.
Is there a minimum period of service before workers are entitled to receive vested rights?
Are there any legal requirements for schemes or providers to index pensions in payment and/or revalue pension rights in deferment?
Minimum period of service
In a defined benefit scheme a worker receives vested rights after two years and after three months may take a transfer of benefits. If the member with less than two years' qualifying service does not take a transfer they will be entitled to a refund of their own contributions. Legislation recently reduced the vesting period for defined contribution members to 30 days.
Legal requirement to index
There is no requirement to index pensions in payment emerging from a defined contribution scheme. In deferment, the pension will rise (or fall) in line with investment performance.
In a defined benefit scheme, members who left their employer on or after 1 January 1991 are entitled to a revaluation of their whole pension during the period of deferment. Members who left on or after 1 January 1986 only have a statutory entitlement to revaluation on benefits accrued on and after 1 January 1985.
Revaluation is done in line with revaluation orders which are published annually. It is based on price indexation capped at 5% for service before April 2009 and 2.5% for later service. In 2010 the measure for price inflation used for this purpose changed from the retail price index (RPI) to the consumer price index (CPI). CPI is generally lower than RPI (one estimate is that it may on average be lower by 0.7% each year).
Defined benefit pensions in payment accrued on and after 6 April 1997 must be increased annually on a broadly similar basis to the revaluation basis (except the change from 5% to 2.5% occurred in April 2005).
Funding and solvency requirements
Funded or unfunded?
All defined contribution schemes are funded and by definition cannot be underfunded. Defined benefit schemes are funded except in some cases where they are established for high earners and pay benefits above the levels that qualify for preferential tax treatment. Some public sector schemes are unfunded.
Solvency requirements for funded schemes
Schemes which promise a defined benefit must have an actuarial valuation at least once every three years to determine whether there are sufficient assets to meet liabilities (and an actuarial report looking at any developments in intervening years). If there is a shortfall in assets, the trustees must formulate a recovery plan to reach an adequate funding level as soon as possible. There will also need to be a schedule showing what contributions are due to the scheme and when. Funding documents (for example, the recovery plan and schedule of contributions) are the trustees' responsibility but will usually require the agreement of the employer, unless under the scheme's own rules, the trustees may require contributions to be paid without the agreement of the employer (and where the employer does not have any powers under the scheme to reduce or suspend contributions).
Some pension schemes in the UK are fully funded on an ongoing basis and are moving to target full funding on a "self-sufficiency" basis (removing funding risk as far as possible). However, these bases are still usually a long way short of having assets sufficient to secure benefits with an insurance company.
Employers must account for pension schemes in their accounts and trustees must generally produce and have audited scheme accounts annually. Deficits in defined benefit schemes will need to be recognised in the employer's accounts.
To what extent can members transfer their funds to another pension scheme?
How do members normally take the benefit of their funds (for example, lump sums, income withdrawals (drawdown), life annuity arrangements)?
What are the legal restrictions upon access to the funds (for example, age)?
What are the common arrangements for early retirement and ill-health retirement?
Are dependants of deceased members entitled to receive benefits payable on the member's death? What form do these commonly take?
Member's transfer of funds
A member has a right to transfer funds in a supplementary pension scheme to another Re-registered Pension Arrangement. Where the member has both defined benefit and defined contribution benefits, each category of benefit may be transferred separately. The right is subject to certain restrictions set out in legislation, in particular a member may also not transfer defined benefit rights above a value of GB£30,000 to a defined contribution arrangement without taking financial advice.
Taking pension benefits
In a defined benefit scheme the pension will usually be paid from the scheme from a specified normal retirement date. However, it may be paid from age 55 subject to the scheme rules allowing early retirement. Often, scheme rules will require employer or trustee consent to the early retirement. If the pension is paid before the scheme's normal retirement age, it will usually be reduced to reflect that it is being paid early.
In a defined contribution scheme, prior to April 2015, a member would have to buy an annuity with the funds in his individual account or could transfer his funds to a drawdown arrangement which would allow him to draw down money each year (within limits) without actually buying an annuity.
From April 2015, where scheme rules permit, defined contribution members can take some or all of their funds as a lump sum or can draw down any amount at any time from their defined contribution funds.
Whatever the type of benefits a member has, generally up to 25% of their entitlement on retirement can be taken as a tax free lump sum.
Generally, funds cannot be accessed until age 55 unless the member has a protected pension age which may entitle them to access funds at 50. Certain hazardous professions who had a right to retire earlier than 50 prior to 6 April 2006 retain that right.
Early and ill-health retirement
Early retirement on the grounds of ill-health can be permitted at any age if the ill-health is such that the member is, and will continue to be, medically incapable (either physically or mentally) of continuing his or her current occupation as a result of injury, sickness, disease or disability. In circumstances of serious ill-health (where death is expected within 12 months) the whole pension may be paid as a lump sum.
A scheme can pay a pension to a dependant of a deceased member. A dependant is a member's spouse, civil partner or child or a person who was either financially dependent on the member or was jointly responsible for a shared standard of living with the member. It is common for a defined benefit scheme to pay a dependant's pension as of right to a spouse or civil partner and, failing that, to one or more children of the deceased.
It is also common that where a pension scheme member dies in the service of their employer, a lump sum is payable which may be a multiple of salary. The lump sum can be paid to anyone set out in the scheme rules (usually a very wide class) and is paid at the discretion of the scheme trustees, so it usually passes free of inheritance tax. A member will usually complete an "expression of wish form" setting out who they would like that money to be paid to.
A member's unused defined contribution funds may also be passed to a nominee or dependant.
The Pensions Regulator is the UK regulator of work-based pension schemes. The Regulator has certain statutory objectives, including:
To protect the benefits of members of occupational pension schemes.
To protect the benefits of members of personal pension schemes (to which the employer pays contributions – either its own or deducted from members' salaries).
To promote, and to improve understanding of, the good administration of work-based pension schemes.
To reduce the risk of situations arising which may lead to compensation being payable from the Pension Protection Fund (PPF).
To maximise employer compliance with the automatic enrolment requirements.
To minimise any adverse impact on the sustainable growth of an employer (in relation to the exercise of the regulator's powers in relation to defined benefit scheme funding).
It also oversees compliance with the auto-enrolment requirements. The Financial Conduct Authority (FCA) regulates personal pension schemes.
Trustees, employers and advisers have a statutory duty to report certain matters which could be of material significance to the Pensions Regulator in the exercise of its powers. The FCA has a detailed reporting framework for those regulated by it.
The Pensions Regulator issues Codes of Practice that supplement pension legislation and also Guidance in relation to a wide variety of issues. Whilst these do not have the force of law, it is likely that a court would take into account the standards required under the Codes and the Guidance.
Other key governance requirements
There are some statutory governance requirements. The Pensions Act 2004 requires trustees to have knowledge and understanding of a range of matters and to be conversant with scheme documentation. There are also requirements for them to have process and internal controls to ensure "that the scheme is administered and managed… in accordance with the scheme rules and… the requirements of law". There are also regulations which set out additional requirements in relation to defined contributions, including the need for a chair or trustees to prepare an annual statement confirming how certain governance requirements have been complied with.
The Pensions Regulator has the power to fine trustees and employers who breach the requirements of pension legislation. In certain rare cases, there are potential criminal sanctions. The Regulator can also issue "improvement notices" which require schemes to take particular steps. In addition, the Regulator can appoint and remove trustees, wind-up schemes and require associates of sponsoring employers to contribute to occupational pension schemes in certain circumstances.
Tax on pensions
Tax relief on employer contributions
Generally, employers can deduct pension costs from their profits for corporation tax purposes.
Tax relief on employee contributions
Employees can contribute the whole of their taxable earnings, or if greater, GB£3,600 in each year.
There are additional limits on the amount of benefits that a member can build up in a registered scheme in any tax year, referred to as the annual allowance. These limits have fallen very substantially in recent years and will be GB£40,000 for the tax year 2016/17. From April 2016, the limit will be even lower for high earners (over GB£150,000) and will taper down to GB£10,000 for persons earning in excess of GB£210,000. Lower limits also apply to members who have flexibly accessed defined contribution benefits and then make further contributions.
25% of the value of the member's pension entitlement on retirement can be paid as a tax-free cash lump sum. The remainder of the pension is taxed as income whether the member takes it by way of pension, or by way of further lump sums.
Additional tax is payable where the member has benefits in excess of the Lifetime Allowance, which was initially set as GB£1.5 million in 2006 and increased to GB£1.8 million in 2010, but has fallen since then to GB£1.25 million and is due to fall to GB£1 million in April 2016. Certain transitional protection is available to individuals whose pension benefits are worth more than the new lower limit. Benefits in excess of the Lifetime Allowance are usually paid in a lump sum that is taxed at 55%.
Legislation allows small defined benefit pensions to be paid as a lump sum, in which case 25% is tax-free and the remainder is taxed at the individual's marginal rate.
Pensions and lump sums payable from schemes registered with HMRC must be of a type permitted by tax legislation, otherwise there will be additional tax charges on both the member and the scheme.
Certain investment transactions may attract tax, such as stamp duty. Schemes will usually also be required to pay VAT on services that they receive. The extent to which they (or an associated employer) can reclaim the VAT is changing as a result of cases before the European Court. The change is due to take effect from 1 January 2017.
Transfer of accrued pension rights
On a business transfer, the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) apply. Whilst pensions are largely exempt from TUPE, an acquiring employer must match any contractual provisions requiring a particular level of payments to a defined contribution arrangement.
Where the seller provided an occupational pension scheme, the acquiring employer must contribute to a defined contribution arrangement at the level that the employee contributes up to a maximum of 6% or must match the contributions that the transferring employer was paying. Rarely, the acquiring employer may offer a defined benefit scheme, and there are also minimum requirements that it would need to satisfy, although these are fairly modest.
Rights under occupational pension schemes, to the extent that they are applicable to early retirement or redundancy, also transfer to the acquiring employer. This might take the form of an unreduced pension on the employee being made redundant. These rights can be complex and expensive and it is not uncommon for an acquiring employer to seek indemnity protection from the seller.
Other protection for pension rights
Government plans to introduce an "automatic transfer system" where small defined contribution pots would follow the employee from job to job have been put on hold.
Participation in pension schemes
Employees who are working abroad?
Employees of a foreign subsidiary company?
Employees working abroad
There is scope for schemes to have members in who are not based in the UK. However, if the scheme is a defined benefit scheme and the overseas members are within the EEA, this can trigger a requirement for the scheme to be fully funded and authorised by the Pensions Regulator, and therefore is generally not done much in practice.
Employees of a foreign subsidiary company
See above, Employees working abroad.
Employer insolvency and overall scheme solvency
The Pension Protection Fund (PPF) provides compensation to members of underfunded defined benefit schemes with insolvent employers. It is funded by a levy on all schemes. In addition, the Financial Assistance Scheme provides government assistance to members of schemes who commenced wind-up before the existence of the PPF. Both arrangements ensure that members will receive the majority of their benefits (within certain limits) but do not replace 100% of the benefits which would have been provided by the occupational pension scheme.
The Financial Services Compensation Scheme covers firms authorised by the FCA and may pay compensation where an authorised firm is unable to meet its obligations.
The Pensions Regulator
Description. The Pensions Regulator is the UK regulator of work-based pension schemes.
Pension Protection Fund
Description. The Pension Protection Fund is a statutory body whose main function is to provide compensation to members of eligible defined benefit pension schemes in the event of an employer becoming insolvent.
HM Revenue and Customs
Description. Official government website for the UK tax authority.
Description. The home of revised enacted UK legislation.
Maria Rodia, Partner
CMS Cameron McKenna
Professional qualifications. England and Wales, 2005.
Areas of practice. Pensions.
Professional associations/memberships. Association of Pension Lawyers; Member of the APL Education and Seminars Sub-Committee.
Dominic Harris, Partner
CMS Cameron McKenna
Professional qualifications. England and Wales, 2003.
Areas of practice. Pensions.
Professional associations/memberships. Member of the Association of Pension Lawyers' Investment Sub-Committee.
Daniel Shaw, Senior Associate
CMS Cameron McKenna
Professional qualifications. England and Wales, 1993.
Areas of practice. Pensions.
Professional associations/memberships. Association of Pension Lawyers.
Amanda Wallbank, Lawyer
CMS Cameron McKenna
Professional qualifications. England and Wales, 2014.
Areas of practice. Pensions.
Professional associations/memberships. Association of Pension Lawyers.