4. GPP/Stakeholder Schemes

How Do They Work?

In recent years many companies have moved away from Final Salary Pension Schemes because they represent an open-ended financial commitment. Costs to employers have increased as a result of additional regulations and there may be the need to pay substantial additional contributions to guarantee benefits during times when the funds have been adversely affected by poor investment returns. Most employers will therefore now offer a ‘Money Purchase’ Pension Scheme or Group Personal Pension/Stakeholder Scheme rather than a ‘Final Salary’ Scheme. Whilst there is no legal requirement for an employer to contribute to a pension scheme, companies with 5 or more employees are obliged to provide access to a Stakeholder scheme if they have not otherwise set up a pension scheme meeting certain minimum standards.

Under Group Personal Pension/Stakeholder Schemes each member has a Personal Pension policy to which he and (usually) the employer contributes and over which the employee has control. This type of arrangement requires little administration commitment from the employer beyond paying their share of the contributions, and collecting the payments via Pay As You Earn (PAYE).

The same contributions and benefits apply as under an occupational money purchase pension. Employees can receive full tax relief on contributions up to the level of their earnings (or £3,600 if more). The aggregate contribution should not exceed the ‘Annual Allowance’ (see Section 1) otherwise a tax charge would apply.

Funds can be accumulated up to the level of the Lifetime Allowance (and there would be a tax charge on any benefits above that level, both on death and retirement). You are able to select a suitable investment fund or funds to suit your individual needs and objectives. It is normally possible to switch between different funds, for a small charge, should your circumstances alter. There are no limits on the pension that can be paid from a personal arrangement. This will depend entirely on what can be purchased from the funds invested.

On death before drawing benefits the full fund is normally payable as a tax free lump sum to the chosen dependants. The company may also make separate insurance provisions, typically to pay out an additional lump sum related to salary, e.g. 2 times salary.

The Government introduced Stakeholder Pensions in April 2001. Most employers are obliged to provide access to a Stakeholder Pension, although some employers already offer suitable pension provision, which exempts them from such an obligation.

There is no requirement for an employer to contribute to Stakeholder, but it is required to collect employee’s contributions net of basic rate tax and direct payments to the plan if requested. Broadly speaking, Stakeholder Pensions work in the same way as Personal Pensions but to be classified as “Stakeholder”, they must meet certain mandatory standards including:

• An overall charge limited to a maximum of 1.5% per annum for the first 10 years, then reducing to 1%*.
• The facility to stop and restart contributions without penalty.
• Transfers must be accepted and transfers out must be penalty free. The only exception to this is the option for product providers to levy a Market Value Adjuster (“MVA”) on With Profit funds following prolonged poor market conditions.
• An annual information statement to members
• A governance procedure established to safeguard the interests of members
• A minimum contribution level of no more than £20 per payment.
• A default investment fund incorporating an element of lifestyling must be available.

*If you started a stakeholder pension before 6 April 2005, the maximum that you can be charged is 1%. If you took out a stakeholder pension before 6 April 2005, it may be cheaper to continue contributing to it rather than take out a new stakeholder pension.

Benefits

Benefits can be drawn between the ages of 50 (rising to 55 from 2010) and 75 and up to 25% of the fund can be taken as a tax-free cash lump sum.

At retirement the type of Pension can vary at the discretion of the plan holder. The balance of the fund (after tax free cash) is normally used to purchase an annuity that provides a set monthly Pension payment. This annuity can provide a spouses or dependants payment on death, a guarantee that it is paid for a minimum number of years (normally 5 or 10), or can ensure that the payments escalate each year, alternatively protection can be incorporated to provide a return of the initial pension fund value less income taken and less a tax charge. The more options that are purchased at outset the lower the initial pension payments will be. You are not limited to purchasing a Pension with the Scheme Provider, and it may be possible to secure a higher Pension elsewhere under a facility known as the Open Market option.

For investors willing to accept a greater level of risk there are also alternatives including withprofit, unit linked and flexible annuities and unsecured income. A Retirement Options fact sheet containing full information regarding these options is available upon request.

Many plans offer external fund links. The Pension provider negotiates with selected investment houses, chosen for their track records in managing funds and their research and investment management expertise. The external fund links will usually be subject to an additional annual management charge. A wide range of funds from investment houses with very different investment styles is thus provided. As a general rule, Personal Pensions offer a larger range of fund links than Stakeholder does but the management charges may be higher.

Contribution Protection is available but only as a stand-alone contract and tax relief is no longer available. This is a benefit whereby if you are unable to work through illness or disability prior to retirement, amounts equal to the contributions you were previously paying will be credited to your arrangement until either you can return to work or until retirement age. The maximum benefit is restricted to £3,600 per annum. The cost of this option varies depending on the contribution level, your age and state of health. Prior to April 2001 waiver of premium benefit was available for plans providing similar cover whilst attracting tax relief. The Employer can cover the costs of adding these benefits to Schemes.

Taxation Issues

• Employee contributions are automatically given basic rate tax relief at source. Higher rate taxpayers need to apply to their Local Inspector of Taxes for the additional tax relief.
• Employers are able to offset regular pension contributions against corporation tax as an expense of the business.
• Income (apart from UK Equity Dividends) and gains within the pension funds are exempt from tax.
• The lump sum available upon retirement is tax free and any pension payments will be subject to income tax at the members highest rate.
• The lump sum payable on death is normally not subject to Inheritance Tax.

Death Benefits

The great majority of Personal Pension Plans and Stakeholder Plans are set up under a Discretionary Trust. This mechanism allows you, should you die before drawing benefits, to nominate chosen beneficiaries to receive your Pension fund as a lump sum death benefit, usually free of Inheritance Tax. There are restrictions in place for the benefits provided from protected rights funds that are made up of National Insurance Contribution rebates from contracting out of the second state pension (S2P).

Additionally, life cover can be provided by a separate insurance policy and the proceeds from that policy would then be aggregated with the death payments from all your pension plans to ensure that the overall value is within the Lifetime Allowance. If the employer does not provide this insurance protection, you may chose to do so separately and, in most cases, receive full tax relief on the contributions.

In the event of death following retirement, the benefits available will be dependent on the option(s) selected. Annuities can include a guaranteed period whereby, if death occurs within the time period, payment will continue until the guarantee period ends. In addition, provision can be made for a percentage of the Pension to be paid to any surviving spouse or dependants. The unsecured income and flexible annuity options provide various ways for benefits to be paid, either by continuing income payments, return of fund less a tax charge or annuity purchase. Further information is given in the Retirement Options factsheet.

Contracting out

The State Second Pension (S2P) was introduced on 6 April 2002, in place of the State Earnings Related Pension Scheme (SERPS). It is part of the State Pension benefit and is available to employees who have made sufficient National Insurance contributions during their working life. The new system also opens the additional state Pension to certain carers and people with erratic work patterns, due to a long-term illness or disability. With effect from 6 April 2006 tax free cash of up to 25% can also be taken from contracted out benefits.

You are able to “contract out” of the government plan and a proportion of your National Insurance contributions will be rebated into your Personal Pension Plan. By contracting out, you give up any perceived security inherent in State Pensions, for a Pension determined solely by investment returns and interest rates at retirement. The combination of lower investment returns achievable in the current economic climate and decreasing annuity rates means that the funds which could be built up from the rebates on offer are by no means certain to provide benefits which will compensate for those guaranteed benefits given up, by opting out of S2P.

Your decision on this will be determined by your attitude to risk and the extent to which you believe the Government may worsen or reduce State Benefits in the future.

Additional Contributions

The basic employer contributions (if any) and any minimum employee contributions may be insufficient to meet the member’s retirement objectives. If it is decided to make additional pension contributions to increase pension (rather than some other means of saving) then the choices are:

• Make additional contributions to the Company Scheme, or
• Set up a separate individual pension scheme to take the additional contributions.

The simplest option will probably be to increase contributions to the existing scheme but this will not be appropriate in each case, for example if the investment choice under the existing scheme is too narrow or if it is desired to split investment risk between different providers. In these circumstances a separate scheme will need to be established after assessing any disadvantages of not using the Company scheme in terms of charges and benefit provision.

In most cases advice should be sought regarding the options for paying additional pension contributions including how these compare with non-pensions savings plans.

Leaving Service

Few people remain with the same employer throughout their working lives and on leaving service a decision needs to be made regarding any entitlements accrued under a Company pension scheme. It should also be borne in mind that valuable insurances (particularly on death or disability) may be provided as part of or in conjunction with the Company scheme, and these insurances will probably cease on leaving service. A review of additional insurance provisions may also be necessary. The following options are available:

1. To leave the entitlements in the previous GPP/Stakeholder. The individual policy under the GPP/Stakeholder will be in your name and control and can be used for future pension funding.
2. To transfer to the pension scheme of the new employer. This is of course only possible if there is a Company scheme available and if that scheme is prepared to accept a transfer. Some schemes do not accept transfers or will only do so after a minimum period of service. The benefits available on transfer will depend on the type of scheme available, e.g. under a Final Salary Scheme it may be possible to buy ‘added years’ with the transfer to provide additional ‘guaranteed’ final salary benefits. Transferring to the new employers scheme will have the advantage of consolidating pensions in one place, but some may prefer instead to avoid having all pensions under the control of the current employer’s scheme.
3. To transfer to another individual pension scheme.Transfers can usually be made to any existing personal scheme or a personal scheme can be established purely to accept the transfer.

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