Occupational workplace pensions

Most employers are obliged to have an occupational pension scheme for their employees

There are two main types of occupational workplace pension schemes:

Defined-contribution schemes
A defined-contribution (DC) or money-purchase pension scheme is one that invests the money you pay into it, together with any employer’s contribution, and gives you an accumulated sum on retirement, with which you can secure a pension income, either by buying an annuity or using income drawdown.

Occupational pension schemes are increasingly a DC, rather than defined benefit (DB), where the pension you receive is linked to salary and the number of years worked. As an alternative to a company pension scheme, some employers offer their workforce access to a Group Personal Pension (GPP) or stakeholder pension scheme.

External provider 
In either case, this is run by an external pension provider (typically an insurance firm) and joined by members on an individual basis. It’s just like taking out a personal pension, although your employer may negotiate reduced management fees. They may also make a contribution on your behalf. GPPs are run on a DC basis, with each member building up an individual pension ‘pot’.

The amount you receive depends on the performance of the funds in which the money has been invested and what charges have been deducted.

Investment choice
Although your total pension pot usually increases each year you continue to pay into the scheme, there’s no way of accurately predicting what the final total will be and how much pension income this will provide. Unlike those who belong to a DB pension scheme, members of DC pension schemes have a degree of choice as to where their pension contributions are invested.

Many opt to put their money in the scheme’s ‘default fund’, but some will want to be more cautious, investing in cash funds and corporate bonds, while others may prefer a more ‘adventurous’ mix, with equity and overseas growth funds. GPPs also offer investment choice, often between funds run by the pension provider.

Personal fund
Defined contribution pension schemes allow you to build up a personal fund, which is then used to provide a pension income during your retirement. The usual way of doing this is to buy a lifetime annuity. The alternative is to leave your pension pot invested and draw a regular income from it each year.

Lifetime annuities are essentially a form of insurance, which removes individual risk by paying out a set amount each year for the rest of your life. How much you get depends on your age, your health and the prevailing annuity rates at the time you come to convert your fund.

Open market option
A workplace fund will usually negotiate a rate on your behalf, but you’re not obliged to take this and can opt instead to shop around, comparing rates from other providers, by exercising the open market option. For those with poor health, it can be particularly advantageous.

Drawdown schemes are less predictable. They continue to depend on investment performance to maintain your pension pot. If the investments do badly, or you deplete your capital too early, there’s a risk of your income declining significantly before you die.

Before buying an annuity, you can currently on retirement take up to 25% of your pension savings as a tax-free lump sum. This reduces the pension income you can secure by buying an annuity, but may be worthwhile if you need the money (to pay off outstanding debts, for example) or decide to invest it independently.

The earliest you can draw a pension or take a lump sum is from the age of 55. However, retirees can now gain greater access to their pension pots since 27 March this year, as the first in a series of radical reforms announced in the Chancellor’s 2014 Budget were introduced.

From 6 April 2015, all restrictions on access to your pension pot will also be removed, with the tax on withdrawing a pension fund cut to your personal rate. This will make it easier to use your entire pot
as you wish.

Defined-benefit schemes
A defined benefit (DB) pension scheme is one that promises to pay out a certain sum each year once you reach retirement age. This is normally based on the number of years you have paid into the scheme and your salary either when you leave or retire from the scheme (final salary), or an average of your salary while you were a member (career average). The amount you get depends on the scheme’s accrual rate. This is a fraction of your salary, multiplied by the number of years you were a contributing member.

Typically, these schemes have an accrual rate of 1/60th or 1/80th. In a 1/60th scheme, this means that if your salary was £30,000, and you worked at the firm for
30 years, your annual pension would be £15,000 (30 x 1/60th x £30,000 = £15,000).

Your pay at retirement
How your salary is defined depends on the type of scheme. In a final salary scheme, it is defined as your pay at retirement, or when you leave (if earlier). In a career average scheme, it is the average salary you’ve been paid for a certain number of years.

Final salary and career-average schemes offer the option of taking a tax-free lump sum when you begin drawing your pension. This is restricted to a maximum 25% of the value of the benefits to which you are entitled. The limit is based on receiving a pension for 20 years – so for someone entitled to £15,000 a year, the maximum lump sum might be £75,000 (25% x £15,000 x 20= £75,000).

Scheme’s ‘commutation factor’
Taking a lump sum at the outset may reduce the amount of pension you get each year. The amount you give up is determined by the scheme’s ‘commutation factor’. This dictates how much cash you receive for each £1 of pension you surrender. If it is 12, for example, and you take a £12,000 lump sum, your annual income will fall by £1,000.

As well as providing pension income, most defined-benefit company schemes also offer additional benefits to their members.

These include as follows:

• death in service payments to a spouse, registered civil partner or other nominated individual if you die before reaching pensionable age and/or a continuing partner’s pension if you predecease them after reaching pensionable age

• a full pension if you’re forced to retire early due to ill health
• a reduced pension if you retire early through choice. It normally cannot be paid before age 55, and it may be considerably reduced by the scheme’s ‘actuarial reduction’ rules. An actuarial reduction is a cut in the yearly pension (to take into account that it will have to be paid out for more years). It is common to surrender 6% for each year below normal retirement age that you retire. The pension will also be lower, because the number of years on which it is based will be fewer than would have been the case if you’d worked a full term

Closed to new members
Most private sector schemes have now been closed to new members and replaced by defined contribution schemes. A large number remain open to existing members who are still employees, however, or those who have left the firm but built up contributions while they were there and retain the right to a ‘preserved pension’ when they reach retirement age.

Many public sector pensions are still defined-benefit schemes, underwritten by central government. This has caused them to be called ‘gold-plated’, as they offer a certainty that few private sector schemes can now match. But, even in the public sector, pension promises are being cut back with a shift from final salary to career average and increases in the normal pension age.

Expensive to run
Because they’re so expensive to run, final salary schemes have been closed to new members since the 1990s. This means that new employees cannot join them, but are covered by defined contribution money purchase schemes instead.

Until recently, closed schemes continued to remain open to existing members, who carried on making contributions each year and accruing additional years’ pensionable service. Some schemes found this too much of a drain, however, and have opted to close to existing members too.

Pension is ‘preserved’
When this happens, employees at a firm can no longer pay into the final salary scheme, even though they continue to work for the same employer. Their defined benefit pension is ‘preserved’ in the same way as someone who has left the firm, and they are typically invited to pay into a defined contribution (money-purchase) scheme for the rest of their career.

This leaves them with two separate pension incomes – one from the old defined benefit scheme,
based on the number of years’ service and salary at the time of closure, and another from the new defined contribution scheme, based on the contributions they have paid into it. This is not guaranteed, but depends instead on the scheme’s underlying investment performance (net of charges) and annuity rates at the time the member wants the pension to start.

Flexible Income Drawdown

In December 2010 the Government announced the introduction of a facility to allow unlimited pension income drawdown as long as members could satisfy a few requirements. This is referred to as ‘flexible income drawdown’ and has been available since 6 April 2011.

Historically income drawdown has been restricted by reference to tables produced by the Government Actuary’s Department (GAD). Since the introduction of income drawdown rules the maximum income has been capped at 120 per cent of GAD for individuals under 75, and this has been reduced to 100 per cent from 6 April 2011 with some transitional provisions.

Flexible income drawdown is a type of income withdrawal where you can take pension income direct from your pension fund without having to purchase an annuity. Ordinarily, there are limits on the maximum income you can take under income withdrawal (known as ‘capped drawdown’).

Secured pension income
Provided you have a secured pension income of over £20,000 ‘Minimum Income Requirement’ a year (which can include any State pension), you could be eligible to use flexible income drawdown in respect of your money purchase pension savings.

The eligibility rules for flexible income drawdown from pensions were untouched by Budget 2013, which is welcome news if this is something you are considering or would like to find out more about.

Under flexible income drawdown there is no limit on the amount of income you can take in any year. You can tailor your drawdown pension to suit your personal requirements, whether taking regular amounts at a set frequency or ad hoc income when required. There is even the option to draw the entire fund in one go. All income withdrawal payments are subject to income tax under PAYE at your appropriate marginal rate.

Flexible income drawdown is tax-efficient, particularly where you wish to ‘phase in’ the use of your pension savings to provide that income. Any money left in drawdown on death is subject to a 55 per cent tax charge, whereas any untouched pension fund money (pre-age 75) can pass on to your beneficiaries free of tax.

Once you go into flexible income drawdown you can no longer make tax-efficient pension contributions, so you should look to maximise all allowances, including carry forward, this tax year.

Flexible income drawdown is a complex area. If you are at all uncertain about its suitability for your circumstances we strongly suggest you seek professional financial advice. This is a high-risk option which is not suitable for everyone. If the market moves against you, capital and income will fall. High withdrawals will also deplete the fund, particularly leaving you short on income later in retirement.

Pension schemes


Occupational pension schemes
These schemes are also called company pension schemes. It’s a scheme set up by an employer to provide pension or death benefits for its employees. An occupational pension can provide pension benefits on a money purchase, defined benefits, cash balance or hybrid arrangement basis. The two most common arrangements for occupational schemes are:

• defined benefits
• money purchase

If you leave your job you’ll normally have to stop building up pension savings in your employer’s scheme. Your employer doesn’t have to let you join their scheme. However, from October 2012 employers had to start enrolling their employees into a workplace pension.

Workplace pensions
A workplace pension is a way of saving for your retirement that’s arranged by your employer. A percentage of your pay is put into the pension scheme automatically every payday. In most cases, your employer and the Government also add money into the pension scheme for you. The money is used to pay you an income for the rest of your life when you start getting the pension. You can usually take some of your workplace pension as a tax-free lump sum when you retire.

If the amount of money you’ve saved is quite small, you may be able to take it all as a lump sum. 25 per cent is tax free but you’ll have to pay Income Tax on the rest. You can’t usually take the money out before you’re 55 at the earliest – unless you’re seriously ill.

October 2012 saw the start of the new pension auto-enrolment system, which is expected to take six years to be fully rolled out.  Workers employed by the UK’s largest firms (those employing more than 120,000 people) from 1 October 2012 have started to be automatically enrolled into company pension schemes. Between now and 2018 all other employers will have to ensure that UK-based workers aged over 22 years and earning a minimum of £9,440 (for the current 2013/14 tax year) are also enrolled into a pension.

Personal Pension schemes
A personal pension scheme is set up and run by a regulated financial organisation such as a bank or insurance company. You can pay regular or lump sum contributions to the scheme, who will invest it on your behalf.

Anyone can start paying into a personal pension scheme – you don’t have to be in employment. If you’re an employee your employer may pay into your personal pension scheme – but they don’t have to.

Personal pensions are money purchase arrangements so the amount of pension you’ll get depends on:

the amount of money paid into the scheme how well the investment funds perform the ‘annuity rate’ at the date of retirement – an annuity rate is the factor used to convert the ‘pot of money’ into a pension

Carry Forward of unused reliefs
You may be able to contribute in excess of the Annual Allowance of £50,000 and receive tax relief at up to 45 per cent using Carry Forward if you have contributed less than £50,000 in any of the previous three tax years. This is the upper limit placed on the total value of contributions that can be paid to your pension scheme in any one year and benefit from tax relief. As this is a potentially complex area, particularly where Defined Benefit schemes are concerned, professional financial advice should be sought.

Annual and Lifetime Allowance reducing
As of 6 April 2014, the Annual Allowance for retirement funding is reducing to £40,000, while the Lifetime Allowance is reducing from its current £1.5m ceiling to £1.25m. The Lifetime Allowance is the maximum pension fund allowed free of tax. The Annual Allowance reduction represents a significant opportunity to fund a higher level of pension contributions prior to this reduction. The reduction in the Lifetime Allowance means that professional advice is more important than ever to ensure that you are optimising your retirement planning, and are fully informed about the latest Lifetime Allowance protection opportunities.