2 : 4 - The Key Characteristics of Defined Contribution (DC) Pension Schemes Flashcards
What’re the advantages of a DC scheme?
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- The employer has control over pension liabilities and the commitment to make payments is only as much as the funds available rather than a deficit situation rising out of the employer’s control.
- If favourable investment performance is achieved, the employee benefits could be better than expected.
- Lower running cost compared to DB schemes.
- Less complexity for transferring in other DC pension benefits so suitable for a mobile workforce.
- Employee – limited liability compared to a DB.
- Employees have no lock-in to the employer so flexibility to move pension to new employer
What’re the advantages of a DC scheme?
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- There is no promise of a defined benefit for the individual as to what their pension will be; it all depends on the contributions and investment growth of the pension fund. Thereafter the individual is at the mercy of annuity rates as well.
- Challenges for the individual to plan for retirement when the final pot is unknown and dependent on investment performance.
- Individual and detailed statements required for each member.
- DC schemes are less likely to encourage retention.
- There has been a degree of negative press coverage when firms have changed their schemes to DC from DB.
In simple terms, what to DC schemes define?
The proportion of earnings that must be contributed to the scheme.
What are the 3 types of DC scheme?
- Trust-Based Money Purchase Scheme
- Group Personal Pension (GPP) Scheme
- Stakeholder Pension Plans
What is a Trust-Based Money Purchase Scheme?
Essentially the assets of the WPS are governed by a trust and the trustees (rather than the employers providing the scheme) holding the scheme’s property.
Although the trustees are appointed by the employer, they act independently for the benefit of members, and part of their duties is to set out some of the initial information in the trust deed, including retirement age and who can join the scheme.
Who sets the level of contribution?
The employer simply agrees what level of contribution the company will make, and it is part of the role of the trustees to ensure the payments are made.
Such schemes normally, but not always, require employees to make a minimum contribution as a condition of joining the scheme.
What is a Group Personal Pension (GPP) Scheme?
A group personal pension (GPP) is not structured as a trust. Instead it is a group of personal pension contracts.
Each one is a personal pension plan (PPP) between one individual and the pension provider; however, by grouping them together the administration costs are lower for both the employer and individual members.
How are contributions set?
Any contributions made will be divided into each employee’s individual pension account, and the fund is likely to be either with-profits or unit-linked.
What do GPPs provide?
They provide employees with greater flexibility, as they can take pensions benefits with them if they change employers. Also, as the contract is directly between the employee and pension provider, the employee can choose their own retirement age.
What are Stakeholder Pension Plans?
At heart, stakeholder pensions are very similar to personal pension plans ((PPPs) , with basic-rate tax relief given on the contribution and a tax-free lump sum of 25% of the fund available on retirement.
Stakeholder pensions introduced the idea that people who were not working could contribute, up to a maximum of £3,600 gross per annum, and still receive tax relief. The minimum age requirement that previously applied to PPPs was also removed, which introduced a new market of thirdparty stakeholder pensions, where individuals could fund on behalf of another.
This would usually be relatives, like parents or grandparents, funding pension plans on behalf of children/grandchildren.
Who would use a Personal Pension?
Many individuals who are self-employed or who work for small employers do not have access to a WPS or GPP.
What are the 2 types of personal pension?
- Retirement Annuity Contracts (RACs)
2. Personal Pension Plans (PPPs)
What are Retirement Annuity Contracts (RACs)?
These were the first form of personal pension planning, and some individuals still fund them, despite the fact that no new RACs have been sold since June 1988.
They were governed by particular rules about the tax-free cash entitlement but, since pension simplification or A-day (see section 6.1.1), they now closely resemble the other types of personal pension provision.
What are Personal Pension Plans (PPPs)?
These replaced RACs.
A couple of the main innovations were the concept of pension relief at source on contributions (given at the prevailing basic rate of income tax), and a tax-free lump sum entitlement of 25% of the pension fund.
What was the issue with PPPs when introduced?
They were designed to encourage individuals to take personal control of their pension planning.
Unfortunately, this led to a large number of individuals being advised to transfer their benefits out of their DB occupational schemes, into the money purchase world of PPPs. As we have seen, this involved a transfer of risk from the employer to the individual and it wasn’t long (the early to mid-1990s) before it became clear that in many situations the individual would have been better off staying with a DB scheme.
The subsequent pensions mis-selling scandal did nothing for the reputation of the industry and cost a lot of money to put right – around £12 billion in compensation was paid out between 1994 and 2002.
What’re group PPPs for?
These are offered by employers who did not want to set up a WPS (with all of the resulting paperwork and trustee requirements) but wanted to allow their employees to contribute to a pension plan via their work.
Sometimes the employer would contribute themselves to these plans, and sometimes they just allowed a source for employees to pay.
What does a Section 32 buyout policy allow?
People to transfer the funds and benefits of their company pension scheme into a private fund.
The scheme allows them to take advantage of the same benefits as the original company scheme, while adding the individual control of a PPP.
How does a Section 32 buyout policy differ from a PPP?
In that individuals can no longer make monthly contributions to the company scheme once they have transferred their company benefits.
They may only make a single transfer, which is why it is ideal for pension transfers from frozen or existing company pension schemes.
What is the benefit of a Section 32 Buyout Policy?
The benefits of a Section 32 buyout policy are that, unlike setting up a new PPP, individuals are able to receive the enhanced benefits that come with a company pension scheme, plus it adds a greater flexibility provided by wider fund management opportunities. Company schemes are often restricted to a certain number of funds, whereas PPPs have much more choice.
What is the drawback of a Section 32 Buyout Policy?
Once they have transferred the funds into a new policy through the Section 32 buyout policy, people cannot pay in any additional funds. If they decide to make payments into a pension plan, they must take advantage of any scheme offered by their new employer, or set up a PPP.
