8.2 Objectives and constraints of UK pension funds

Question 1

What is a pension fund?

Answer 1

A pension fund is an investment scheme where the contributors are saving for retirement.

Question 2

What benefits do pensions approved by the HMRC Pensions Schemes Office enjoy?

Answer 2

• Contributions to an approved pension fund are free of tax
• Whilst investments are in the fund, any capital gains or income are not subject to tax

However, when the pension fund begins to pay out a pension, the recipient will be subject to income tax on their pension income.

Question 3

What do National Insurance payments contribute towards in the UK?

Answer 3

State pension schemes

Question 4

What are occupational pension schemes (OPSs)?

Answer 4

Pension schemes provided by companies (‘sponsoring’ companies) for their employees.

Question 5

What is a personal pension plan?

Answer 5

A pension plan taken out from a private pension provider.

Question 6

What are stakeholder pensions?

Answer 6

Stakeholder pensions were introduced on 6 April 2001. They allow a low cost pension alternative to the self-employed and to middle-income employees.

Employers are generally obliged to offer stakeholder pensions to their staff unless they already offer adequate pension arrangements or have less than five employees. Alternatively, the pensions can be bought directly from pension providers.

Question 7

What are the two types of occupational pension schemes?

Answer 7

Defined contribution schemes and defined benefit schemes.

Question 8

What are defined contribution schemes?

Answer 8

• These are schemes where the sponsoring company contributes a set amount to the fund on the employee’s behalf.
• These contributions are invested and grow over time.
• The returns from the investments determine the pensions paid. Personal pensions are usually of the defined contribution type.

Question 9

What are defined benefit schemes?

Answer 9

• These are schemes that guarantee to pay a pension of a certain size once the employee retires, i.e. a fixed percentage of the employee’s final salary.
• The returns from the investments in defined benefit schemes are known as ‘actuarial’ returns.
• Many defined benefit schemes have switched away from equities towards bonds. A number of schemes have adopted liability-driven investment (LDI) strategies that involve not just a switch to bonds, but the use of swaps and other derivatives to more accurately match assets to liabilities.
 

Question 10

What does the Pension Act 2008 require?

Answer 10

The Pension Act 2008 was implemented in 2012. The Act requires all eligible workers who were not already in a good quality workplace scheme, to be automatically enrolled into either their employers’ pension scheme.

Question 11

Who is an eligible worker under the Pensions Act 2008?

Answer 11

Eligible workers are essentially those between 22 and state retirement age who earn above £10,000 annually.

Question 12

What is the National Employment Savings Trust (NEST)?

Answer 12

If the employer does not have an existing scheme, the government set up a new savings vehicle. This is known as National Employment Savings Trust (NEST).

Question 13

What does the Pensions Act do to encourage participation?

Answer 13

To encourage participation, any employees’ pension contributions are supplemented by contributions from employers and are subject to tax relief.

Question 14

Who approves pension schemes?

Answer 14

HMRC Pensions Scheme’s Office

Question 15

What benefits do approved pension schemes enjoy?

Answer 15

Tax benefits, e.g. no income or capital gains tax liabilities.

Question 16

What is a pensions trustee?

Answer 16

The trustee will be appointed by the sponsoring company to oversee the running of the fund and take legal ownership of the scheme’s assets. They are responsible for the creation of the statement of investment principle, setting out the nature of the fund. The trustee also has the final say over decisions regarding the scheme and essentially is the representative of the beneficiaries of the scheme.

Question 17

Can the trustee delegate some of their roles?

Answer 17

The trustee can delegate some of his roles to others, the trustee retains overall responsibility.

Question 18

Who does the trustee consult with and why?

Answer 18

The trustee will consult with the sponsoring company to draw up a statement of investment principles (SIP).

Question 19

Who appoints the pension’s investment manager?

Answer 19

The trustee

Question 20

Why must the trustee take every care in selecting and supervising the investment manager?

Answer 20

The trustees will ultimately be held responsible for any losses or criminal acts that are perpetrated by the investment manager.

Question 21

What must the trustee ensure the investment manager adheres to?

Answer 21

The regulations and objectives of the fund.

Question 22

Who maintains responsibility for the investment strategy?

Answer 22

The investment manager maintains responsibility for the investment strategy i.e. achieving the objectives set by the trustee.

Question 23

What is an important consideration regarding the investment strategy of the pension fund?

Answer 23

The age of the fund’s members.

Question 24

If the members of the pension fund are, on balance, older, what might the investment manager consider investing in?

Answer 24

The investment manager might consider moving into bonds and fixed interest securities. This increases the reliability of payments to the fund and hence its ability to meet imminent liabilities.

Question 25

What would pension fund managers invest in when there is a higher tolerance of risk from the trustees?

Answer 25

The portfolio would move towards equities. UK pension funds, typically, are more heavily weighted towards equity than their European counterparts.

Question 26

What are pension fund managers more likely to desire and why?

Answer 26

Although equity may be a major factor, managers are more likely to desire income bearing securities rather than having to realise capital gains. This is not a tax consideration, as there will be no tax on the gain or the income, it is more to do with transaction costs. Where the manager has to realise gains in order to rebalance the portfolio, this leads to two lots of costs – the sale and the purchase. With income, there is only the purchase cost.

Question 27

Can a fund invest in the shares of the sponsoring company?

Answer 27

The fund may wish to invest in the shares of the sponsoring company. Although this is permitted, it is limited to a maximum investment of 5% of the sponsoring company’s share capital.

Question 28

What is the first thing the sponsoring company must do when creating an occupational pension scheme?

Answer 28

Appoint a trustee

Question 29

What must the trustees of most schemes must draw up?

Answer 29

A written statement of investment principles (SIP) in consultation with the scheme sponsor.

Question 30

What is set out in the statement of investment principles (SIP)?

Answer 30

Principles governing how decisions about investments must be made.

Question 31

The statement of investment principles (SIP) must include the trustee’s policy on which 6 things?

Answer 31

1. Choosing investments
2. The kinds of investments to be held and the balance between different kinds of investment
3. Risk, including how risk is to be measured and managed, and the expected return on investments
4. Realising investments
5. The extent, if at all, taken into account of social, environmental or ethical considerations when taking investment decisions
6. Using the rights (including voting rights) attached to investments if they are available

Question 32

When will a trustee need to review the SIP?

Answer 32

A trustee will need to review the SIP regularly – at least every three years and whenever there has been a significant change in investment policy.

Question 33

What do pension regulations set out?

Answer 33

How trustees or fund managers must exercise their investment powers.

Question 34

Trustees and fund managers must exercise their powers to ensure which 4 things?

Answer 34

1. Security, quality, liquidity and profitability of the fund
2. Due consideration towards the nature and duration of the expected future retirement benefits of the scheme
3. Diversification in the choice of investments for the scheme
4. The scheme assets are invested mainly in regulated markets

Question 35

What must the trustee (or the fund manager acting on his behalf) do when choosing investments?

Answer 35

When choosing investments, the trustee (or the fund manager acting on his behalf) must exercise his investment powers in line with the scheme’s statement of investment principles (SIP).

Question 36

What duty does the trustee have in relation to the scheme’s assets?

Answer 36

The trustee has a duty to make sure that the scheme’s investments are held securely.

Question 37

What should a trustee do if the services of a custodian are not used?

Answer 37

If the services of a custodian are not used, a trustee should check that the arrangements in place for holding the scheme’s assets are satisfactory.

Question 38

What responsibilities do trustees have when it comes to keeping scheme money?

Answer 38

Trustees must be able to clearly identify scheme funds. They must keep scheme money received in a suitable account with a bank or building society separate from the employer’s account.

Question 39

What responsibility does the trustee have If a custodian is appointed to hold the scheme’s assets?

Answer 39

If a custodian is appointed to hold the scheme’s assets, the trustee should ensure they have adequate insurance arrangements and that, if the custodian uses sub-custodians, sufficient guarantees are in place.

The trustee should also check the arrangements in place between the custodian and the fund manager for making sure the assets the custodian holds are the same as those reported by the fund manager.

Question 40

What are the 4 objectives of the Pensions Regulator?

Answer 40

1. Protect the benefits of members of work based schemes
2. Reduce risk of situations requiring compensation from the Pension Protection Fund
3. Promote good administration and improve understanding of the schemes it regulates
4. Maximise employer compliance with employer duties

Question 41

What is the Pensions Regulator’s principal aim?

Answer 41

The Pensions Regulator’s principal aim is to prevent problems from developing. Where possible, they will provide support and advice to trustees, administrators, employers and others where potential problems are identified.

Question 42

What are the 3 broad categories the Pensions Act 2004 provides the Regulator with?

Answer 42

1. Investigating schemes: gather information to help identify and monitor risks
2. Putting things right where problems have been identified
3. Acting against avoidance: ensure that employers do not sidestep their pension obligations

Question 43

What are the various ways the Pensions Regulator receives information about pensions schemes?

Answer 43

The Pensions Regulator collects data through the scheme return. It also expects to receive reports of significant breaches of the law from ‘whistleblowers’, and reports of notifiable events from trustees and employers.

Trustees or scheme managers are also responsible for notifying the Regulator promptly of changes to information such as the scheme’s address, details of trustees, or the types of benefit provided by the scheme.

Question 44

What 3 things does the Pensions Regulator have the power to do when they believe that a scheme is deliberately avoiding their obligations?

Answer 44

1. Contribution notices – where there is a deliberate attempt to avoid a statutory debt, those involved must pay an amount up to the full statutory debt, either to the scheme or to the Board of the Pension Protection Fund
2. Financial support directions – these require financial support to be put in place for an under-funded scheme
3. Restoration orders – if there has been a transaction that under-valued the scheme’s assets, the Regulator can take action to have the assets (or their equivalent value) restored to the scheme

Question 45

What does the regulator expect in regards to scheme funding?

Answer 45

The Regulator also expects to receive reports where a scheme is unable to comply fully with the new scheme funding framework. If a scheme has a shortfall, the Regulator expects to receive scheme funding information.

Question 46

What does the Pensions Act 2004 require of trustees in regards to the statement of funding principles?

Answer 46

The Pensions Act 2004 also requires that the trustees prepare a statement of funding principles specific to each scheme explaining how the statutory funding objective will be met.

Question 47

What does statutory funding mean?

Answer 47

The statutory funding means that the fund has sufficient resources to meet an amount required for the fund to meet its obligations. This amount is based on actuarial calculations.

Question 48

What 3 things must the scheme specific funding requirement include details on?

Answer 48

1. Regular actuarial valuations and reports: how they will be made and how often
2. Preparing a schedule of contributors, showing the rates of contributions payable to the scheme and the dates on which they are to be paid
3. Putting in place a recovery plan for when the statutory funding objective is not met. This must set out the steps to be taken to meet the funding objective and the period within which this will be done

Question 49

How often must the statement of funding principles be review?

Answer 49

Every three years

Question 50

What is the main function of the Pension Protection Fund?

Answer 50

To provide compensation to members of eligible defined benefit pension schemes, when there is a qualifying insolvency event in relation to the employer, and where there are insufficient assets in the pension scheme to cover the Pension Protection Fund level of compensation.

Question 51

Who is the Pension Protection Fund run by?

Answer 51

The Pension Protection Fund is a statutory fund run by the Board of the Pension Protection Fund, a statutory corporation established under the provisions of the Pensions Act 2004.

Question 52

How is the Pension Protection Fund, funded?

Answer 52

To help fund the Pension Protection Fund, compulsory annual levies are charged on all eligible schemes.

Question 53

If an employer is insolvent and the pension scheme cannot meet its liabilities then the Pension Protection Fund will provide compensation of how much?

Answer 53

• Up to 100% of benefits to existing pensioners
• Up to 90% of benefits to those who have not yet retired