Employers are under an obligation to offer at least Stakeholder Pensions to their employees (but they are not under an obligation to make contributions) if they have at least five employees (see Chapter 4). Alternatives to this include group Personal Pension Schemes or Occupational Schemes.

Occupational Schemes

These are schemes set up by and sponsored by employers. The actual scheme is, however, run by a board of trustees, who are independent of the employer, and are there to ensure that the benefits under the scheme are properly funded and actually paid out. They also ensure that the pension funds are kept separate from the business’s own money.

Employers must contribute to occupational schemes, but employees are not obliged to contribute. Schemes in which only the employer contributes are known as ‘non-contributory schemes’.

The scheme must be approved by the Inland Revenue, which has a dedicated office, the Pension Schemes Office (PSO) for this purpose.

There are two main types of occupational schemes:

• 1.Final Salary Schemes, and
• 2.Money Purchase Schemes.

Tax advantages

Approved Occupational Schemes enjoy considerable tax benefits. To take advantage of these tax benefits, the trust deed and the rules must comply with Inland Revenue requirements. A summary of the requirements in terms of the limits imposed is given in Appendix 2.

The tax benefits include exemptions from:

• Income Tax on all income from investments and deposits, (but see exception below).
• Income Tax on underwriting.
• Capital Gains Tax.
• Income Tax on lump sums at retirement.
• Corporation Tax for the employer’s contributions.
• Income Tax for the employees’ contributions.

However, Income Tax is payable on:

• Dividend income in the scheme’s fund.
• Refund of pension scheme contributions, at 20%.
• Refund of surplus AVCs and FSAVCs, at 32%.
• Commutation of pension into a lump sum, when the excess of the lump sum over the maximum allowable tax-free lump sum is taxed at 20%.

Final Salary Schemes

These schemes are also sometimes referred to as ‘defined benefit’ schemes, or ‘salary related’ schemes. Contributions are made to the scheme by employers and employees, in an agreed proportion. The benefits payable under the scheme are related to three elements:

• 1.The length of service by the employee in the scheme.
• 2.The earnings at retirement date (known as final pensionable salary).
• 3.The scheme’s ‘accrual rate’. This is the proportion of the final salary paid as benefit for each year of service.

It is usual to allow an employee to remain as an active member during a temporary absence. This may be due to illness, or taking a sabbatical. The maximum period of temporary absence allowed is 30 months. During this period of temporary absence, the member’s retirement benefits continue to accrue, and the member is covered for death in service benefits.

Money Purchase Schemes

These are sometimes referred to as ‘defined contribution’ schemes. Contributions are made to the scheme by employers and employees, in an agreed proportion. The money is invested in a specific fund for each member. The benefits under the scheme depend on:

• 1.The amount paid into the pension fund.
• 2.How well the investment performs.
• 3.The annuity rate at the date of retirement.

One feature of a Money Purchase Scheme is that the tax free lump sum may be drawn up to the maximum permitted by the rules or the Inland Revenue limits. Only the balance of the fund is then used to provide an annuity.

In a Money Purchase Scheme, the employer must contribute at least 10% of the total contributions.

Simplified Defined Contribution Schemes (SDCS)

These schemes are not very common. They are, as the name implies, a money purchase type of scheme. Further restrictions apply, including:

• Membership is not allowed to a director holding 20% or more of the voting power of a company.
• Concurrent membership is not allowed except to an FSAVC (see below).

The maximum contribution for an employee into an SDCS is 15%, but the maximum combined contribution of employer and employee is 17.5%, of which 5% may go towards a lump sum death benefit. Up to 25% of the fund at retirement may be used to pay a tax free lump sum.

Hybrid Schemes

A hybrid scheme combines elements of Final Salary Schemes and Money Purchase Schemes. The calculation of the benefits is based on money purchase and final salary basis. So, if the member retires or leaves the scheme early, the member will receive a fund or an income, whichever is the greater. This type of scheme can provide more security of benefits linked to salary, and often means that the member is less likely to lose benefits on leaving the scheme early, whatever the reason.

Contribution limits

All contributions to an Occupational Pension Scheme that is approved by the Inland Revenue receive full tax relief at the top rate of tax paid. This applies to all contributions made – from employees and from the employer.

Because of this tax-advantaged status, there are limits on the amounts which may be contributed. Employees may contribute up to 15% of their total remuneration in any tax year. For these purposes, the remuneration includes:

• Normal pay taxed under PAYE.
• Benefits charged to tax (such as company cars, medical insurance, etc.).
• Profit related pay.
• Amounts used to purchase partnership shares in share incentive plans.

The remuneration, however, excludes:

• Golden handshakes.
• Share option gains.

There is an overall earnings cap which applies to the earnings for the purpose of calculating the 15% limit. For the current tax year (2005/2006) the earnings cap is £105,600. Therefore, the maximum any employee could contribute in the current tax year is 15% of £105,600 – or £15,840.

The employer may also make contributions to the scheme on behalf of employees. In fact, the contribution of employers is a condition of approval of a scheme by the Inland Revenue.

The contributions of the employer are not limited to a maximum, but there is a lower contribution limit of 10% of the total contributions to the scheme (i.e. employees and employer together) in any tax year.

Payment of contributions

Employees’ contributions to an Occupational Scheme must be paid over to the trustees by the 19th of the month following the month in which the contributions were deducted from the pay of the employees.

The trustees of the scheme must monitor the prompt payment of contributions. If payment is made late, the trustees must:

• report the non-payment or late payment to the Occupational Pensions Regulatory Authority (OPRA) within 30 days of the due date, and
• report to the members of the scheme if the contributions have still not been paid after 60 days from the due date.

However, the trustees need not report the late payment:

• if the payment is made within 10 days of the due date, and
• late payment has not happened previously more than once.

Employer’s contributions dates are made at their discretion, but once a regular date has been fixed, it must be adhered to, and the trustees must monitor this also.

Members’ contributions to other schemes

Members of Occupational Schemes are not limited to making all their retirement provision by their employer’s scheme. Extra contributions may be made by:

• Additional Voluntary Contributions (AVCs), or
• Free Standing Additional Voluntary Contributions (FSAVCs), or
• Concurrency provisions (see Chapter 4).

AVCs (Additional Voluntary Contributions)

To obtain the approved exempt status for tax purposes, Occupational Schemes must offer to the members the ability to pay AVCs – i.e. additional contributions into the same scheme. These allow the members the opportunity to contribute extra money to top up their retirement fund. AVCs do not usually benefit from any matching contribution from the employer, whereas the normal contributions often do.

The contributions paid into AVCs are nearly always Money Purchase Schemes, even if the main Occupational Scheme is a Final Salary Scheme. AVCs are also usually negotiated by the trustees of the scheme with the pension provider at low cost or no cost. Contributions to AVCs enjoy the same tax relief as normal contributions, always subject, however, to the normal 15% limit and the earnings cap. The trustees of the scheme are responsible for ensuring that the limits are not breached. If the limit is breached however, a refund of excess AVC contributions is paid to the member, subject to a tax charge of 33% if the member is a basic rate tax payer, or 48% if the member is a higher rate tax payer.

AVC contributions may be used to provide additional pension (and the Open Market Option is available for AVCs), or, in certain circumstances, to buy extra years of service within a final salary pension scheme. Either benefit may be taken within the normal retirement dates applying to pension schemes – between age 50 and age 75. They do not have to be taken at the same time as the benefits from the main scheme (providing that the Occupational Pension Scheme rules allow this).

AVCs may not be used to provide a tax-free lump sum (unless the arrangement was in place before 8 April 1987). AVCs are a good way to make up any shortfall in retirement funds due to breaks in service, or early retirement.

FSAVCs (Free Standing Additional Voluntary Contributions)

FSAVCs are a way of contributing additional amounts to a retirement fund outside of the Occupational Scheme. In other words, a member of an Occupational Scheme may make additional contributions to any other provider he wishes, outside of the employer’s Occupational Scheme. FSAVCs are only available to people who are members of an Occupational Scheme. Because FSAVCs are not included in the sponsored AVCs of the employer’s scheme, they would normally be expected to bear extra costs, both initial set up costs and annual charges.

FSAVCs are also subject to the same overall limits as AVCs – 15% of earnings subject to the earnings cap. The responsibility for ensuring that the limits are not breached is with the provider of the FSAVC.

FSAVCs enjoy the same tax advantages as AVCs.

• FSAVCs may only be used to provide additional pension.
• The benefit may be taken within the normal retirement dates applying to pension schemes – between age 50 and age 75.
• They do not have to be taken at the same time as the benefits from the main scheme (providing that the Occupational Pension Scheme rules allow this).

FSAVCs may seem to have disadvantages, but their advantages are:

• The contributor can choose the company into which the money is invested, and the type of investment.
• The contributor may continue to pay into it even if there is a change of Occupational Scheme, or if he changes employer.

Concurrency

As we have seen in Chapter 4, concurrency means the ability to contribute to more than one type of pension provision, provided generally that the overall limits are observed (i.e. 15% of earnings up to the earnings limit). An Occupational Scheme member may contribute to a Personal Pension Plan or a Stakeholder Pension provided that:

• he has not been a controlling director of the employer in any of the past five years, and
• he has earned less than the remuneration limit (currently £30,000 plus the value of the member’s annual contributions to the Occupational Scheme) in any one of the last five years.

If the member of an Occupational Scheme takes advantage of the concurrency provisions, the maximum contributions to a Personal Pension Plan or Stakeholder Pension are £3,600 per year gross (£2,808 net) at current tax rates.