Pensions - practical advice for reps

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Pensions advice is 'regulated' by the Financial Services Authority and the provision of advice by an unregulated adviser is a criminal offence. The golden rule is union representatives can help - but you should tell members that your figures are unlikely to be 100 per cent accurate and you must advise them to check and have the figures explained by their employer or specialist union or financial adviser. You should also note that the law governing pensions changes frequently, so the information in this guide may not reflect the current position at the time you are reading this.

Overview of the UK pension system

There are three main kinds of pension provision in the UK:

  • state pensions: basic and State Second Pension (S2P)
  • occupational pensions (set up by the employer)
  • personal and stakeholder pensions, sometimes called private pensions.

Nearly everyone pays National Insurance (NI) contributions at some point in their working lives, so most people can expect to receive some state pension when they retire.

Alongside the state pensions are the two kinds of - non-state - pensions. First, there are occupational (also called 'company') pension schemes. Employers are not generally legally required at present to provide pensions for employees (but see the section below on the 2012 reforms).

The second type of non-state pension is a personal or stakeholder pension. With these, you have an individual contract with an insurance company or another provider. An employer may set up the contracts and make a contribution, and then it is called a group personal pension or group stakeholder pension.

Basic State Pension

State Second Pension

Occupational pension (contracted out)

Personal or stakeholder pension (contracted out)(only until April 2012)

may be topped up from S2P

Can add

contracted-in occupational or personal pension

Can add

additional voluntary contributions

separate personal or stakeholder pension

 

Many people in the UK are not saving enough, or at all, for their retirement. Some can't afford to save: others are put off because their employer doesn't make any provision, or because they don't trust the pension system or the government. Most employers - particularly those employing fewer than 500 people - don't make any pension provision for their employees. Providing pensions is very expensive, mainly due to the very rapid increase in life expectancy over the last few years.

The Pensions Commission set up by the government in 2003 concluded that there would be:

  • 50 per cent more pensioners by 2050
  • rising life expectancy and uncertainty about the increase
  • over seven million people under-saving for retirement
  • a major fall in pension contributions by private sector employers
  • a state system that left major gaps in provision for people with caring responsibilities
  • a wide dispersion of private pension provision.

Because of these issues it concluded that future pensioners would inevitably be poorer relative to the rest of the population, unless either:

  • individuals saved more for their own retirement, or
  • the proportion of tax revenue devoted to pensioners went up, or
  • people delayed their retirement.

In practice, a combination of all of those will be happening.

State pensions

The state pension comes in two parts. There is a flat-rate Basic State Pension, and an earnings-related additional pension on top, currently called the State Second Pension (S2P). The government is currently considering major changes to the state pension system, which could take effect in 2015.

The state pension age

The minimum age at which a man can draw the state pension is 65. The women's state pension age is increasing to 65 between April 2010 and March 2018, and the state pension age will then rise to 66 for men and women. There is a state pension age calculator on the Direct.Gov website.

State pension age is not the same thing as retirement age - you can choose to retire before you reach state pension age, and you can go on working (and draw your state pension) after you reach state pension age.

The Basic State Pension

The Basic State Pension is payable at the same rate to everyone who has reached state pension age and meets the National Insurance contribution conditions. To get a full Basic State Pension you must have 30 'qualifying years', that is, years in which National Insurance contributions have been paid, or NI credits given. (Note that the rules changed in April 2010: different requirements applied to anyone who reached state pension age before that date.)

You can find out more about the Basic State Pension and how to qualify for it at www.direct.gov.uk/en/pensionsandretirementplanning/statepension

Pensions increases

The Basic State Pension is increased each year in April, on the first Monday after 6 April. The current government has promised that the pension will be increased by the greater of national average earnings, CPI (consumer prices index) (using the figure from the previous September) or 2.5 per cent. If you retire abroad, pensions increases may not be paid, depending on where you live; they will be paid if you are living in another EU country.

Deferring your state pension

Once you have reached state pension age, you can draw your Basic State Pension whether or not you are still working. You will pay tax on it, but no further National Insurance contributions are payable (though the employer must still pay them). Alternatively, you can defer taking your pension; if you defer taking it for at least five weeks it will be increased by 0.2 per cent for each week you defer. This works out as 10.4 per cent for each full year. If you defer for at least 12 months, you can choose to have instead a one-off taxable lump sum payment when you start drawing the pension, based on the amount of pension you have foregone with compound interest.

Finding out what state pension you will get

You can request a forecast online from the Direct. Gov website, which also gives a phone number and address for the State Pension Forecasting Team.A number of employers, and some insurance companies, issue Combined Pension Forecasts. These are brief summaries of the information about your state pension alongside details of the pension from the employer or the insurer.

The State Second Pension

The State Second Pension was originally called the State Earnings Related Pension (SERPS). SERPS was replaced in 2002 by the State Second Pension (S2P). S2P is intended to skew benefits towards the less well off, including those on very low pay and carers. It is not earned by the self-employed.

Who qualifies for S2P?

In order to have any S2P you must either:

  • have paid Class 1 National Insurance contributions for employees (for S2P or SERPS before it), or
  • be covered by the special provisions for carers or disabled people (for S2P only).

It is possible to have some pension from SERPS or S2P, even if you do not qualify for any Basic State Pension. Widows and widowers may qualify for SERPS and S2P on their spouse's contributions.

How does S2P work?

Your S2P (and SERPS before it) depends on your 'band earnings' or 'reckonable earnings' during your working life. These are your earnings between the Lower Earnings Limit and the Upper Accrual Point (the Upper Earnings Limits before 2010) for each tax year from 1978/79 until the year before you reach state pension age. Your earnings over the relevant tax years are then revalued in line with rises in national average earnings since the date you earned them.

The formula for calculating S2P is complicated, because it links back to the way SERPS was calculated up to April 2002. From 2002 to 2010 S2P was calculated on three bands of earnings, but the formula was changed again in 2010:

  • For earnings between the Lower Earnings Limit and the top of Band 1, the pension is 40 per cent of the Band 1 figure (regardless of what the claimant actually earned).
  • For earnings in Band 2 up to the Upper Accrual Point the pension is 10 per cent of the revalued earnings figure.

From an unspecified future date, the Band 1 (40 per cent band) will be replaced by a weekly flat-rate accrual of £1.60 (£83.20 p.a.). The 10 per cent accrual component will be withdrawn around 2030, leaving a wholly flat-rate benefit. However, the state pension reforms proposed in 2011 may bring forward the date at which S2P becomes a flat-rate top-up pension.

You can find the National Insurance bandings and contribution rates at www.hmrc.gov.uk/rates/nic.htm.

Contracting out

An employee who is building up a non-state pension (occupational, personal or stakeholder) may be either contracted in to or contracted out of SERPS/S2P. Most occupational-defined benefit schemes (including all the public sector schemes) are contracted out. If you are contracted out, your SERPS/S2P is replaced by your non-state pension. So both the employer and employee pay lower National Insurance contributions. Currently the reduction for employees is 1.6 per cent but this is due to reduce to 1.4 per cent in 2012. In order to be contracted out, a scheme must meet certain standards, which changed in 1997 and again in 2002. In summary, the rules for defined benefit schemes are:

Dates

Position

6 April 1978 to 5 April 1997

Contracted-out pension schemes (based on final salary) had to provide a Guaranteed Minimum Pension (GMP) equivalent to SERPS. To make up any gap because GMP and SERPS were calculated in different ways, many people receive a limited amount of SERPS as well as the pension from their employer.

6 April 1997 to 5 April 2002

No guarantee of the amount from your contracted-out scheme. For any year you were contracted out, no SERPS pension is payable.

6 April 2002 to present day

No guarantee of the amount from your contracted-out scheme, but top-up system for lower-paid workers and carers.

Note that it will not be possible to contract out with any form of defined contribution scheme from April 2012. It is also possible that contracting out will be ended altogether as part of the state pension reforms currently under review by the Department for Work and Pensions.

Pension Credit

Pension Credit is a means-tested social security entitlement for people aged 60 and over. You do not need to have paid National Insurance contributions to qualify for Pension Credit, but your income and any savings and capital over a certain level will be taken into account. Pension Credit comes in two parts: the Guarantee Credit tops up your income to a level set by the government; and the Savings Credit gives extra to people aged 65 and over who have income over a certain level, from sources such as pensions and savings. You may be entitled to the Guarantee Credit or the Savings Credit or both.

People entitled to Pension Credit may also qualify for Housing Benefit and/or Council Tax Benefit. So long as you are over 60, you can work and receive Pension Credit, though most of your earnings will be taken into account.

Note that there are some restrictions on people who have come from abroad claiming means-tested benefits, depending on their immigration status.

Workplace pension provision

There are three main legal arrangements for workplace pension schemes:

  • statutory schemes, i.e. public sector schemes
  • trust-based occupational schemes
  • personal and stakeholder pensions that are contract-based run by an insurance company.

Defined benefit and defined contribution schemes

Workplace pension schemes may be either defined benefit (DB) or defined contribution (DC) arrangements. In a DB scheme, the pension is worked out on a formula, almost always linked to the member's pay and length of service. In a DC scheme, also known as money purchase, the pension is based directly on the contributions and the investment return on them.

Scheme governance

'Occupational' pension schemes are set up under trust law and are run by a board of trustees. The board must include at least a third of member-nominated trustees. However, all the trustees have the same legal duty - to act in the interests of scheme members. The trustees are advised by experts such as lawyers and actuaries. It is the trustees' duty to ensure that contributions are paid into the scheme when due, that the money is properly invested, and that benefits are paid out to the right people when they are due.

Contract-based schemes do not have trustees or anyone looking after member interests. However, the Pensions Regulator recommends that there should be a governance committee. This should include member representatives. You can find out more about the role of trustees and governance committees on www.thepensionsregulator.gov.uk.

Information about your pension

You are entitled to information about your pension scheme and your own benefits. When you joined the scheme you should have been given a booklet that gave information about the benefits of the scheme and how the scheme is run. You may get sent a benefit statement each year showing how your own pension is building up; if you are not sent this automatically you are entitled to ask for one. Some schemes issue a short annual report but you are also entitled to ask to see the full annual report and accounts. If you are in a DB scheme, you should also receive each year a 'summary funding statement' saying how well the scheme is funded, and providing some more information about the scheme and how it is run. The summary funding statement will also state the other documents you are entitled to ask for.

Other occupational scheme documents must be supplied on request (or made available to view) to scheme members and recognised union reps. These include the trust deed and rules, the formal annual report and accounts, and (for DB schemes) the most recent actuarial valuation of the scheme. These documents contain all the information you will need about the scheme, both for helping members with enquiries and for negotiations.

When can you get your pension?

Pension schemes will always have a 'normal pension age', or 'normal retiring date'. This is the age at which you can retire and draw your pension without needing special agreement, and without the pension being reduced for early payment. In most schemes the normal pension age is 65. Most schemes will allow members to take their pension at a lower age, but this may need the employer and/or the trustees' agreement. The earliest age at which you can draw your pension is 55 (unless you are retiring on ill-health grounds), though there are some exceptions to this.

Since April 2006, the tax rules have allowed scheme members to draw their pension and continue to work for the same employer. This may be called 'flexible retirement' or 'phased retirement'. Employers do not have to allow this.

The public sector schemes

The occupational schemes for the Civil Service, teachers, the NHS, the Armed Forces, Police and Fire Brigade are statutory schemes and each of them has a set of regulations that have gone through Parliament that set out the rules that have to be followed. Most of these schemes are 'unfunded', which means that people's contributions go into the overall Treasury funds, and the pensions are also paid out of these Treasury funds. An exception is the Local Government Pension Scheme (LGPS), which does have funds; member and employer contributions are paid into these funds, which are managed by the local authorities.

All the public sector schemes are currently DB, although in the Civil Service there is a DC alternative. You can find out more about the public sector schemes from your union's website or from the website for the scheme: www.civilservice.gov.uk/pensions; www.teacherspensions.co.uk; www.nhsbsa.nhs.uk/pensions; www.lgps.org.uk.

Private sector schemes

Many employers outside the public sector do not provide any pension arrangement for their employees beyond the current legal minimum (access to a stakeholder arrangement) and those that do are most likely, at least for new employees, to provide a DC arrangement. This may be anoccupational scheme (run by trustees) or a contract scheme, for example a group personal pension (GPP). The pension works in much the same way in either case; the difference is in who runs it and who (if anyone) is looking after members' interests. (See section above on Scheme Governance.)

Defined contribution schemes

DC schemes work in very much the same way as other savings. Contributions go into an individual 'pot', and the investment returns are added to them. The money that builds up is then used for the pension.

So what will my pension be?

What you get as a pension will depend on:

  • what contributions have gone in
  • how long the money has been invested
  • how good the investment returns were
  • how much you paid out in charges to the insurance company
  • what sort of annuity you choose for when you retire, and how much the insurance company charge you for it.

Estimates of your pension

The provider must send you a statement each year of how much has gone into your pension, and an estimate of how much this will give in retirement. The estimates are in terms of today's money, and are based on a number of assumptions, including:

  • your future payments into your pension
  • how your funds might have grown by the time you retire
  • future inflation
  • how much it could cost to buy a pension income with your pension fund
  • when you retire.

Contributions

The amount of money that goes into the DC plan is likely to be the key factor in the size of the eventual pension. Many employers will match or even double-match an employee's contributions, up to a certain limit. Double-matching, together with the associated tax relief, has a significant impact. For example, a basic rate taxpayer who pays £10 into their pension account will, if their employer double-matches their contribution, have their account credited with £37.50.

Investment choices

There is usually a choice of investment funds into which to put your contributions, with different aims for risk and return. Most schemes have a'default' fund, where your money is put if you do not make a choice yourself. This is usually a 'lifestyle' or 'lifecycle' fund, which means that it is invested to start with mainly in equities (company shares). These can be risky, but have in the past provided the best returns in the long run. It is then moved into safer but lower-returning investments such as gilts (lending money to the government) as you come up to retirement.

Schemes may offer members an 'ethical' option, such as a fund specialising in environmentally sustainable companies.

Charges

In most cases, scheme members will bear the direct costs of the DC scheme through an 'annual management charge' on their fund, which, depending on the type of fund and size of scheme, will typically be between 0.4 per cent and 1 per cent of their fund each year. Charges may be significantly higher for specialist funds. There may also be hidden charges, for example for switching funds.

State Second Pension (S2P)

Most DC arrangements are not contracted out of the S2P, so members will pay standard rates of National Insurance and will be accruing entitlement to S2P benefits as well as to their scheme pension. Under current legislation, no one will be able to contract out of S2P on a DC basis after April 2012.

Ill-health benefits

DC plans do not generally provide ill-health retirement benefits, though the employer may provide this through an insured arrangement (often known as PHI - permanent health insurance).

Retirement income

At retirement, up to 25 per cent of the 'pot' can be paid out in a tax-free lump sum but, unless the DC 'pot' is so small that the tax rules allow it all to be paid as cash, the rest must be turned into pension income. For most people, this will be through the purchase of a lifetime annuity, that is, a guaranteed income for life provided either by the pension provider or another insurance company. Members face a range of choices in respect of guarantee periods, pension increases, spouse pensions etc. Pension providers must offer an 'open market option', i.e. the right to buy a pension from a different company; this can offer a significantly better retirement income. You can find out more about annuities at www.pensionsadvisoryservice.org.uk

There are alternatives to annuities, especially for those who have built up a sufficiently big 'pot'; individuals in this position should take independent financial advice.

Family benefits

The employer will generally provide for an insured lump sum benefit on death in service. On retirement, it will be down to the member to decide whether or not to provide for a dependant's pension following their death.

Stakeholder pensions

Stakeholder pensions are a type of personal pension. Employers who don't have any other sort of pension scheme available are legally required to give people access to a stakeholder scheme through the workplace, and to make deductions from pay and pass them on. However, employers are not required to contribute to stakeholder schemes.

There are particular rules on charges and contributions; for more information see www.pensionsadvisoryservice.org.uk

Defined benefit schemes

Most DB schemes are final salary schemes, that is, the pension is based on pay at or close to retirement. Pension is based on:

  • your final pensionable pay
  • your pensionable service, and
  • the 'accrual rate' (the rate at which the pension builds up each year).

Final pensionable pay will be defined in the scheme rules. It may be based on earnings only in the final 12 months, or may allow count back as far as 13 years. Generally it will not include things such as overtime. It is important to understand how the scheme rules define pensionable pay.

The accrual rate will usually be a fraction, such as 1/80th (often referred to as '80ths') or a percentage (such as 1.5 per cent).

Jane joined the ABC company scheme at 20 and

is now due to retire at 60. She has exactly 40 years' pensionable service. The accrual rate in her scheme is 80ths.

Her pensionable pay is £24,000 a year. So £24,000 ÷ 80 x 40 = £12,000.

Working part time

Pension schemes will usually work out pensions for people who work part time by using the full-time equivalent pay rate and reducing pensionable service in proportion to the hours worked. Some schemes may use a different formula.

Sam worked 20 years full time, then 10 years at half time, then 5 years at 2 days a week. So his total service for pension is 27 years.

When he left he was being paid £6,000 a year, so the full-time equivalent salary was £15,000.

The accrual rate in his scheme is 80ths.

Sam's pension will be based on 27 years' service and salary of £15,000.

So 27/80 x 15,000 = £5,062.50 a year.

DB schemes may instead be 'career average' schemes (often called CARE - career average revalued earnings), which base pension on each year's pay, which is then revalued. So in a CARE scheme the key factors are not just pay, service and the accrual rate but also the revaluation rate.

Lump sums (tax free cash)

In some pension schemes, members automatically build up an entitlement to a lump sum payment as well as their pension. Typically, pension builds up at 1/80th pay for each year of service, and a lump sum at 3/80.

In other pension schemes, you build up entitlement only to pension, but can then exchange pension for a tax-free lump sum. This is called 'commutation'. Under current tax rules, 25 per cent of the total value of pension benefits can be taken as tax-free cash. Whether this is good value or not depends on what the 'commutation rate' (i.e. the exchange rate) is. Often this is not published. In the public sector schemes, the commutation rate is 12, that is, each £1 of pension given up provides £12 of lump sum. In the private sector, the rate may be set in the scheme rules, or may be decided by the employer or by the trustees (depending on what the rules say). A typical commutation rate at age 60 may be about 18.

The maximum lump sum you can take, under current tax rules, is worked out by multiplying the annual pension by 20, and dividing that by 4.

Bill's pension is £10,000 a year. The maximum lump sum he can take is 10,000 x 20/4 i.e. £50,000.

Bill decides he wants a lump sum of £45,000. The commutation rate in his scheme is 15. So, to get that lump sum, he will have to give up £3,000 a year of his pension, giving him a pension of £7,000 a year.

Benefits for your family

Most DB pension schemes will provide benefits for your family after your death. This may be a lump sum and/or a pension.

Most schemes will pay a lump sum based on a multiple of your salary if you die in service - this may be referred to as a 'death in service benefit', or 'death grant', or 'life assurance'. Typically this is between one and four times salary.

In the public sector schemes, this payment will generally be made strictly in accordance with the member's nomination form. In private sector schemes, members will be asked to complete an 'expression of wish' form, which the trustees will take into account when they decide who the lump sum should be paid to. It is very important that members complete these forms. (Paying the money out 'at the trustees' discretion' means it can generally be paid tax-free.)

Contracted-out pension schemes are legally required to pay a pension to a member's widow, widower or surviving civil partner. Schemes may also pay a pension to an unmarried partner, but this is generally at the discretion of the trustees. If pensions are payable to unmarried partners, trustees must not discriminate between opposite sex and same sex partners. Spouse or partner pensions are typically half the member's pension.

Schemes may also pay a pension to any dependent children at the time of the member's death. Scheme rules vary considerably as to which children may qualify (for example, whether the member's partner's children are eligible), but there is an overriding tax rule that children's pensions must stop at age 23 unless the child is dependent because of a serious disability.

Ill-health retirement

Most DB schemes will provide early retirement arrangements for members who are too ill to work, whatever their age. However, schemes vary widely on the terms they offer, and the criteria. There are three issues to look at:

  • Who makes the decision or whose consent is needed. This may be the trustees, the employer, or the scheme's medical adviser, depending on the scheme rules.
  • How ill you have to be. Most scheme rules require the illness or incapacity to be permanent, but some will require only permanent incapacity for the member's own job, whereas other schemes may not allow ill-health retirement unless the member is considered to be too ill to undertake any work in future.
  • How the pension will be worked out. The least generous will simply allow the member to draw their accrued pension early without any reduction for early payment. The most generous will work out the pension as if the member had continued to work until their normal pension age.

Leaving a scheme before retirement

In general, when you leave an employer you have to leave their pension scheme (though there are exceptions, if you are in a scheme with many 'participating employers'). You then have several choices about your pension:

  • Your pension can be 'deferred' or 'preserved' in the scheme, and you can collect it when you retire. People often refer to this as a 'frozen' pension but in fact it will be increased broadly in line with price inflation, subject to a cap.(You may not be offered this option if you have less than 2 years' service).
  • Alternatively, you can take a transfer to another employer's scheme, or to a personal pension. You have the right to ask for a transfer out of a scheme at any time up to a year before retirement date. However, your new pension scheme may not accept transfers-in at all, or may allow them only within a certain time limit, especially in the public sector.
  • If you are 55 or over when you leave, you may be offered an immediate pension, but it will probably be a reduced amount.

You can find advice on pension transfers and similar issues on the Pensions Advisory Service (TPAS) and Money Made Clear websites.

If you have moved jobs several times, you may have several deferred pensions in different places by the time you come to retire. You will then need to write to the administrators of each, asking for your pension to be paid. Some of the firms concerned may have closed, or merged with other ones and changed their names. If you have trouble tracking down your previous pensions, you can use the Pensions Tracing Service. (Contact details on the www.Direct.Gov website.)

Pension increases

When pensions come into payment, they would quickly lose their value if they did not increase each year. Until 1997, it was legal for pensions not to be increased, though in practice most schemes did pay increases even then. Since 1997, there has been a requirement for DB pensions earned after that date to be increased in line with inflation, up to five per cent. However, under the Pensions Act 2004 that was reduced to 2.5 per cent. Many schemes will have rules that require them to be more generous than this. Because of the legal changes, however, it is likely that pensioners will find that parts of their pension do not increase at the same rate as the rest. From 2011, depending on the scheme rules, pension increases may be in line with CPI rather than RPI.

Pension contributions

The benefits provided by a final salary scheme typically cost between 20 per cent and 30 per cent of paybill. Generally (but not always) the employee contribution rate is fixed, and the employer pays the 'balance of cost'. It is a legal requirement for pension schemes (other than the statutory public sector schemes) to be valued at least every three years, after which the trustees and the employer will agree a 'schedule of contributions' setting out how much, and when, the employer must pay into the scheme. The valuation report and the schedule of contributions must be disclosed on request to scheme members and recognised trade union reps.

Increasing your pension benefits

Members in a contract-based DC arrangement run by an insurance company will generally have the option to pay additional contributions at any level and whenever they want (though note there is a limit on tax relief, see below).

Members in an occupational scheme may have some or all of the following options:

  • purchase of added pension or added years within the scheme
  • additional voluntary contributions
  • personal or stakeholder arrangement or 'free standing AVCs' (additional voluntary contributions).

Added pension or added years are unlikely to be available other than in the public sector schemes. Purchase of added years or added pension will generally appear expensive, as it is a defined benefit, usually with inflation-proofing of some sort.

Most schemes will offer the option to pay AVCs, though this is no longer a legal requirement. AVCs are usually a DC arrangement; scheme AVCs may provide better value than a personal pension as charges are likely to be lower, and (depending on scheme rules) it may be possible to draw the AVC fund as a tax-free cash payment on retirement.

Since 2006, members in an occupational pension scheme have also been able to save in a personal pension arrangement (see section above on Defined Contribution Schemes).

Taxation of pensions

On 6 April 2006 ('A day'), rules came into effect around how pensions are taxed, offering simpler and more flexible retirement arrangements. They included:

  • There is no limit on the amount of money you can save in a pension scheme or the number of pension schemes you can save in - although there are limits on the tax relief you can get.
  • You will get tax relief on contributions up to 100 per cent of your annual earnings.
  • If in a tax year the value of your pension increases by more than the 'annual allowance' (currently £50,000), you will be liable to a tax charge.
  • Even if you are not a taxpayer you can still get tax relief on pension contributions. You can put in up to £2,808 in any one tax year and the government will top this up with another £792 - giving you total pension savings with tax relief of £3,600 per year.
  • If your scheme rules allow, you can take up to 25 per cent of the total value of your pension as a tax-free lump sum. Depending on the scheme rules, you may be able to take this lump sum from your main pension scheme, or your AVC arrangement, or any other pension you have, so long as you do not go above the overall limit.
  • If the total value of your pension is more than the 'lifetime allowance' (currently £1.8 million) when you come to take your pension, you may be subject to a tax charge at that time.
  • You will not be able to take a pension before you are 55. There are a couple of exceptions: you will still be able to retire early due to poor health, and if at 6 April 2006 you had the right to draw pension before 55, that right may be protected.
  • The new rules introduce flexible retirement, allowing people in occupational pension schemes to continue working while drawing their pension, where the scheme rules allow it.

Tax relief on pension contributions

Pension contributions attract tax relief, that is, you pay less tax because you are making the contributions. Both occupational and personal or stakeholder pensions get tax relief, but it works in different ways.

If you are contributing to an occupational scheme (whether DB or DC), you get the relief 'at source'. That means the money is deducted from your gross pay before your PAYE income tax is worked out.

For personal pensions, the pension contribution comes out of your net (take-home) pay, and the pension provider then reclaims basic rate tax from HMRC. Higher-rate taxpayers have to claim the additional relief on their tax return.

Employers also get corporation tax relief on any pension contributions they make for their employees.

Salary sacrifice

Many employers are asking employees to pay their pension contributions through a salary sacrifice arrangement (sometimes called 'Smart Pensions'). The employer will pay the contributions direct to the scheme, and the employee takes a cut in their gross pay to match. The aim is to reduce National Insurance contributions.

Wilfred earns £20,000 a year. His pension contribution is 5 per cent, so he pays £1,000 a year from his gross pay into his pension. If, instead, he takes a pay cut and his employer pays £1,000 directly into the scheme, Wilfred's take-home pay goes up slightly because he will be paying his NI contributions on £19,000 instead of on £20,000. His employer's National Insurance contributions will also be reduced.

These arrangements are at present legal and can save money. However, the terms need to be negotiated carefully to ensure there is no impact on other pay-related benefits such as redundancy pay.

The 2012 reforms

New employer duties come into force on 1 October 2012. Under these duties, employers have to:

  • automatically enrol eligible workers into a qualifying workplace pension arrangement
  • choose the qualifying scheme(s) they want to use, and either
    • make a minimum three per cent contribution towards a defined contribution scheme (based on qualifying pensionable earnings) or National Employment Savings Trust (NEST), or
    • offer membership of a DB scheme or a certain hybrid scheme that either has a contracting-out statement or meets the test scheme standard.

An eligible worker is an employee aged between 22 and state pension age and earning above the income tax personal allowance (£7,475 in 2011/12). However, once enrolled, contributions become payable on earnings over the National Insurance primary threshold. The rules on when workers must be auto-enrolled and the level of pay that is taken into account are complex and subject to change: you can find detailed guidance on the Pensions Regulator's website: www.thepensionsregulator.gov.uk.

From October 2012 employers also have an ongoing duty to maintain qualifying pension provision for workers who are already members of qualifying schemes, or who become members of such schemes.

Although the new duties come in from 1 October 2012, individual employers' own duties will be introduced gradually over the following four years and will be based on the size of the employer, typically by PAYE size. The schedule of phasing in dates can be found on the Pensions Advisory Service (TPAS) website.

There will be a three-month waiting period before employers are required to enrol workers into their designated scheme. During this period, workers can choose to opt in to start saving, and to receive the employer contribution straight away.

Minimum contributions for DC schemes and NEST

Where a worker is automatically enrolled in a DC scheme or NEST, there will be a minimum contribution of eight per cent of qualifying earnings, of which the employer must pay a minimum of three per cent. When the employer pays the minimum three per cent, the worker will pay four per cent, with a further one per cent paid as tax relief by the government. (Qualifying earnings is currently earnings between £5,715 and £33,540 in 2010/11). However, these minimum contribution levels will be phased in between October 2012 and October 2017.

  • October 2012 to September 2016 - total minimum of two per cent of qualifying earnings with at least one per cent from the employer
  • October 2016 to September 2017 - total minimum of five per cent of qualifying earnings, with at least two per cent from the employer
  • from October 2017, total minimum of eight per cent of qualifying earnings, with at least three per cent from the employer.

Opting out

Workers will be able to opt out of their employer's scheme if they choose not to participate. Workers who give notice during the formal opt-out period will be put back in the position they would have been in had they not become members in the first place, which may include a refund of any contributions taken following automatic enrolment.

NEST

NEST (National Employment Savings Trust) is a simple and low-cost DC pension scheme designed to give its members an easy way of building up their retirement pot. It is an occupational scheme (run by trustees) and has a 'public service obligation', that is, any employer who wishes to will be able to use NEST to auto-enrol their employees. You can find out about NEST, including the contributions, investment arrangements and charges at www.nestpensions.org.uk.

What if...

...your employer changes by means of a TUPE transfer?

Any provisions relating to old age, invalidity or survivors' benefits under an occupational pension scheme are specifically excluded from TUPE by Regulation 10 and do not transfer. Limited protection of pension rights is, however, provided by the Pensions Act 2004 and the Transfer of Employment (Pension Protection) Regulations 2005. Under these regulations, if the previous employer provided a pension scheme the new employer must provide some form of pension for those who were members of or eligible to join the previous employer's scheme. It does not have to be equivalent but must be of a minimum standard.

The requirement is for:

  • a DB scheme that meets the requirements of the Reference Scheme Test (i.e. the test used for allowing schemes to contract out of S2P (previously SERPS), or
  • a scheme providing benefits equal in value to the member's contributions plus 6 per cent of pensionable pay. (This could be a DB scheme or, for example, a cash balance scheme or hybrid arrangement), or
  • a money purchase arrangement to which the employer matches the employee's contribution up to six per cent of pensionable pay.

Note that if the previous employer provided a contract-based scheme, it is likely that any arrangements for employer contributions are contractual and therefore transfer under TUPE.

The new employer's intentions in respect of pension provision should be covered in the 'Measures' document provided to trade union representatives.

Early retirement provisions do, however, transfer according to a landmark ruling by the European Court of Justice in the case concerning rights for over-50s of Beckmann v. Dynamco Whicheloe Macfarlane C-164/00. The NHS scheme provided that those aged over 50 who are made redundant would receive an early retirement pension. The ECJ held that early retirement benefits are not old-age, invalidity or survivors' benefits and were not covered by the pensions exclusion, which, it said, must be narrowly interpreted.

...your employer wants to change the scheme?

Employers almost always have the right to change pension arrangements, but only for future service. It is generally not possible to change pension benefits that have already been earned, unless each individual agrees. Employers (except small employers) must consult scheme members if they want to make changes to the pension scheme.

The ABC Company pension scheme has a normal pension age (NPA) of 62. The employer wants to change this to 65. Following consultation, agreement is reached to change NPA to 65, but scheme members will still have the right to draw their pension from age 62, even if they are still working for the company. But any pension they earn after the date of change will be reduced for early payment if they draw it before 65.

Mary was 59 at the date of the change, and had 25 years' pensionable service. At age 63, her employer agrees she can go part time. Mary decides to draw her pension as well. The 25 years' pension she had built up before the change will be paid in full, but the four years' she had built up since then would be reduced by about 10 per cent because she is drawing it two years early.

....your employer goes bust?

The Pension Protection Fund (PPF) was set up in 2005 to provide compensation if an employer becomes insolvent and there is not enough money in the pension fund to pay all the benefits that are due. It is funded by a levy on occupational pension schemes, based on the number of members and the degree of risk the scheme poses to the PPF, based on a complex formula.

It will not cover the full amount of a loss, but will pay:

  • 100 per cent of pensions currently being paid to pensioners who are over the scheme's pension age or who were retired on ill-health terms
  • 90 per cent of pensions due for active members, deferred members and early retirees
  • pension increases based on CPI but limited to 2.5 per cent a year, and paid only on service since 1997.

There is also a cap on benefits paid from the PPF.

The PPF does not cover any DC benefits.

More information at www.pensionprotectionfund.org.uk

...a member has a complaint about their pension?

If the complaint is about an occupational pension scheme, the scheme will have an Internal Dispute Resolution Procedure (similar to a grievance procedure). The scheme booklet should include the details.

If the complaint is about a contract-based scheme, then, depending on the nature of the complaint, it will need to be pursued either through the employer's grievance procedure (if the complaint is about something within the employer's control such as wrong deduction of contributions) or through the pension provider's complaints procedure.

The Pensions Advisory Service can provide advice and assistance over any pension complaint.

Equality and fairness in pensions

Maternity or paternity and parental leave

Individuals taking maternity or paternity or parental leave using the Work and Families Act 2006 (which allows longer paternity leave) may need to assess the effect on National Insurance contributions and/ or how any occupational pension scheme they contribute to is affected. It may be the case that unions can make arrangements with employers to minimise the impact of the losses in contributions. Those in receipt of Working Tax Credit or Child Benefit will be credited towards Basic State Pension.

Migrant workers

Migrant workers who are eligible to work and make National Insurance contributions would be eligible for the state pension. However, this is dependent on long-term working in the UK, currently a minimum 10/11 years. Short-term spells will not provide them with any or, at best, a minimal state pension. Migrant workers also need to ensure that National Insurance payments are made by their employer to the state. It has been known for rogue employers to make deductions but not forward these to HMRC.

Workers within the European Union may be covered by the Posted Workers Directive whereby people who are sent to work for short spells in other EU countries would be entitled to the minimum conditions of the country or sector they work in. Under the Pensions Act 2004, and fulfilling the EU directive on Occupational Pensions, an employer located in the UK may pay contributions towards an occupational scheme established in another EU member state.

Same-sex couples

Following the introduction of the Civil Partnership Act in December 2005, registered same-sex partners now have the same pension rights as married couples. It is still, however, legal for schemes to discriminate against unmarried or unregistered couples (whether opposite sex or same sex).

Divorce Courts are legally required to take pension assets into account when they work out a divorce settlement. They may order pension assets to be earmarked for the ex-spouse, or split between the couple, or they may allow a trade-off between pension rights and other assets. This is a very specialist area and legal advice should always be taken.

Part-time workers

Under the Part-time Workers (Less Favourable Treatment) Regulations 2002, part-time workers have to be allowed to join occupational pension schemes. If a member was excluded from the employer's pension scheme, the earliest date that a claim can be made from is 8 April 1976. If the employee began working for the employer after this date, then the earliest they can claim from is the employment start date, unless their service was broken for any reason; then the earliest they can claim from is likely to be the date they resumed working. Any claim should be made within six months of leaving the employment.

Industrial action

Periods of industrial action will impact on pension rights: they may be treated as a break in pensionable service, and any loss of pay will affect pension contributions. Union negotiators may want to seek an agreement with employers about covering pension contributions during any action.

! Role of the representative: advising members on pensions

  • Never advise members over decisions regarding their pension. Pensions advice is 'regulated' by the Financial Services Authority and the provision of advice by an unregulated adviser is a criminal offence.
  • The golden rule is, union representatives can help, but warn members that your figures are unlikely to be 100 per cent accurate as there will inevitably be some variations that you do not take into account. So, you can give a rough calculation, but you must advise members to check and have the figures explained by their employer or specialist union or financial adviser.
  • Don't guess or give information if you are unsure. It is better to wait until you can get specialist pension advice from the union or to signpost your member to the appropriate contact.
  • Know the main contents of their pension scheme and the different formulae for calculating benefits available to members. Be aware that new starters may have completely different pension contributions and entitlements to those of existing employees. You may find the table below helpful in making sure you know the scheme details.
  • Have a basic understanding of the pension scheme calculations as it applies to the member's scheme to help inform decisions. You can ask your union pension adviser to create some written examples for you.
  • Have a representative in the branch who specialises in pension information, keeps up to date and regularly attends training courses.
  • Organise regular pensions surgeries at work where a pensions expert can offer advice
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