Pensions can be a daunting topic for members, but the principles are actually straightforward and there is no shortage of information available to help reps and workers get to grips with the basics.
Union reps can offer information and guidance about pensions, including explaining the benefits of joining a workplace scheme, but must be careful to avoid giving ‘financial advice’ – that’s a job for a qualified and regulated financial adviser.
This chapter runs over some of the basic issues that might crop up, focusing on:
What is a pension anyway? Pensions are generally understood to be an amount of money paid regularly by the state, or from funds set aside by a former employer, to someone too old or too sick to work. That’s broadly true in the UK where both the state and employers have a role to play in ensuring workers get a retirement income. The state pension provides a regular income for life to anyone who has built up an entitlement once they reach the state pension age. This age is currently 66 but is scheduled to rise to 67 by 2028, with further increases planned. The amount received will not be the same for everyone, but rules introduced in 2016 provide for a pension of £175.20 (2020–21) for everyone who has built up a full entitlement, increasing each year in line with average earnings.
This is among the lowest public pension among advanced economies, with the UK system relying heavily on workplace pensions to supplement this income from the state. Depending on the type of scheme offered by an employer, these workplace pensions will either provide:
The first is generally referred to as a defined benefit (DB) pension, and the second is known as a defined contribution pension (DC). Many workers will have accrued a mixture of DB and DC over their career. Legislation phased in from 2012 requires all UK employers to provide a workplace pension scheme, and to ‘auto-enrol’ all workers that meet certain criteria into this scheme with mandatory minimum levels of contributions. Although workers can still opt out, auto-enrolment has brought more than 10 million additional people into occupational pension schemes. By 2019, 77 per cent of UK employees were in a workplace pension scheme, up from 47 per cent in 2012. But this still leaves out around 10 million workers who either do not meet the earnings or age thresholds, have opted out, or are self-employed. Unions and the TUC are working hard to close this pensions gap.
Workers will generally have to contribute a percentage of their salary into their workplace pension, so it is worth reminding them of the benefits. It’s never too soon for members to think about what will replace their working income in old age. According to latest estimates, a man aged 65 can expect to live for a further 18.8 years on average, and a woman 21.1 years, so members will have to plan for around 20 years of retirement. Our relatively low state pension means that if they want to maintain a decent standard of living that will need to be funded by some form of additional savings. And a workplace pension is generally the most effective way of doing this. Belonging to a workplace pension ensures that members receive employer contributions, and employee contributions benefit from tax relief. So, money paid into a workplace pension by a worker is effectively topped up by their employer and the government. Occupational pension schemes are also regulated and run to ensure that members’ pensions are not put into high-cost or high-risk investments.
The tax treatment of pensions is known as tax exempt because contributions to, and investment growth within, pension funds is largely tax-free, but money withdrawn in old age is taxed like any other income.
Pension contributions are exempt from income tax, within pretty broad limits – up to £40,000 a year with a lifetime allowance of £1,073,100 (2020–21). Although pensions in payment are taxed in the same way as earnings, individuals can take up to 25 per cent of their workplace pension fund as a tax-free lump sum on retirement. Most people have lower incomes in retirement than when they are working, so it is generally the case that contributing to a workplace pension will reduce the amount of tax they will pay. Employers are legally required to make contributions on behalf of many workers. Although the legal minimum requirements are lower, many employers – particularly those that offer DB schemes – make substantial contributions to employees’ pensions.
There are three main kinds of pension in the UK and it is possible build up a future retirement income in all three:
State pension: managed by the government, this scheme starts working automatically when workers are in employment and earning more than a minimum amount (or are ‘credited’ with qualifying, see below). It is paid for by employee and employer national insurance contributions.
Workplace pensions: employees may become a member of a workplace pension if their employer enrols them into one under auto-enrolment rules or by their contract of employment. If members aren’t enrolled automatically, they can still ask to join.
Individual personal pensions: individual contracts can be set up with a pension provider, but these arrangements are likely to have higher charges than a workplace pension and will not generally benefit from employer contributions.
There are other non-pension vehicles that could help people to save for old age, including the Lifetime ISA (LISA). This product allows people to save or invest up to £4,000 a year, with any contributions topped up by a 25 per cent government incentive. The funds in a LISA can be used to purchase a first home, or be accessed after the age of 60.
There also are different kinds of workplace pension, and the type your members join could make a big difference to their entitlement. Even though that’s a decision made by the employer, unions can and do have an influence over the kinds of scheme chosen:
Defined benefit: traditionally, employers offered DB pension schemes that paid workers a guaranteed income for life after retirement based on their length of service and either their final salary or their average salary. Although many employers have closed their DB schemes either to new members or to all employees, they still play an important role.
Defined contribution: most open workplace pension schemes in the private sector are now DC arrangements in which members accumulate a savings ‘pot’ that is invested on their behalf. This pot can be accessed after the member reaches age 55 and can be drawn down gradually, exchanged for a guaranteed income from an insurance company, or take as a lump sum.
Alternatives: ‘hybrid’ schemes exist that combine some features of DB and DC but are much less common. Legislation introduced in 2021 paved the way for collective defined contribution (CDC) that allow members to pool investment and mortality risk. Although CDC schemes do not provide the guarantees found in DB, they should provide higher and more predictable retirement incomes than traditional DC.
A further key difference between workplace pension schemes is how they are run. In brief:
Occupational/trust-based pensions: these are DB and DC schemes run by trustees (either either as a single-employer trust or a multi-employer master trusts). Trustee boards comprise a combination of employer nominated, employee-nominated, and independent trustees who all have a ‘fiduciary duty’ to act in members’ interests.
Group personal pensions (GPPs) and stakeholder pensions: these are personal pensions sponsored by an employer but based on a legal contract between the individual member and a pension provider (usually an insurance company).
Public service pensions: these are established by legislation and run by a board.
Two things are worth keeping in mind when, as a rep, you are dealing with pensions. First, they are heavily regulated, which means there are rules to be followed and ways to complain if things go wrong. Second, there is an important difference between information, guidance and advice. The UK government runs the state pension, so complaints and queries can be taken up with the Pension Service, or with HM Revenue and Customs (HMRC) which deals with national insurance (NI). NI contributions are collected by the employer, so if a member has a query, that’s likely to be the place to start.
The Pensions Regulator (TPR) is there to make sure employers put staff into workplace pension schemes and pay money into them, and to oversee trust-based pensions. Its brief is to protect workplace pension savings, and to improve how occupational schemes are run.
TPR is also responsible for ensuring that DB schemes are sufficiently funded to pay out the benefits members have been promised. DB schemes must submit valuations to TPR every three years and agree recovery plans with employers to cover any shortfalls in funding through additional employer contributions. If no recovery plan can be agreed, then the regular can impose one on an employer.
The Financial Conduct Authority (FCA) regulates the financial services industry, which includes the insurers who provide GPPs, as well as financial advisers who might play a part in members’ retirement planning. Some parts of the insurance industry are also regulated by the Prudential Regulatory Authority (PRA), part of the Bank of England. There is a Pensions Ombudsman to deal with complaints or disputes about pension schemes, and a Financial Ombudsman that settles complaints about businesses regulated by the FCA. Guidance is provided by the Money and Pensions Service (MaPS) – an arm’s-length body sponsored by the Department for Work and Pensions. MaPS is the umbrella for the Money Advice Service, the Pensions Advisory Service and Pension Wise (see below). But watch out, there are plenty of other operators whose names and websites look very similar to these, and plenty of scammers that would like to walk off with your members’ hard earned pension savings. Please double check you are looking at the right ones:
The move away from DB pensions means that members are increasingly required to make decisions about their workplace pensions – how much to contribute, how to invest their GPP, or how to turn a pension pot into a regular income, for example.
To make informed decisions they may need financial advice. Advisers must be properly qualified, signed up to a code of ethics, have done at least 35 hours of professional training each year, and be registered by the FCA. Independent financial advisers (IFAs) can give unbiased advice about financial products from all the different companies available. Restricted advisers give advice on a limited range of products or companies. Pension providers are likely to have their own advisers, but the Unbiased web site can be used to find an IFA www.unbiased.co.uk . This is not generally a free service (although some employers provide it as an employee benefit), and if members’ pension pots are considered to be too small, it may be difficult or impossible to find an independent adviser who can help. But there are free and independent sources of guidance. The Money Advice Service, the Pensions Advisory Service and Pension Wise are good places to start. Members over 50 can book a free 45-minute conversation with a Pension Wise guidance specialist. Although this person is unable to make an explicit recommendation about what the member should do, they can talk them through their pension options, tax issues, and what they might do next.
Union reps and pensions
In the first instance members are likely to look to the employer, pension trustees or pension provider for information and help. The scheme booklet or website should have plenty of relevant details, and it will be easier if they have kept pension correspondence they’ve received. Union reps and branches can help members to navigate through these options, by being well informed and trained, but the golden rule is that union reps must avoid giving ‘financial advice’ about pensions. You may be able to assist by dealing directly with the employer, taking part in pension committees or other oversight arrangements if they exist, or perhaps becoming a member nominated trustee (see below). If necessary, you may be able to help members make use relevant grievance or disputes procedures provided by the employer, trustees or the pension provider.
The state pension system changed in 2016, when the government brought in a new, flat-rate state pension worth £175.20 a week (full rate in 2020– 21). However, the actual amount a person receives will vary depending on how much state pension entitlement they built up under the pre-2016 system, and how many qualifying years they have accrued. Earlier systems were more complicated, combining a basic state pension paid to everyone who qualified for it with an additional earnings related element. The state pension is increased annually. Different elements are increased at different rates, but in recent years the basic state pension (since 2010) and the new state pension (since 2016) have been linked to a formula known as the triple lock. This guarantees that payments will increase in line with average wage growth, inflation as measured on the Consumer Prices Index (CPI) or by 2.5 per cent – whichever is highest. Although all parties pledged to keep the triple lock in the 2019 general election, the government is not actually required to do so by law. It is legally obliged to increase the basic and new state pensions in line with wage growth, however. Members who are considering living in another country in retirement should also be aware that that the government does not give annual pension increases to people resident in many countries. The full list of countries to which this applies can be found on the gov.uk website. The age from which men and women can claim their state pension (state pension age) is 66. This is due to rise to 67 between 2026 and 2028, and then to 68 (possibly between 2037 and 2039, although the timetable hasn't been confirmed). Members can use the government’s state pension age calculator www.gov.uk/statepension- age to work out when they will receive their state pension. People above state pension age whose income falls below £173.75 (or a combined £265.20 for couples) are likely to be eligible for pension credit, which tops their income up to this level. Although nine out of 10 claims for pension credit are successful, up to 40 per cent of those eligible do not claim. This not only deprives them of extra income but also prevents them from accessing other benefits that are linked to pension credit, such as the cold weather payment, help with council tax, and free TV licences for over 75s. Other benefits potentially available to a pensioner are the winter fuel payment, warm homes discount, disability living allowance/ personal independence payments, attendance allowance, free prescriptions and help with eye tests and glasses, dental treatment and travel costs to hospital, bus passes and war widow’s or widower’s pension.
National insurance contributions (NICs) allow workers to qualify for the state pension. At 2020–2021 rates, NICs were paid by employees earning above £183 a week (known as Class 1 contributions) and self-employed workers making a profit of £6,475 or more a year (Class 2 or 4 contributions). Category A employees paid 12 per cent on earnings between £183 to £962 a week and 2 per cent on earnings above £962 per week. If they earned less (between £120 and £183 a week) their contributions are treated as having been paid. Employers also pay NICs (Class 1A or 1B), at 13.8 per cent of earnings over £169.01 per week for a Category A employee (2020–2021). It has been known for rogue employers to make deductions but not forward these to HMRC, so if things don’t look right, you’ll probably want to check it out. There are other NI rates and categories, as may be indicated on pay slips. These include married women and widows who opted to pay reduced NICs before 1977 (Category B), employees over state pension age (C), those who can defer NI because they’re already paying it in another job (J), apprentices under 25 (H), employees under 21 (M or Z), and those who don’t have to pay, for example, under 16s (X).
To qualify under the new state pension rules, a man must be born on or after 6 April 1951 and a woman on or after 6 April 1953. They will usually need at least 10 qualifying years on their National Insurance record to get any new state pension. If a worker has gaps in their NI record, they may be able to make voluntary NI contributions. To get the full new state pension, a worker with no national insurance record before 6 April 2016 would need 35 qualifying years, but most workers will have service under previous state pension rules to be taken into account (see below). People may be entitled to national insurance credits if they cannot work, for example because of illness or disability; if they’re a carer (on carer’s allowance); unemployed (on Jobseeker’s Allowance or employment and support allowance); claiming child benefit; claiming statutory maternity, paternity or adoption pay, or on statutory sick pay.
Many people currently in employment will have built up state pension entitlement before 2016, when things were different:
These factors are taken into account under the transitional rules used to work out what they will get in future. Their new state pension may be less or more than the full amount as a result.
The best way to check state pension entitlement – at any age – is to get a state pension forecast, and members can also apply to HMRC for a National Insurance statement to check any gaps. Applications can be made online (alternatively the BR19 application form can be used, or a call to the Future Pension Centre). To apply online members will need to prove their identity, using:
Workers who have reached state pension age won’t get their state pension automatically. They have to claim it (online, by phone or by post). They should receive a reminder letter two months beforehand. State pension payments become part of taxable income (if that adds up to more than their personal allowance). Workers claiming a state pension can still carry on working but won’t have to pay any more national insurance. If widowed, they may be able to inherit an extra payment on top of their new state pension, unless they re-marry or form a new civil partnership before they reach state pension age. People can defer their state pension (it will be automatically deferred until they claim). In that case payments would increase by the equivalent of 1 per cent for every nine weeks or just under 5.8 per cent for every 52 weeks (worth about £10 more per week, increasing by Consumer Prices Index inflation). Deferring can affect benefits, so members on benefits must tell the pension service if they want to defer.
For employers, providing a workplace pension that they contribute to on behalf of their staff used to be voluntary, or a benefit to be negotiated with the trade unions. But around half of employees lacked any kind of workplace pension. A system of ‘auto-enrolment’, phased in from 2012, was intended to remedy that by:
Auto-enrolment has dramatically increased the number of workers in workplace pensions but in many cases their new pension entitlements are basic. There is still a pensions gap because auto-enrolment excludes millions low paid and part time workers, an issue that disproportionately effects women, BME and disabled workers. However, there are laws in place to prevent some kinds of inequality:
Under the 2008 Pensions Act, every employer in the UK – no matter how large or small – must put certain workers into a workplace pension scheme that meets certain standards and must contribute towards it. This is known as auto-enrolment. Employees are classed as workers for this purpose, but so too are agency workers and some self-employed people. There is no simple test of worker status, but guidance on who is considered a worker for auto-enrolment purposes is available from TPR and includes factors such as whether they:
Workers will fall into one of three categories. They may be eligible job-holders, non-eligible jobholders, or entitled workers. Their classifications may change over time and, depending on how they're classified, employers have different ongoing auto-enrolment duties.
Eligible job-holders are workers who are:
Unless an eligible job-holder opts out, an employer must auto-enrol them into a qualifying scheme and contribute at least the mandatory minimum amount into their pension fund.
Non-eligible job-holders are workers who are:
Employers don't have to auto-enrol these workers but may choose to. They must provide information about the scheme and a non-eligible job-holder can opt in. If they do so, the employer must make contributions to their pension fund.
Entitled workers are employees who are:
Employers don't have to automatically enrol these employees. They can opt in but, if they do, employers are under no obligation to contribute to their pension fund.
Employers must assess and automatically enrol eligible job-holders, but can postpone enrolment for up to three months (the waiting period). Jobholders must be told:
The government’s auto-enrolment scheme is the main framework for workplace pensions, but it isn’t the whole story. Some employers “contractually” enrol all workers into a pension scheme when they first start work and re-enrol them annually if they cease membership in the year. In that case enrolment would be in accordance with the contract, rather than the employer’s auto-enrolment duties. In this case (unlike auto-enrolment) the employee’s consent would be required but the opt-out and contributions refund wouldn’t be available. The employer should still ensure that the scheme would meet the auto-enrolment qualifying criteria.
Employees who are automatically enrolled have the right to opt out, by completing a valid opt-out notice, but they must not be induced to opt out by their employer. Opting-out employees can get a refund of any contributions they have made if they do so within a 30-day opt out period. If the scheme is a personal pension, they may have cancellation rights under Financial Conduct Authority rules. Opting out means un-doing active membership, as if the worker had never been a member of a scheme on that occasion. The employer must re-enrol them three years later, if they are still an eligible job-holder. If a member chooses to leave after the end of the opt-out period, or if they joined without being auto-enrolled (they weren’t eligible job-holders), or if they joined contractually, they can leave a scheme by “ceasing active membership” but in that case different rules apply (see below).
An employer must ensure that their pension scheme meets the criteria to be an automatic enrolment scheme if they want to use it for automatic enrolment, or for enrolling any job-holders who have opted in. This includes automatic enrolment criteria, qualifying criteria, and minimum requirements, which are set out by TPR. For DC schemes, it also requires a minimum level of contributions (see below). Auto-enrolment has not fundamentally changed the different kinds of workplace pension scheme on offer, but it has an impact on how they are designed and how widely different kinds of scheme are used. Of the 77.4 per cent of employees in a workplace pension in 2019:
These figures do not take into account any individual personal pensions that workers may have directly contracted into with a pension provider.
In DC schemes, also known as money purchase schemes, individual members build up a pot which they can use in later life as a source of replacement income. DC schemes don’t offer a guaranteed retirement income, their value at any point in time depends on contributions, investment returns (after costs have been deducted) and tax relief. Many schemes are run by insurance companies, but more workers are now in occupational schemes run by trusts. There are minimum contribution levels for a DC scheme to qualify as an auto-enrolment pension. Under current rules at least 8 per cent of a jobholder’s qualifying earnings must be contributed to the scheme, of which the employer must contribute at least 3 per cent. Employers can pay the full amount, but if they contribute less than 8 per cent, job-holder contributions (4 per cent) and tax relief (1 per cent) are taken to make up the difference.
For auto-enrolment, qualifying earnings are all earnings, including salary or wages, commission, bonuses, overtime, statutory sick pay, statutory maternity pay, ordinary or additional statutory paternity pay, and statutory adoption pay, between the lower earnings threshold and an upper threshold. In the 2020–21 tax year, these thresholds were set at £6,240 and £50,000 a year respectively. Those minimum levels may be different if the employer’s scheme defines “pensionable pay” differently from auto-enrolment qualifying earnings – for example, just basic pay, or deducting contributions from the first pound earned. This is allowed under “self-certification” and may require minimum contributions of 7 per cent (employer minimum 3 per cent) or 9 per cent (employer minimum 4 per cent).
As a rule of thumb, DC members will need contributions of twice the mandatory minimum level to maintain their standard of living in retirement. So many employers pay more than this minimum level and may “match” higher contributions made by members themselves, or better. Double-matching, for example, together with tax relief, would mean a member taxed at the basic rate who contributes £10 could have their pension account credited with £37.50. Members may be able to save more into their scheme (including lump sums) if they can afford to and want to, benefitting from additional tax relief. As a rep, you could check with the employer or scheme provider to find out what is possible, and perhaps negotiate a better deal. The voluntary Pensions Quality Mark (PQM) could be useful in negotiations. It is a kitemark that requires schemes to demonstrate that they are well run with decent levels of contribution. To achieve certification, DC schemes need minimum contributions of 12 per cent (at least 6 per cent from the employer) while for “PQM Plus” it’s level is 15 per cent with at least 10 per cent coming from the employer.
DB schemes, which are run by independent boards of trustees, guarantee their members an earnings-related pension for life. A pooled fund of employer and members contributions (plus assets and investment returns) is used to pay current and future pension commitments. The employer’s legal obligation and financial ability to support the scheme in future is known as their covenant. Pension benefits are based on the member’s final or career average salary, multiplied by their years of pensionable service and an “accrual rate” (how the pension builds up each year). Good final salary schemes provide pensions worth 1/60th or 1/80th of final salary per year of service. Under a 1/60th final salary scheme, 40 years of service would provide a retirement income of two-thirds of final salary. A career average scheme works on the same principle but bases the calculation on a worker’s average salary revalued to account for inflation. DB members may be able to build up additional entitlement, either by purchasing added years (by paying additional voluntary contributions, AVCs) or saving into a free-standing AVC (FSAVC) which is not connected to the employer’s pension scheme (a DC scheme offered by an insurance company). To qualify as an auto-enrolment pension, a DB scheme must at least meet or be broadly equivalent to the ‘test scheme standard’.
The number of private sector DB pensions has been in decline but by 2020 there were still more than one million active members in schemes open to new benefit accrual and who continued to accrue benefits. Many more are in schemes that still function but are closed to new members and/ or to future accrual by existing members. In some cases, adjustments have been negotiated, like a like higher contributions or a cap on pensionable pay increases, in order to keep DB schemes open. Trustees and the employer agree a ‘schedule of contributions’ that sets out what contributions are due and when. Trustees must also appoint an actuary to conduct a triennial valuation to ensure the fund has enough assets to pay out all the pensions promised to members. These must be disclosed on request to scheme members and recognised trade union reps. If the scheme has insufficient assets, trustees must agree a ‘recovery plan’ with the employer under which it must make additional contributions to close the funding gap. This must be approved by TPR, which can impose a recovery plan on an employer if it is unable to reach agreement with trustees. If the employer supporting a DB pension scheme becomes insolvent before a recovery plan has been completed, Pension Protection Fund ( www.ppf.co.uk ) will in most cases step in to ensure members still receive the majority of their pension. This ‘lifeboat fund’, which is supported by an annual levy on DB schemes, takes on the assets and liabilities of such insolvent pension funds. Subject to an annual compensation cap (£41,461 at age 65 in 2020–21) PPF will pay:
If you and you members work for a local council, a government department or agency, a school, the NHS, the emergency services, the armed forces or the judiciary, you are likely to be members of one of the big public service pension schemes for England, Wales, Scotland or Northern Ireland. These are generally set up by statute and operate within a regulated framework that defines their design and normal pension age. They are likely to be run by a scheme manger and a board, with a scheme advisory board, and they’ll include a mechanism for regular valuations, with a cap to contain employers’ costs. Most are ‘unfunded’ or pay-as-you-go, which means member contributions go into overall Treasury funds, and the pensions are paid out of Treasury funds. Schemes like this don’t rely on investment pots or assets to generate returns. There are ‘funded’ exceptions outside central government, notably the Local Government Pension Scheme (LGPS), which operate like private sector DB schemes.
The current generation of public service schemes dates back to 2015, when they replaced existing schemes and significant changes were introduced. They continued in almost every case to be defined benefit (DB) schemes, but provide benefits based on career average revalued earnings (CARE) rather than final salaries. In most but not all cases retirement ages are now linked to state pension age. When the changes were introduced transitional protections were negotiated for members closest to retirement. However, the courts subsequently ruled that these directly discriminated against younger members. To remedy that, plans are being drawn up to offer all members the choice of accruing benefits under either old or new schemes, until 31 March 2022. At the time of writing these plans have not been finalised but in many cases it will be unclear which option would best serve members, so they will require support from pension scheme administrators and potentially a financial adviser before making a decision. The Local Government Pension Scheme for England and Wales (LGPS), which is among the biggest public service schemes, provides an example of the benefits available. Members pay between 5.5 per cent and 12.5 per cent (average 6.5 per cent) and average employer contributions are 19 per cent. Each year an LGPS member accrues pension worth 1/49th of their average pensionable pay, adjusted to account for inflation. Additional benefits include death in service benefits and a spouses’ pension to be paid to a members’ partner after their death.
Members can boost their pension by paying more contributions. Unusually, in the LGPS, there is also a “50/50 section” allowing members to pay half of normal contributions in return for half of the normal pension entitlement. LGPS pensions are usually payable from a normal pension age linked to the member’s state pension age but they can choose to retire between 55 (on a lower pension) and 75 (on an increased pension). In late 2020 the UK government introduced a cap limiting public sector ‘exit payments’ to £95,000. This includes so-called ‘pension strain payments’ which were made to the LGPS on behalf of members aged over 55 who were made redundant to allow them to receive an early, unreduced pension. The cap could reduce the level of pension received by members made redundant after this age, particularly if they have long service.
Workplace pensions are not all DC or DB, but alternatives are much less common. Mixed-benefit or ‘hybrid’ schemes combine defined benefits with individual pots. They may offer more member benefits than a straight DC scheme, while leaving the employer less exposed to the risk of having to pay more to meet their commitments. Hybrid schemes are more complicated to explain to members, and the Pensions Regulator warns that there may be risks in how they are run, unclear or incorrect member communications, incorrect benefits and funding levels, inappropriate investment strategies, or the failure to offer the correct retirement options for DC members. Other alternatives have been explored by the government, unions, employers and the ‘pensions industry. They include Collective Defined Contribution schemes that allow individuals’ investments to be pooled, with potentially better returns, lower charges, and other distinctive features. Crucially they allow members to pool mortality risk. This means individual members do not have to ‘insure’ against the chance of living significantly longer than average, and allows higher pensions to be paid. The 2021 Pension Schemes Act has put in place legislation to allow the Royal Mail to implement an agreement with the Communication Workers Union to introduce a CDC scheme for its workers. This could potentially provide a model for other employers to follow.
Applying tax relief
Relief from income tax is an essential part of pension saving but the way that it is applied can make a difference, especially for low-paid workers.
Relief at source (RAS): the employer collects members' pension contributions AFTER taking tax from their pay. The pension provider then claims back tax relief, adding tax relief at the basic rate of 20 per cent to members’ pension pots. This is generally seen as better for workers whose earnings fall below the income tax threshold (£12,500 in 2020-21) as they receive a ‘government top up’ regardless of whether they pay income tax or not. Members who pay higher rates of tax claim money back through their self-assessment tax return.
Net pay arrangement: the employer collects members' pension contributions BEFORE their pay is taxed, so members only pay tax on what's left. Lower-paid workers may be disadvantaged as they won't receive tax relief on their contributions. This means it costs 25 per cent more for a low paid worker to contribute to a net pay scheme than to a RAS scheme.
In most types of pension scheme, savings are invested with the aim of securing growth over the long term. In DC pension schemes, which have become much more common under auto-enrolment, contributions go into an individual pot, which is invested by the trustees or the insurance company that holds the individual’s contract. There will always be a risk that the value of investments can go down as well as up, and some kinds of investments carry more risk than others. DC members have to make their own choice from a range of available investment funds, but auto-enrolment rules require there to be a default fund (in case the member does not express a preference) with an appropriate investment strategy and relatively low charges. If members need help making decisions about their investments, that is a job for a qualified adviser, not for a union rep. Pension providers may offer a “lifestyle” or “lifecycle” fund, where savings are initially invested mainly assets that generated higher levels of returns but have higher levels of risk and volatility, such as equities. Investments are then on into safer but lower-returning investments such as gilts (lending money to the government) as the member approaches retirement age. There may be an ‘ethical' option in DC schemes, such as a fund specialising in environmentally sustainable companies. But ethical considerations are not limited to individual choices. DB pension funds wield huge investment power, and often face pressure to encourage more ‘responsible investment’ though environmental, social and corporate governance (ESG) commitments. The management of ESG risk goes beyond ethical concerns however – failing to do so can often have a financial impact on pension funds. In future, for example, pension funds will be required to report on how they are managing risks to their portfolio associated with climate change.
Part of the money saved in a pension scheme is used to pay running costs or charges, and for the management of investments. In a DC scheme that can have a long-term impact on the value of an individual’s pension pot. These charges are limited by law, but it is worth members checking to see what DC charges they are paying, as they do vary. From April 2015, annual management charges in auto-enrolment pension ‘default funds’ had to be capped at 0.75 per cent. However, there are other costs (such as transaction costs, when investing in funds or switching, or when the manager of the funds changes investments). Employers, trustees or pension providers can be asked to provide information on all charges.
Members are entitled to information about their pension scheme and benefits. Auto-enrolment introduced a new range of specific duties on employers, pension trusts and other providers to give information. Scheme booklets and other useful documents should be kept safe if possible, for future reference. Members should receive a benefit statement each year showing how their entitlement is building up, or a funding statement showing how their pension savings are growing. Some schemes also issue a short annual report and members are entitled to ask to see any other information that might be relevant (such as a full annual report and accounts, details of the last actuarial valuation, or the performance of DC funds). After all, it is their money at stake. DC scheme statements will indicate the extent of an individual’s investment units but also what they were worth at the time (the value of investments can go down as well as up). They may include an estimate of how much regular pension this would give in retirement, if used to buy an annuity from an insurer. These estimates would be in terms of today’s money, and based on a number of assumptions, including expected future payments, how funds might have grown by the time the member retires, future inflation, and how much it could cost to buy a pension income with the available pot.
Members have a lot of money tied up in pension schemes so it is important to know who is running them (this is known as ‘governance’). In an occupational scheme set up under trust law the board of trustees controls the scheme. 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. Boards are normally expected to include at least a third of member-nominated trustee (MNTs). This is an opportunity for trade union activists to get involved, although all the trustees have the same legal duty – to act in the interests of scheme members. Trustees with a trade union background are often well-equipped to make their voice heard and opinion count in trustee meetings. MNTs provide a link between the scheme and its members. It is often argued that they are more sceptical of the received wisdom of pension industry professionals, and more willing to challenge information and advice submitted by providers and advisers to the scheme.
While some employers have a single-company trust, multi-employer master trusts (used by two or more unconnected employers) are becoming increasingly important, as they provide economies of scale and opportunities to pool investment funds for DC pensions. Master trusts are exempt from the MNT requirements, but gather the views of their members through other ways, directly through consumer panels and surveys, and indirectly through employer forums and surveys. NEST, the National Employment Savings Trust (set up and supported by government loan) is one of around 40 Master Trusts authorised by the Pensions Regulator and operating under its Code of Practice. It doesn’t have member-nominated Board members but does have a Members’ Panel (and Employers’ Panel) to take members’ views and considerations into account. Since it was set up, this panel has included reps of the trade union movement. Private or contract-based pension schemes do not have trustees. However, from 2015 providers had to establish Independent Governance Committees (IGCs) to ensure that members are getting value for money. Providers themselves appoint members to IGCs and there is no requirement to have reps of scheme members on such bodies. Whether a workplace pension is provided by a master trust or an insurance company there is nothing to prevent unions and management establishing a pensions committee to oversee and review pension arrangements.
Many employers encourage or allow members to pay contributions through a salary sacrifice arrangement. The employer pays contributions the member would have made directly to the scheme, and the employee takes a cut in their gross pay to match. A salary sacrifice can’t be used if it would reduce earnings below the minimum wage. The aim is to reduce national insurance contributions and income tax, but it does need careful consideration. A lower salary could potentially affect any calculations based on what the member earns, from mortgages to life insurance, certain state benefits (such as statutory maternity pay). Where salary sacrifice arrangements are proposed the employer should explain clearly how it might affect members and whether or not the employer would pay some or all of the NICs they save into members’ pension pots. They should also show how salary sacrifice affects take home pay, so that members can decide whether they would benefit.
Workplace pension saving can be interrupted in a number of ways, something you as a union rep may want to keep an eye on.
Leave: reasons for taking leave vary but reps can help by confirming how workplace pension contributions or accrual will be handled. In the case of maternity leave, for example, the member must receive the same benefits as they would if they were at work, including pension contributions. Unpaid leave may be different: for auto-enrolment purposes, if a member does not receive any pay, no auto-enrolment pension contributions be due from them or the employer (unless alternative arrangements are agreed).
Industrial action: periods of industrial action may be treated as a break in pensionable service, and any loss of pay could affect pension contributions. Union negotiators may want to seek an agreement with employers about covering pension contributions during any action. Lay-off or furlough: if lay-offs are in prospect it is important to check how the employer intends to handle pension contributions. Under the Coronavirus furlough scheme deductions such national insurance and pension contributions continued to be made and paid into the pension scheme; but employers receiving a furlough grant from the government after 1 August 2020 were not able to claim for employer pension contributions.
Posting abroad: the European Union’s Posted Workers Directive and the Pensions Act 2004 allowed a UK employer to pay contributions towards an occupational scheme established in another EU member state. If that situation arises, it is an issue that should be checked out in advance.
A member may choose to leave a workplace pension scheme without necessarily changing their job. Unless they opt out from being auto-enrolled within the 30-day opt-out period (see above). This is known as ‘ceasing active membership’. On ceasing active membership, members do not lose benefits already built up in a scheme. Depending on a number of factors, they may be able to claim a refund of their contributions instead, although this will generally involve giving up employer contributions and tax relief. Leaving a scheme can also have long-term implications and should not be a decision taken likely. If a member is intent on leaving they should consult their employer, trustees or scheme provider (something reps may be able to help facilitate). Broadly, the possible outcomes are:
A similar situation can arise whenever a member leaves a job in which they belonged to a workplace pension (unless they belong to the same public service pension or master trust scheme in use at their old and new workplaces). This is has become a more common, with one estimate suggesting we have an average of 11 different jobs in a working lifetime. When a member leaves a job but is not ready to claim their workplace pension, their membership is ‘deferred’ or ‘preserved’. Deferred DB rights will be increased broadly in line with price inflation, while a DC pension pot can remain invested so its value should increase over time. It’s important to keep track of different pension memberships while still working, as there may be steps to consider in order to get the most out of them later, such as transferring or consolidating them into a new scheme. This is where members may need advice that only a qualified adviser can give. The government’s Pension Tracing Service can be used to help find pensions that a member may have lost track of, but will only provide contact details of the scheme’s administrator. The planned new Pensions Dashboard service should go much further, enabling individuals to access all their pension information online in one place.
If a member’s job is transferred to a new employer, pension entitlements they acquired with their original employer have some protection but that depends on what type of scheme they were in, and there are specific arrangements in different parts of the public sector. Overall protections are provided by the Transfer of Undertakings (Protection of Employment) Regulations 2006 (TUPE) as amended by the Collective Redundancies and Transfer of Undertakings (Protection of Employment) (Amendment) Regulations 2014. Broadly, the new employer doesn’t have to offer the same pension terms and conditions, but must offer the following provisions (which must meet auto-enrolment minimum standards):
For workers previously in a DC scheme: a DB scheme with a specified level of pension; or a DC scheme where the employer matches employee contributions up to 6 per cent of basic pay, or the level of contributions the old employer made. For workers previously in a DB scheme: a DB scheme which provides a specified level of pension; or a DC scheme where employer contributions match employee contributions up to 6 per cent of basic pay.
For workers who previously had a contractual DC entitlement: a DC scheme where employer contributions match the level of contributions the old employer made. Any contractual promise by the previous employer to pay a regular lump sum or percentage into a DC scheme will transfer under TUPE, along with any early retirement provisions unless they are related to ill-health (Beckmann v. Dynamco Whicheloe Macfarlane C-164/00). Any provisions relating to old age, invalidity or survivors’ benefits under an occupational pension scheme are specifically excluded and do not transfer. The employer must provide information about pension arrangements before any TUPE transfer and consult over any planned measures, for example planned changes to contribution rates. Failure to consult can lead to a protective award, and may be a separate obligation to consult on pension changes (see below). The employer owes important legal duties to take proper care when giving employees information about the impact of TUPE on their pension and not to mislead them. In parts of the public sector under the control of government ministers (including the NHS), where public service pensions are in place, there is an additional non-statutory policy, New Fair Deal. For staff compulsorily transferred to independent providers delivering public services, the new employer must offer them membership of a public sector pension scheme, by arranging a “participation agreement” with that scheme before any transfer takes place. The Fair Deal policy doesn’t apply to local authorities which are ‘best value’ authorities, including members of the LGPS Under a separate policy (the Best Value Authorities Staff Transfers (Pensions) Direction 2007), they must either be given continued access to the LGPS (via an admission agreement) or to a “broadly comparable pension scheme”. Proposals being considered in 2019 would have amended the LGPS to remove the “broadly comparable” option, but they were not immediately implemented.
Decisions about workplace pension schemes lie with employers in the first instance, although where there is a board of trustees they will also be involved, while in public service pensions government decisions and policies have a big impact. 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. The scheme rules will have to be followed in any event. Employers with over 50 employees must consult actual and prospective scheme members at least 60 days in advance if they want to make changes to the pension arrangements, including contribution rates. The Pensions Regulator can fine employers up to £50,000 for failing to consult and can order backdated payment of unpaid contributions at the higher level.
How and when members start turning their pension savings into a retirement income (known as the ‘decumulation phase’ in pensions jargon) will depend on their age and circumstances, and the pension scheme or schemes they are members of.
There is no longer a ‘retirement age’ at which employers can compel employees to retire. The right to make employees retire at 65 ended when the default retirement age was abolished in April 2011. An employer can only make an employee retire by agreement (usually recorded in the contract of employment) and they risk age discrimination unless they can objectively justify it as a proportionate means of achieving a legitimate aim. Workplace pension schemes may still have a “normal pension age”, or “normal retiring date” (for example, 65) but its significance will depend on the type of pension is involved. It does not mean they have to stop working or start receiving money from the scheme at that age.
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 member’s entitlement under all their pension schemes will be checked against the Lifetime Allowance (see above). The earliest age at which they can draw a workplace pension without tax penalties is 55 (unless retiring on ill-health grounds), though there are some exceptions to this. That’s due to rise to 57 from 2028 and it will increase at the same rate as the state pension age after that.
DB schemes are usually seen as the gold standard for pensions, providing a guaranteed income for life. DC schemes can also provide a pension for life, if they are used to by an ‘annuity’ from an insurance company, although the level of income will be dependent on the value of a member's pension pot at retirement and the ‘annuity rate’ – the cost of turning that pot into a guaranteed income with an insurer.
Until 2015 almost all DC members had to buy an annuity at retirement. However, the government’s ‘freedom and choice’ policy changed the rules, increasing the potential options for DC members. Members can use any of the following approaches, or mix and match:
Although these options give DC members much more flexibility around their retirement income, they also increase the chances that they will make inappropriate decisions, like leaving their money invested in an excessively risky (or excessively cautious) way, or that they will run out of money before they die. It is always worth looking in detail at any pension rules, handbook, brochures, updates or other correspondence to see what the pension provider actually offers: if a member decides to transfer their pot to a different provider in order to secure the options they want, such as a drawdown, there could be charges. They also need to check whether they would lose any valuable guarantees, such as guaranteed annuity rates, by transferring. Annuities are the traditional way of converting a pension pot into an income for life.
Members are not bound to accept annuity products on offer from their existing pension provider, they can ‘shop around’. However, once an annuity has been bought, they are unlikely to be able to get any money back (other than through the agreed payments). Drawdown more risky option but gives members the opportunity to withdraw money to live on (with up to 25 per cent as a tax-free lump sum) is, while leaving the balance of their pot invested – where it could grow or shrink, and potentially be passed on when they die. There will be more to do in this case, keeping an eye on investments and how quickly the pot is depleted. With UFPLS lump sums, each time the member takes a lump sum a quarter of it each withdrawal is normally tax-free. The options available to members of DB schemes are more limited. They may be able to access the new pension freedoms but would have to transfer out of their current pension scheme into a DC arrangement. This is only allowed for those in ‘funded’ DB schemes and therefore excludes most public service schemes. Because transferring out from a DB pension scheme to a DC arrangement is not generally in people’s best interests – a guaranteed income is a very valuable benefit – those with benefits valued at more than £30,000 have to take obligatory financial advice before transferring. Members wishing to transfer out of a scheme would have to start by contacting the scheme trustees.
In most cases up to 25 per cent of pension benefits can be taken as a lump sum, but how that lump sum is provided depends on what type of scheme is involved. In a DC scheme part of the fund at retirement is paid as a lump sum with the balance being used to provide an income. In a DB scheme it involves ‘commuting’ some of the lifetime benefits into a Pension Commencement Lump Sum (PCLS). Commutation factors (usually calculated by the scheme actuary) are used to determine the amount of pension which needs to be given up in order to provide the lump sum. The amount commuted could be greater, or the benefits paid entirely as a lump sum (subject to some taxation) if it qualifies as a small lump sum; a trivial lump sum (where the member’s pension rights under all registered pension schemes is not more than £30,000); or a serious ill-health lump sum. The rules are complicated, so consulting the employer, trustees or pension provider would be the first step. Once tax-free lump sums have been taken, the balance of pension income is taxable at the marginal rate (the highest rate of income tax they pay in a tax year) if it takes their income above their personal allowance. The provider will generally deduct tax at source. They may use an emergency tax code which might deduct too much tax initially – if so, it can be reclaimed from HMRC either by completing a P50 tax form, or when you complete a self-assessment tax return.
Price increases, which are measured by the Retail Prices Index (RPI) or the Consumer Prices Index (CPI), will eat away at the value of pension payments unless they are ‘indexed’ to rise in line with inflation. In a DB pension, increases are likely to be written into the rules of the scheme, and pensions will be increased each year in line with RPI or CPI (the latter is generally lower). These increases often have a cap and a collar, meaning for example that annual increases can never exceed 5 per cent even if inflation rises above this figure, and pensions cannot be reduced if prices fall. Schemes often apply different rules to different parts of a pension depending on the rues that applied at the time the benefits were accrued, so the actual calculations can be complex. Members of DC pensions have more decisions to make about how to use their savings. If they decide to buy an annuity, they may buy a flat rate annuity that does not increase in line with inflation, or one with inflation proofing. A flat rate annuity will have a higher starting value but this will be eroded over by rising prices. If they make a draw-down arrangement, they’ll have to decide how much to withdraw and how much to leave invested, and judge whether the remaining pension pot is sufficient to support them for the rest of their life. That will depend on how investments perform, the rate of inflation, and how long the member lives. DC members with a range of health issues (or other factors that affect their expected longevity, such as smoking) will generally be able to secure an ‘enhanced annuity’. This offers a level of pension than a regular annuity to reflect the fact that they are likely to live less long in retirement than others.
Schemes that provide an income in the case of death in service, or an illness that prevents the member from working, may be stand-alone workplace benefits (insured Death in Service schemes or Permanent Health Insurance). Alternatively, they may come as part of a defined benefit pension (such as a public service pension). Ill-health early retirement can be a valuable option, depending on:
An important aspect of a pension will be what it is worth to dependants when the member dies, and that will depend on what type of pension involved. A defined benefits pension is likely to spell out in its rules what dependants’ benefits are available. Most schemes will pay a lump sum benefit or grant based on a multiple of the member’s salary if they 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 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.) In a defined contribution pension, any of the savings that remain un-used could be inherited by the member’s beneficiaries, and if the member dies before the age of 75, they inherit tax-free. After 75, they will pay tax at their own marginal rate. If the member has retired and used all or part of their savings to buy an annuity, dependents’ benefits could be one aspect of the annuity product. In all cases it will be important to check who counts as a dependent or beneficiary: spouses, civil or unmarried partners (same-sex partners now have the same pension rights as married couples), or children (under 23 unless the child is dependent because of a serious disability). 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.
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