money purchase –
trust or contract based pension schemes
by Roderick Ramage, solicitor, www.law-office.co.uk
first published (by distribution to professional
contacts) New Year 2006
DISCLAIMER
This article is not advice to any person
and may not be taken as a definitive statement of the law in general or in any
particular case. The author does not accept any responsibility for anything
that any person does or does not do as a result of reading it.
If an employer decides to
establish a money purchase (defined contributions) pension scheme or to convert
its existing final salary (defined benefits) to a money purchase one, the next
decision is the type of money purchase scheme.
There are two types, but a number of variations. The first is an occupational pension scheme
(OPS) and the second could be any of personal pension policies, a grouped
personal pension plan (GPPP) and a stakeholder pension scheme (theoretically an
employer could establish this as an OPS).
The distinction between these two types can be made clear by an alternative nomenclature (not found in the definitions in s1 of the Pension Schemes Act 1993). A traditional OPS is sometimes referred to as a trust based scheme and the others as contract based. In short, such an OPS is established by an employer to provide benefits for employees and others and is managed by trustees who collect the contributions, hold the scheme’s assets and pay the pensions and lump sum benefits. There is therefore a three sided relationship between the employer, the trustees and the members. Contract based schemes are schemes established by insurance companies, unit trust managers etc, and the main significant relationship is one of contract between the member and the provider. There may also be a collateral contact between the employer and an employee, under which the employer pays contributions to the provider and provides a payroll deduction service for the member’s own contributions, but this does not make the employer a party to the scheme.
For all practical
purposes final salary or other salary related pensions are provided only
through an OPS (trust based), but money purchase benefits can be provided by
either type. Many employers, who have
provided salary related benefits through an OPS, have continued to use the OPS
structure to provide money purchase benefits.
Employers starting their first pension scheme or changing to money
purchase are sometimes advised to use an OPS.
My purpose in this note is to suggest that it is likely that a contract
based scheme is to be preferred, expect perhaps where the economies of scale of
a very large OPS might give better value for money than a contract based
scheme.
I
set out overleaf a table comparing some of the advantages or otherwise of the
two types. Advantages are shown as
“yes”. Although there are many more possible examples, the advantages
of contract based schemes can be reduced to two, which are that:
a)
there are no trustee responsibilities (and corresponding
liabilities); and
b)
the regulatory requirements of the pensions legislation
apply, for the most part, only to OPSs and not to contract based schemes.
An important example of
(a) is that, in a final salary scheme, the trustees’ duty of care in making
investment decisions is owed mainly to the employer, who must pay increased
contributions if poor decisions are made.
As the trustees or a majority of them are appointed by the employer, and
the employer is likely to be a party to the investment policy, there is a close
relationship in which the trustees are unlikely to be sued by the
employer. It is very different with a
money purchase scheme. Here the duty is
owed solely to the members, who have no loyalty or other ties to inhibit them from
making claims against the trustees for unsatisfactory investment results.
|
topic |
OPS |
GPPP
etc |
|
freedom from principal
employer’s responsibilities |
no |
yes |
|
freedom from trustees’ general
responsibilities |
no |
yes |
|
freedom from trustees’
responsibility for investments |
no |
yes |
|
freedom from trustees’
responsibility for annuities |
no |
yes |
|
freedom from trustee knowledge
and training |
no |
yes |
|
freedom from winding up
expenses |
no |
yes |
|
freedom from red tape |
no |
yes |
|
company booklet, employee care |
yes |
yes |
|
member’s ownership of benefits
(“portability”) |
no |
yes |
|
choice of indexed or flat rate
pension |
yes |
yes |
|
company’s contributions |
yes |
yes |
|
employees’ contributions |
yes |
yes |
|
tax relief |
yes |
yes |
|
contracting out if existing
OPS contracted out (no need to change arrangements) |
yes |
no |
|
continuity (avoidance of
change and uncertainty on change of existing scheme) |
yes |
no |
Some proponents of the
OPS say, as a trump card, that an OPS shows a commitment to the employees that
is not existent with a contract based scheme.
To this my answer is that commitment is shown far more in how much the employer
is willing to contribute and in its communications with employees and scheme
members. Generous contributions with a
good explanatory booklet, regular reports and clear forms are what the
employees see, and these can be provided equally effectively in either pension
type. The only real difference may be that, in many cases, the routine work to
be done and fees that an adviser can earn are likely to be higher in the case
of an OPS than a contract based scheme.
30 December 2005
copyright
Roderick Ramage
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