CMS Expert Guide to Pensions in United Kingdom

Until April 2016, the UK had a three-pillar system: a basic state old age pension, which is funded by national insurance contributions and topped up by additional welfare benefits where the individual has made insufficient contributions to get the full benefit; a second pillar of earnings-related state benefits; and private occupational or personal pension provision. On the 6 April 2016, the two tiers of state pension provision were replaced (for those reaching pension age from that date) with a single tier benefit. The level of income provided by state retirement benefits in the UK is relatively low.

Both occupational and personal pension schemes exist within the UK. Occupational pension schemes are set up by a sponsoring employer or for multiple (connected or unconnected) employers. The assets are held under trust and invested by scheme trustees. Such schemes typically provide benefits on either a defined benefit or a defined contribution basis (or a combination of these). Personal pension schemes are typically individual agreements with insurance companies and provide benefits on a defined contribution basis.

All UK employers (regardless of size) must automatically enrol employees earning over a certain threshold into a pension arrangement that satisfies certain minimum criteria. Employees can opt-out of this mandatory pension provision but need to continue to do so at three-yearly intervals.

A pension arrangement which benefits from the tax privileges set out below can generally only be set up by an employer, a government body or an entity regulated by the Financial Conduct Authority (FCA) (such as an insurance company or bank).

Occupational pension schemes are run by trustees, but almost anyone can be a trustee (subject to certain exceptions where for example an individual has been convicted of an offence involving fraud or dishonesty or has been disqualified from being a director of a company). If a pension scheme qualifies for the tax reliefs set out below, the UK tax authorities must be satisfied that the trustees are “fit and proper” persons. 

In defined benefit schemes, there are no mandatory contribution requirements, but a scheme will need to provide a minimum level of benefits if an employer is using it to satisfy the auto-enrolment requirements. In addition, there will be a schedule of contributions setting out the level of contributions which the employer needs to pay to fund the promised benefits, determined as a result of the scheme’s actuarial valuation. Employee contributions are determined by the scheme rules. 

There are mandatory requirements for a defined contribution scheme used for auto-enrolment. There are several alternative methods for calculating mandatory contributions, but the basic requirement is that employers need to contribute at least 3% of earnings (between two thresholds) and total contributions need to be at least 8%. 

For both defined benefit and defined contribution schemes, there are also minimum contribution requirements which a transferee employer must meet following the transfer of a member’s employment between undertakings.

Schemes which promise a defined benefit must have an actuarial valuation at least once every three years to determine whether there are sufficient assets to meet liabilities (and an actuarial report looking at any developments in intervening years). If there is a shortfall in assets, the trustees must formulate a recovery plan to reach an adequate funding level as soon as possible. There will also need to be a schedule showing what contributions are due to the scheme and when. Funding documents (e. g. the recovery plan and schedule of contributions) are the trustees’ responsibility, but may require the consent of the employer where the employer has any powers under the scheme’s documentation to determine or suspend contributions.

In addition to triennial funding requirements, trustees must also ensure that the scheme has a supportable long-term ‘funding and investment strategy’.

7. What age are benefits taken?

In defined benefit schemes, the rules will stipulate a ‘normal retirement date’, which is typically between the ages of 60 and 65. There is no formal maximum retirement age. Under legislation, benefits cannot normally be paid before the age of 55 – known as the ‘normal minimum pension age’ (NMPA). Exceptions to this rule include cases of ill-health and certain members who have a right to a protected pension age. The NMPA is scheduled to increase to 57 in 2028.

In defined benefit schemes, employees may make fixed contributions, but the balance of the cost is provided by the employer. In defined contribution schemes, financing will either be provided by the employer, employees, or both (depending on the scheme documentation).

Occupational and personal pension schemes can register with His Majesty’s Revenue and Customs (HMRC). If they do so, investments and contributions will be eligible for certain tax reliefs. The scheme will also be subject to certain reporting requirements and restrictions on benefits.

Tax relief is available on the majority of employer and employee contributions.

No (assuming the scheme is registered with HMRC).

12. Are benefits taxed?

Yes. Pensions are subject to income tax. However, there are several different kinds of lump sums which can be paid tax free or with a tax-free element (either on death or retirement). From April 2027, inheritance tax may be applied to unused pension funds and death benefits paid from registered pension schemes.

No.

Only a certain proportion of benefits can be taken as a lump sum from a defined benefit scheme. Since April 2015, the whole of a member’s defined contribution account may be taken as a lump sum. There are restrictions on the maximum level of benefits which can accrue and benefit from tax relief each year. There are also maximum allowances for lump sums with a tax free element. 

The Pensions Regulator (TPR) is a public body which has extensive powers in relation to the regulation of workplace pension schemes (including occupational pension schemes). It can fine trustees for non-compliance with legal requirements, appoint and remove trustees, wind-up schemes and require associates of sponsoring employers to contribute to occupational pension schemes in certain circumstances. It also oversees compliance with the auto-enrolment requirements. The FCA regulates providers of personal pension schemes.

TPR has wide information-gathering powers. Trustees, employers and advisers also have a statutory duty to report certain matters which could be of material significance to TPR in the exercise of its powers. The FCA has a detailed reporting framework for those regulated by it.

The Pension Protection Fund (PPF) provides compensation to members of underfunded defined benefit schemes with insolvent employers. It is funded by a levy on all defined benefit schemes. The Financial Assistance Scheme provides government assistance to members of schemes that commenced wind-up before the existence of the PPF. Both arrangements ensure that members will receive the majority of their benefits (within certain limits). The Financial Services Compensation Scheme covers firms authorised by the FCA and may pay compensation where an authorised firm is unable to meet its obligations.

There is extensive legislation which prevents discrimination on grounds of age, sex, sexual orientation, disability, race, religion and part-time or fixed term worker status. Both employers and trustees have obligations to prevent discrimination and generally speaking, trustees must ensure that schemes are operated on a non-discriminatory basis.

All members of defined benefit occupational pension schemes have vested entitlements to benefits after two years. Members of defined contribution occupational pension schemes will have vested entitlements after 30 days. Once a member has ceased to accrue benefits in a scheme, their vested entitlement is index-linked (subject to a current cap of 2.5% per annum) until the point of retirement. A member leaving an employer before benefits have vested can have their own contributions refunded or, in the case of a member leaving after three months, can request a transfer payment to another occupational or personal pension scheme of their choice. There are regulations setting out provisions in relation to the calculation of such transfer payments.

At least one third of occupational pension scheme trustees should be nominated by a process in which active and pensioner members can participate. Participation can be by way of a representative organisation such as a trade union. In addition, there are statutory requirements to provide recognised trade unions on request with certain information relating to both the scheme and member benefits under it.

As above, trade unions can participate in the trustee nomination process. In addition, they can be consulted when certain amendments are proposed to schemes. This can be an obligation on the employer if there are pre-existing agreements in place.

There is scope for schemes to have members who are not based in the UK, although there may be tax implications. Post Brexit, there is no longer a requirement for a scheme to be fully funded (or comply with other EU cross-border rules) if it has overseas members within the EEA. 

There are generally few restrictions on a member switching between plans providing the plan the member wishes to switch to meets certain conditions, although the framework for transfers has been tightened in recent years to reflect the risk of pension scams. If a defined benefit member with benefits in excess of GBP 30,000 wishes to transfer to a defined contribution arrangement, they will need to obtain independent advice.