Types
Below is a summary of the main types of occupational pension schemes.
Final Salary Scheme
Sometimes known as a defined benefit scheme, benefits are based on the length of a member's pensionable service and final pensionable salary. A common basis is a 60 th of pensionable pay for each year of service.
For example, John has been a member of his employer's scheme for 12 years and his final pensionable salary is £25,000 a year. His pension benefit is therefore calculated as follows:
12 years / 60 x £25,000 = £5,000 a year.
However, other rates, e.g. 80ths may also be used, depending on a scheme's rules.
Schemes may be contributory or non-contributory. If a scheme is contributory, members will be required to pay a percentage of their pensionable salary to the scheme.
Career Average Scheme
A career average scheme is a type of final salary arrangement. They have recently become more popular as employers attempt to control funding costs, but continue to deliver a defined benefit scheme.
A career average scheme matches each year's benefit accrual to earnings in each year rather than the final years' earnings. The earnings figure will be uprated in line with prices rather than the actual increase in earnings. For example, if the scheme provides a pension calculated as 1/60 of pay for each year of service and the member retires in 2010 with 30 years' service, then to calculate pension, each year's pay will be uprated with inflation and then aggregated. It will then be divided by 30 to provide the "average" pay, which in the example would be multiplied by 30/60 to arrive at the pension.
Money Purchase Scheme
In a money purchase scheme, sometimes known as a defined contribution scheme, each member builds up separate money 'pots' based on theirs and the employer's contribution, plus investment return. This pot is then ultimately used to provide pension benefits. Like all investments, its value may go down as well as up.
These types of plans may ask you to make an investment choice, although many schemes do offer a 'default' investment if you do not want to make an investment decision yourself.
At retirement some of the pot can be used to provide a tax-free cash sum. This is limited to 25% of the final value of the member's pot. The excess must then be used to provide an income.
Hybrid Schemes
These are schemes where benefits are based on alternative options, for example a money purchase scheme which also operates a final salary underpin.
Contracted-out Pension Schemes
The basis of contracting-out will depend upon whether the scheme has contracted-out on a final salary or money purchase basis. See section on contracting-out.
Additional Voluntary Contribution (AVC) Schemes
These are policies used to house additional contributions from members in order to improve their overall pension benefits in an occupational scheme. Commonly benefits are provided on a money purchase basis, but some schemes, particularly in the public sector, offer AVC plans that secured additional years of pensionable service. AVC plans can be offered alongside an employer's scheme or individuals can independently save via a Free-Standing AVC plan offered by insurance companies. Contributions to an AVC arrangement must ceased when active membership of their occupational scheme ceases.
Section 32 Policy
This is a policy that can be used to house a transfer from an occupational pension scheme. No further contributions, apart from the initial transfer value, can be made to the policy. The policy will ensure payment of any Guaranteed Minimum Pension (GMP) included in the member's transferred pension rights. Benefits above any GMP are provided on a money purchase basis.
Executive Pension Schemes
These are plans set up for directors or senior employees. Benefits are provided on a money purchase basis.
Small Self-Administered Pension Schemes (SSAS)
A SSAS will have fewer than 12 members, and a scheme member will be connected to at least one other member, a trustee or an employer in relation to the scheme. SSAS' offer wide investment powers and provides scope to make loans to the company; purchase property from the company; and invest in company shares. Loans must however be on a commercial basis and are limited to 50% of the fund.
Until 6 April 2006 it was a requirement that the trustees of a SSAS appoint a pensioneer trustee. The main function of a pensioneer trustee was to ensure the scheme was not wound up except in accordance with normal pension scheme practice. However, from 6 April 2006, the appointment of a pensioneer trustee is no longer necessary.
