Defined contribution (DC) schemes look set to dominate the landscape for private sector pension provision for the foreseeable future. Increasingly, employers believe it is crucial for the success of their business to firmly control pension scheme expenditure.
DC pensions meet this requirement. Where companies review pension arrangements, employers can choose to set-up contract based personal pension policies or a trust based occupational scheme.
About 5m people have DC pensions and numbers look set to increase as more private sector employers abandon defined benefits (DB) schemes. Recent statistics published by the Pensions Regulator state that three in four new DC schemes are set-up as contract based. We consider below the reasons why contract based schemes are increasingly the preferred route for employers and why trust based schemes suit some employers.
There is a requirement, particularly amongst small and medium size businesses, to limit the time spent in dealing with the company pension scheme. Pensions are regarded as complex and employers wish to remove themselves from the responsibilities and decisions of investing the assets of the scheme and dealing with administration.
Attraction of contract based schemes
The requirements for employers are simply:
To appoint a pension adviser who will recommend the provider to manage the scheme
Deduct employees contributions from earnings
Remit member contributions to the chosen pension provider, along with the employer contribution
Notify the provider of new joiners and leavers
Choosing personal pension contracts means the
employer is NOT required to:
Explain the benefits of joining the scheme – this is undertaken by the adviser and provider
Be party to pension contracts with the provider – a contract is created between each member and the provider
Execute a trust deed, appoint a board of trustees and take decisions about payment of discretionary benefits -the responsibilities for regulatory governance is undertaken by the provider through committees of pensions specialists
Take investment decisions on behalf of the members the pensions adviser should recommend which investment funds should be offered to members
Pay an annual levy to the Pensions Regulator – the levy is paid by the pension provider
Distribute information to members – this is typically handled by the provider and/or pensions adviser.
It is easy to understand why the limited employer involvement makes the contract based route attractive.
Further, members of contract based schemes have considerable protection for their benefits. The likelihood of the provider winding-up a contract based scheme is extremely remote, compared to the risk of failure of an employer occupational trust based scheme.
Employers who opt for a trust based occupational scheme have an active role in all the tasks referred to above. This means greater management involvement and higher costs in running the scheme. However some employers believe a trust based scheme is the most appropriate vehicle.
Where the DC scheme replaces a defined benefit (DB) scheme, the employer may prefer to continue with an occupational scheme, this can easily be accommodated using the existing trust. Such employers understand the ongoing management commitment. A hands on approach often stems from a paternal desire to retain control, to ensure the assets of the scheme are securely held and effectively managed for the benefit of the members.
The market is likely to polarise over the next few years with most small and medium size employers, together with some of the larger ones, preferring the less onerous role associated with contract based personal pensions. Some large companies with greater in-house resource may still prefer to run an occupational trust based scheme.
Providers committed to the DC pensions market should offer competitive products and services whichever route the employer chooses.