 |
Final
salary pension
The term final salary is used to describe the employers pension
scheme that offers a predetermined level of pension benefit
and is also known as a defined
benefit scheme. The benefits are expressed as a fraction
of the final salary for every complete year worked for the
company or as a scheme member of the final salary pension.
The cost of providing this scheme cannot be accurately determined
and therefore although the benefits can be defined, the contributions
will need to be reviewed by the scheme
trustees and adjusted accordingly.
These contributions must now be made in accordance with the
minimum funding requirement (MFR)
to ensure final salary schemes are adequately funded. For
joiners after 1 June 1989 the maximum pension from a final
salary scheme is 2/3rds final remuneration requiring a minimum
of twenty years service, subject to the earnings
cap. This means the fraction cannot be less than 1/30th
for each year of service with most companies offering 1/60th
schemes requiring 40 years of service to achieve the maximum
pensions in retirement.
The member will also have the possibility for commutation
to a tax
free lump sum and this will be based on the formula of
3/80ths for each year of service times the total number of
years of pensionable service, or if a larger sum is calculated,
two-and-a-quarter times the full initial pension income before
commutation.
For members
leaving early, the accrued benefits in the scheme can
be left as a deferred pension as long as the member has been
in the scheme for 2 years or more. The member will also have
the opportunity for a pension
transfer to another scheme.
Occupational money purchase
If an employee contracts out of the state earnings related
pension scheme (SERPS)
the employer will be able to fund a contracted out money purchase
scheme (COMPS)
with the National Insurance (NI) rebates. COMPS will provide
a pension to the member that is based on the performance of
the underlying investments. A
contracted in money purchase scheme (CIMPS)
is a defined contribution approved occupational pension scheme.
Since Pension
Simplification from 6 April 2006 the amount of retirement
benefits from a money purchase scheme is limited to the Lifetime
Allowance which is a total fund of £1.5 million
in 2006/07. In terms of contributions the member is limited
to the Annual
Allowance which is £215,000 in 2006/07.
However, tax relief on the contributions is limited to the
higher of 100%
of relevant earnings or where tax relief is given at source,
limited to £3,600. There is now no restriction to the
earnings
cap or to the 15% contribution of pensionable earnings
as existed before A-Day.
For all money purchase schemes the
retirement benefits can be taken between 50 to 75 years of
age. At age 75 the member can purchase an annuity after taking
a tax free lump sum of 25% or switch to an Alternatively
Secured Pension (ASP) and draw an income.
Previous to A-Day the maximum pension income at retirement
age was 2/3rds of final pensionable
earnings and the maximum commutation to a tax free lump
sum was two-and-a-quarter times the pension income at retirement
age or 3/80ths for each year of service times final remuneration
up to a maximum of one-and-a-half times final remuneration.
It is possible that a scheme member of a CIMPS that makes
contributions significantly below the Inland Revenue maximums
will be able at retirement
age to commute the whole of the pension fund value to
a tax free lump sum. This tax
free lump sum could now buy a purchase
life annuity that has annuity taxation advantages over
a pension annuity. Whereas the pension income pays tax at
22% for basic rate taxpayers, the income from a purchase life
annuity is paid as capital
and interest of which 2/3rds is capital that is tax free
and the 1/3rd interest pays tax at a savings rate of 20%.
A CIMPS scheme must be audited each year to comply with the
Occupational Pensions Regulatory Authority (OPRA)
regulations and there must be an employers contribution to
the scheme, although not an employee contribution.
Group personal pension
Unlike an occupational pension scheme such as a final salary
pension or small self administered scheme (SSAS),
a group personal pension (GPP) is effectively a series of
individual personal
pensions provided by a single life insurance company.
A GPP will cost a scheme member more to operate than a final
salary pension and this cost will be met out of the contributions
made. Under the Pensions
Act 1995 however, the regulation requirements of the employer
by operating a GPP are much less onerous and with lower administration
costs than a final salary pension scheme.
Both the employer and the employee can contribute to a group
personal pension and these contributions will be limited to
the Inland Revenue maxima based on the members age. The employee
will pay the contributions net of basic rate tax, after pay-as-you-earn
(PAYE) tax has been deducted. Any employer contribution will
be made gross to the members personal pension. The employee
will decide on contracting out of the SERPS but if they do,
the NI contributions will be the same as the contracted in
rates.
A GPP is a defined
contribution scheme, unlike a final salary pension, with
no maxima on the retirement benefits paid as a pension income
and/or partial commutation to a tax free lump sum, provided
at retirement age. However, the members contributions will
be limited by the earnings cap.
The group scheme, established by the employer as a GPP or
group stakeholder
pension, represents a collection of individual policies
owned by the member and operated by a provider. When the member
leaves the company all the contributions accrued to that date
that include those made by the member and the employer will
belong to the member. The contributions can be left in the
group scheme or transferred to another provider.
Public service scheme
The civil service, armed forces, NHS, teachers, fire services,
police and local authorities have access to a public service
scheme for retirement benefits and where the scheme rules
and regulations are defined by statue. In the case of the
principal civil service scheme, there is no direct cost to
the scheme member as it is non
contributory scheme.
This is in contrast to the NHS pension scheme where scheme
members are expected to contribute 6.0% of their pensionable
earnings. The accrual
rate for public service schemes is a 1/80th of the final
salary for each year of service with a maximum pension income
of 40/80ths for forty years of service, or half final salary.
In addition there will be a non-optional tax free lump sum
calculated as 3/80ths of final salary for each year of service
with a maximum of 120/80ths for forty years service.
The member can elect for an increase in pension income at
retirement age by the commutation of the tax free lump sum.
However, the pension income will be taxable as earned income.
The pension income and widows pension are subject to limited
price indexation (LPI)
and payments will rise by the retail price index (RPI) but
are capped at 5.0%. In cases of pension
sharing section 36 of the Welfare Reform and Pensions
Act 1999 (WRPA) allows for indexing
benefits. This means that the the former spouse will receive
equal terms enjoyed by the scheme member as an integral part
of the pension
credit.
As statutory schemes are either unfunded or notionally funded,
there is no need to comply with the minimum funding requirement
as pension benefits are guaranteed by statute, unlike private
sector employers pension schemes.
For an unfunded public
service scheme the qualifying service will determine
a scheme members eligibility to pension benefits. The actual
number of years of service usually represents the qualifying
service. This can be enhanced with a pension transfer
from a previous scheme and extra service credits or added
years will also count towards qualifying service for pension
benefits.
In addition, the reckonable
service will add to a scheme members pension at retirement
age. This will include any part-time work, pension transfers
from a previous scheme and added years purchased thereby enhancing
benefits at retirement age.
Armed Forces Pension Scheme
The Armed Forces Pension Scheme is a final salary, contracted
out, unfunded occupational pension scheme and is an exception
to other public service schemes being governed by prerogative
instruments. These documents are not subject to approval,
annulment or amendment by parliament, they derive their authority
directly from the Queen.
Under the Naval and Marine Pay and Pensions
Act 1865, the prerogative instruments for the Royal Navy and
Royal Marines is by an Order of Council, for the Army it is
the Pensions Warrant 1977 and for the RAF it is the Queen's
Regulations for the Royal Air Force. Unlike private sector
companies, the Armed Forces Pension Scheme is designed to
meet the special requirements of service life, where youth
and fitness are essential elements of the occupation.
This means that the scheme
will provide immediate pension benefits to may of the
members that leave early and full retirement benefits
can be earned by the age of 55. The final value of the
retirement
benefits will depend on the members years of service
and rank, which will determine the members pensionable
earnings.
|
|
