Types of approval
Under section 590 of the
Income and Corporation Taxes Act 1988 (ICTA
88) an approved scheme must receive approval from the
Pension Schemes Office (PSO).
The strict conditions of approved schemes as set out by ICTA
88 means most employer pension schemes will seek more flexible
benefits through an exempt approved scheme granted by the
PSO under the occupational
pension scheme practice notes (IR12 (1997)).
An approved scheme will be granted approval if:
||It is established
under irrevocable trust;
company and administrator must be resident in the UK;
pays at least 10% of the total contributions;
and benefits are within Inland Revenue maximums;
income will allow total commutation to a tax free lump sum;
retirement benefits payable to the scheme member or as
a widows pension can exceed the 1/60th accrual rate;
employees must be informed in writing of the terms and
conditions of the scheme.
To be recognised as exempt
approved schemes they must:
under irrevocable trust;
||Have a UK
contributions to the scheme;
must comply with the Practice Notes.
A scheme member who retires before the normal retirement date
(NRD) of an occupational pension scheme is recognised as taking early retirement.
The Inland Revenue will allow early retirement and the taking
of a pension income from the age of 50 for men and women with
the latest date to take a pension being 75. An employers pension
scheme will have rules that determine the generosity of the
pension benefits payable to members on early retirement.
An individual could retire early voluntarily and this means
that the accrued members
pension rights within a final salary scheme will usually
be scaled down, typically between 4.0% to 6.0% by each year
early retirement precedes the normal retirement age. If early
retirement is due to ill health many schemes will pay benefits
the member would have received at normal retirement age based
on the current pensionable earnings and without scale down.
If early retirement is compulsory such as in the case of redundancy,
the scheme may pay an early pension based on accrued retirement
benefits without scale down and possible enhancements
such as half the years to retirement.
In terms of an employers treatment of men and women in an
occupational pension scheme and since the Barber Judgment
of 17 May 1990, the European
Court of Justice (ECJ) has ruled that men and women must
have equal rights to join employers pensions and that occupational
pensions earned from service must be equal for men and women.
The Barber Judgment established the equal-pay-for-equal-work
Article 119 (now Article 141) of the Treaty of Rome that if
an occupational pension scheme does not contain an equal treatment
rule shall be treated as including one.
This means that if a scheme member of opposite sex is employed
in similar work, or work of equal value, then the benefits
to both sexes must be the same including the retirement ages,
unless the trustees can prove that the inequality is due to
a factor that is not sex related. Regulations made under the Pensions
Act 1995 have required occupational pension schemes to
treat the sexes equally since January 1996. Also, under section
126 of the Pensions Act 1995 the state retirement age for
the state basic pension will be equalised to 65 for both men
Scheme funding requirements
Under section 56 to 61 of the Pensions Act 1995 the minimum
funding requirement (MFR) was introduced to help occupational
pension schemes such as a final salary pension to offer the
members more security. MFR in general will not apply to an occupational
money purchase scheme unless that scheme also provides
other salary related benefits that are subject to MFR.
On the discontinuance of the scheme, MFR is designed to ensure
that the scheme will have sufficient assets to secure all
pensions in payment to pensioners as well as pay a cash equivalent
transfer value (CETV)
for all active members and deferred members not yet in receipt
of a pension
The minimum funding requirement was effective from 6 April
1997 and the scheme trustees must put in place a scheme that
covers the next five years from the date of the actuarial
valuation showing that the contributions made are sufficient for the scheme to be 100.0% funded. There
is a transitional period of 5 years that ends on 5 April 2002.
Where the valuation shows the scheme to be below 90.0% funded
to the MFR level the schedule must show that the scheme will
be at least 90.0% funded by one year after the transitional
period, or 5 April 2003. Where the valuation shows funding
of 90.0% to 100.0% the transitional period is extended by
5 April 2007. In certain circumstances a seriously underfunded scheme can apply to the Occupational Pension Regulatory Authority
(OPRA) to have these time limits further extended.
Where the scheme is in surplus OPRA will require the employer not to make contributions.
If the scheme is seriously in surplus the employer may establish
the pension non
contributory scheme for a period of time in which case
the employees will not need to make a contribution.
MFR requirements increase the burden of a final salary pension
on the employer as the assets of these schemes are usually
equity based, reflecting the younger age of the workforce
and longer term expected to retirement ages. It also means
that the schemes will experience a cash inflow as few payments
would be made to pensioners.
As a final
salary pension scheme matures, the situation could be
that benefits paid exceed contributions received and the scheme
trustee would have to apply a more conservative strategy with
more investment in fixed income securities to meet cash outflows.
Minimum funding requirement may force the scheme to sell equities
and buy fixed income securities and meet the valuation targets.
The government has recognised the problems an employers occupational
pension scheme has with MFR and announced in September 2001
that it proposed to reform MFR requirements, with an interim
solution of extending the time limits and in the long term
to replace MFR with a scheme specific funding standard.
Ending existing schemes
For an employers pension scheme a bulk
transfer of the assets and liabilities other than on winding
up could occur if; the employer closes a scheme such as a
final salary pension to new entrants in favour of a money
purchase scheme and offers an existing scheme member with
accrued retirement benefits the option of a pension transfer;
or if part of the business is sold to a new employer the members
pension rights will be protected by regulations although any
future retirement benefits may not be maintained at previous
Ending a final salary scheme in favour of a money purchase scheme would mean a significant change for the members future pension planning. Whereas a defined benefit scheme would pay an inflation proofed income based on a final salary, a money purchase scheme requires the member to purchase an annuity from the available pension accumulated from stock market growth, which is a less certain route. At retirement the individual must use the pension fund to buy pension annuities and has the option to search for the highest annuity rates using an open market option. Before making a decision at retirement, learn more about annuities, compare annuity rates and secure a personalised annuity quote offering guaranteed rates.
Where a sale takes
place the consent of the scheme member is required
although an individual could instead choose a pension
transfer to a personal
pension, section 32 policies or no transfer at all. If
the scheme is in surplus, on a bulk transfer the new scheme
trustees will take responsibility for this amount. If the
new scheme is underfunded, this surplus would help the scheme
to meet the minimum funding requirement. A bulk transfer could
be achieved without the consent of members, however rarely
occur due to the restrictions of the Preservation of Benefits
Regulations 1991 and the restrictions imposed by the scheme
Alternatively, an employer of an occupational
pension scheme may decide on winding
up, due to the increasing administrative costs and obligations,
rather than consider a bulk transfer of the assets and liabilities
to another scheme such as stakeholder
pensions. On winding up there is a priority rule for schemes
subject to the MFR as stated in section 73 of the Pensions
Act 1995 where certain liabilities take priority such as pensions
in payment, members in deferred retirement, additional voluntary
and guaranteed minimum pensions (GMP).
Unless stated in the scheme rules the scheme trustees have
discretion as to how to distribute a surplus after providing limited
price indexation (LPI) for all pensions.
Under the Social Security Act 1990 if the scheme is underfunded
the employer must meet this obligation on winding up. The
scheme will also have to meet the schemes liabilities and
satisfy the equalisation
rules as per the requirements of the European Court of
Role of the trustees
This can be an individual, a number of people or independent
institution that are responsible for the management of a trust
in accordance with the Trust Deed. Scheme
trustees have the power to select any investment they
wish in order to adhere to the Trust Deed. The activities
of scheme trustees come under the jurisdiction of OPRA that has extensive powers set out in Part I of the Pensions
A failure of a scheme trustee to comply
with their duty is likely to be of material significance to
the functions of Occupational Pension Regulatory Authority.
Therefore there is a statutory duty
blowing imposed on the actuary or auditor appointed to
an occupational pension scheme such as a final salary pension
or money purchase scheme to immediately give a written report
to OPRA if they have reasonable cause to believe there is
a material problem with the employers
The Trustee Act 2000 came onto force on
1 February 2000 establishing a new statutory duty of care
for trustees when carrying out their duties under trust deed
of the Trustee Act. The Trustee
Act 2000 only applies to England and Wales and gives trustees,
including pension scheme trustees, wide investment powers.