Are you making the most of your pension scheme?

Are you making the most of your pension scheme?

10th June 2024, 11:59 am

Employers face a range of options and challenges in providing pension saving arrangements for their employees. Whether you offer a traditional occupational scheme or a basic auto-enrolment arrangement, there are opportunities to be maximised. We look here at some of the chances for scheme sponsors to achieve cost effective pension provision for them and pension security for their employees.

Occupational defined benefit schemes

Defined benefit (“DB”) pension schemes are believed by many to be a thing of the past. A type of pensions savings vehicle that belongs to the previous generation. But the reality is that whilst many such schemes, where pension benefits are calculated by reference to salary and service and where the sponsoring employer bears the balance of costs, have closed to ongoing accrual, their legacy continues to impact businesses.

The latest official figures1 show that there are still more than 5,000 DB schemes across all sectors of the economy, providing benefits, now and into the future, for almost nine million members. Assets across all DB schemes in the UK total around £1.4 trillion. A figure which broadly exceeds the assets needed to match the minimum benefit requirements by £367 billion2.

Many employers, particularly across industries in the North-west of the UK, may have changed their pension arrangements for ongoing pensions savings. But many also still retain legacy DB schemes which need to be funded and which present ongoing governance issues.

The following ‘top tips’ set out some opportunities for employers who sponsor DB schemes and may be looking for initiatives to manage the ongoing liability that such schemes present.

1. Bulk annuity purchase

Commonly known as a Buyout, bulk annuity purchase presents an opportunity to employers, and scheme trustees, to secure DB scheme members’ accrued liabilities, ie their pension benefits, through an insurance company rather than through the pension scheme. Buyout offers employers sponsoring DB schemes the opportunity to divest themselves, completely and permanently, of their liability to underwrite the scheme’s funding. It also offers the greatest level of security for DB scheme members, given their pensions are secured through an insurance company, underwritten by the Financial Services Compensation Scheme.

Traditionally, Buyouts were prohibitively expensive because of the mismatch between the way in which insurers and DB schemes valued pension liabilities. Whilst sponsoring employers and trustees value pension liabilities on an ongoing, scheme specific, basis, insurers value benefits on a much more conservative basis. As a result, either where schemes had a funding deficit or were fully funded but on an ongoing basis, the shortfall between available scheme assets and the cost of Buyout needed to be met by the sponsoring employer and often ran into several million pounds.

However, over the last few years the funding position of DB schemes has improved to the extent that Buyout is now an option that can be cost neutral for many sponsoring employers. During 2023, 254 employers took the opportunity to transfer their scheme’s liabilities, totalling £50 billion in assets, to an insurer, divesting themselves of risks related to funding, investment, interest rates and mortality and ensuring greater security for scheme members.

Many insurers now offer template documents and processes to speed up the process and the required advice processes are now refined through experience such that many consultants and legal advisers operate on a fixed fee basis.

Buyout represents a positive opportunity to both DB scheme members and sponsoring employers and should be given serious consideration for any employer sponsoring a well funded scheme.

2. Refund of surplus funds

A further development which follows from the improved funding position for DB pension schemes is that sponsoring employers may, once again, be able to access surplus funds previously locked into their scheme.

In February the Government launched a consultation with a view to “overhauling the

pensions landscape to provide better outcomes for savers, drive a more consolidated market, and enable pension funds to invest in a diverse portfolio.”

It acknowledges that private sector defined benefit schemes will play an important role in this and has committed to make it easier for trustees of well-funded schemes to make payments from surplus to sponsoring employers and scheme members.

The stated aims of the consultation are to:

· support schemes to invest for surplus in productive asset allocations by making it easier to share scheme surplus with employers and scheme members;

· remove practical barriers to surplus extraction such as those relating to scheme rules; and;

· remove behavioural barriers by bringing surplus extraction in line with trustee duties.

The current legal position on dealing with scheme surplus is, broadly, that a repayment of surplus may only be made to a scheme’s sponsoring employer if its rules expressly permit such repayment in any situation other than on winding-up the scheme.

In addition, under the Pensions Act 2011, scheme trustees must have passed a resolution before April 2016 to maintain such a power in their scheme’s rules. Schemes which did not pass such a resolution cannot make payments to the sponsoring employer.

According to research from the Pensions Regulator, of the approximately 5,000 defined benefit schemes, around 3,750 are in surplus on a low dependency basis, with a further 950 schemes approaching that position. This represents an aggregate surplus in excess of £225 billion.

One of the questions in the consultation is whether the Government should look to introduce a statutory override power for schemes to amend their rules to allow for payments from surplus funding, or to introduce a statutory power to make such payments.

Any payment of surplus to a scheme’s sponsoring employer is subject to a tax charge. The consultation confirmed the Government’s intention to reduce the rate of tax payable by employers on repayment of surplus from 35% to 25% and, as a result, that change was effected from 6 April 2024.

Employers who sponsor DB schemes should be looking to engage with their scheme trustees now, to determine:

· their scheme’s ongoing funding position;

· the extent of any surplus now and in the future; and

· whether the scheme’s rules permit for repayment of surplus.

Where employers don’t engage with scheme trustees, the result may be a locked in surplus that may otherwise be an available source of funs to facilitate corporate growth and investment.

3. Restructuring

Employers who sponsor DB schemes and operate as part of a wider group are able to take advantage of legislation allowing one employer to apportion its DB pension liabilities, and ongoing responsibilities, to another company within the same group.

Typically, employers will look to apportion DB scheme liabilities and responsibilities where they are looking to sell a part of their business that has a DB pension scheme attached or, alternatively, where they are looking to release a particularly successful part of the business from DB pension liabilities, in order to encourage further growth.

Legislation was introduced, in 2011, specifically to allow for one or more replacement employers to become responsible for the leaving employer’s scheme liabilities under a legally enforceable agreement. The arrangements were introduced to facilitate flexibility into group restructurings whilst still ensuring that benefits accrued by DB scheme members continued to be secured and protected.

DB scheme sponsoring employers can take advantage of a flexible apportionment arrangement, (“FAA”), which is an arrangement made in relation to an employer that stops participating in a multi-employer DB pension scheme. The arrangement must provide for one or more replacement employers to become responsible for the leaving employer’s scheme liabilities, under a legally enforceable agreement.

The FAA is one of a number of methods by which an employer may cease to participate in a multi-employer DB scheme. Historically, and typically, they were introduced to allow an employer to withdraw without incurring a debt to the scheme under section 75 of the Pensions Act 1995.

Through a series of steps, broadly comprising:

· admitting an employer, which may be a Newco established for the purposes, to participate in an existing DB scheme;

· replacing the exiting employer with the new employer;

· apportioning liabilities to the new employer; and

· facilitating the exit from the scheme of the existing employer, without either any obligations to the scheme or any debt payable to it.

Where a DB scheme sponsoring employer is looking to restructure or transact, an FAA can be attractive in facilitating the process without negatively impacting the scheme financially or in terms of scheme member’s security.

Occupational defined contribution schemes

Where employers do not offer pension savings to their employees by means of a DB scheme, the alternative will be a scheme by which pension benefits are provided through investment fund accumulation during a member’s employment, followed by decumulation in retirement. Such schemes are known as defined contribution (“DC”) schemes.

The attraction for employers is the shift in risk from the employer, as with a DB scheme, to the member. DC scheme benefits are not underwritten by a member’s employer, so where poor investment performance results in reduced pension benefits, there is no obligation on the providing employer to make good any pension shortfall.

4. Auto-enrolment expansion

Since the relevant parts of the Pensions Act 2008 came into effect from 2012, every employer in the UK has been required to put in place a pension scheme, with minimum standards, for its employees and to automatically enrol those employees into that scheme.

The legislation has undoubtedly been a success. In 2021, employees across the UK had saved £114.6 billion into their pensions. An increase of £32.9 billion compared to 2012, following the introduction of the automatic enrolment legislation.

Over the same period there has been an increase of more than 50 per cent in the number of people saving for their retirement at the workplace, to more than 10.7 million employees. The number of young people aged 22 to 29 saving into a workplace pension has more than doubled in the same time period.

Since introducing the auto-enrolment legislation, the government is under a legal obligation to review how the system is operating, every five years. Since 2017, the Government has been considering extending employers’ legal duties, to expand the provision of workplace pensions.

In particular, the focus of that consideration has been whether to extend the age by which employers must automatically enrol employees into their workplace scheme and whether it was fair to continue to allow a percentage of an employee’s earnings to be disregarded for the purposes of calculating how much to pay into their scheme.

As a result, at the end of last year the Pensions (Extension of Automatic Enrolment) Act 2023 received) Royal Assent. Its key measures are that:

· the age at which employers will be under a duty to auto-enrol employees into their workplace pension scheme will fall from age 22 to age 18; and

· employers will no longer be allowed to disregard the first £6,240 of an employee’s earnings when calculating how much to contribute into their scheme.

These measures have been welcomed generally, especially by younger workers and those at the lower end of the pay spectrum. However, they will also mean additional duties and costs for employers at a time when the economy has yet to fully turn the corner from recession into growth.

Whilst the new legislation will be subject to industry consultation before any changes are enacted, employers would be well advised to begin discussions with scheme providers now. The Pensions Regulator is responsible for ensuring employers comply with their legal duties under auto-enrolment and will ‘name and shame’ employers who fail to comply with those duties.

In addition, given the likely increased costs to employers under the expanded regime they should consider how that additional cost should best be absorbed into their business. That should be done at the same time as considering how any changes to their auto-enrolment arrangements may impact on recruitment and retention of employees.

5. DC Master Trusts

Since the introduction of automatic enrolment, 97% of employers have chosen to use a DC scheme as their pension savings vehicle. Of these, 78% are using a DC trust-based scheme and 19% are using a DC contract-based scheme (such as a group personal pension plan). Of those employers that have chosen to use a DC trust-based scheme, over 99% are using a Master Trust.

At the conclusion of its authorisation process for existing master trusts in November 2019, the Regulator announced that it had authorised 37 Master Trusts.

A Master Trust is defined as an occupational pension scheme that:

· provides money purchase benefits (whether alone or in conjunction with other benefits);

· is used, or intended to be used, by two or more employers;

· is not used, or intended to be used, only by employers which are connected with each other.

Some Master Trusts are open to all employers and will accept any individual as a member. Others will only accept certain employers or certain individuals as members. For example, some Master Trusts are only open to employers operating in particular sectors or industries and some providers might refuse to accept lower earners.

The basic structure of a Master Trust is a central trust deed, establishing how the scheme will operate and be governed. The Master Trust then incorporates specific sections for each adhering employer, to set out the benefit structure and contribution regime for the employees

of each participating employer. The funds and rights of individual sections are never co-mingled with other sections.

As well as establishing schemes for new employees, master trusts also allow employers to transfer into their section of the master trust any employees who are in an existing occupational DC arrangement.

The advantage to an employer of using a Master Trust to provide a pensions savings vehicle for employees, and for transferring members of its own DC pension scheme to the same Master Trust, is that all pension scheme administration and governance responsibility is removed from them and taken by the master trust. Typically, the only significant interaction between an employer and a Master Trust is the payment of contributions on behalf of members.

In addition, because of economies of scale, charges imposed by master trusts for running a Master Trust section for a particular employer, are often noticeably lower than for individual arrangements.

Employers who provide their own trust based DC pension scheme should give serious consideration to the Master Trust option for future pension savings by their employees. Following that, the next logical step for consideration, should be for them to approach their scheme trustees to discuss facilitating a transfer of existing members of their scheme to the master trust.

1 The Purple Book 2023, DB pensions universe risk profile – The Pensions Regulator

2 On a s.179 valuation basis

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