money purchase – trust or
contract based pension schemes
by Roderick Ramage, solicitor,
www.law-office.co.uk
first published (by distribution to
professional contacts) New Year 2006
DISCLAIMER
This article is not advice
to any person and may not be taken as a definitive statement of the law in
general or in any particular case. The author does not accept any
responsibility for anything that any person does or does not do as a result of
reading it.
If an
employer decides to establish a money purchase (defined contributions) pension
scheme or to convert its existing final salary (defined benefits) to a money
purchase one, the next decision is the type of money purchase scheme. There are two types, but a number of
variations. The first is an occupational
pension scheme (OPS) and the second could be any of personal pension policies,
a grouped personal pension plan (GPPP) and a stakeholder pension scheme
(theoretically an employer could establish this as an OPS).
The distinction between these two types can be made clear by an alternative nomenclature (not found in the definitions in s1 of the Pension Schemes Act 1993). A traditional OPS is sometimes referred to as a trust based scheme and the others as contract based. In short, such an OPS is established by an employer to provide benefits for employees and others and is managed by trustees who collect the contributions, hold the scheme’s assets and pay the pensions and lump sum benefits. There is therefore a three sided relationship between the employer, the trustees and the members. Contract based schemes are schemes established by insurance companies, unit trust managers etc, and the main significant relationship is one of contract between the member and the provider. There may also be a collateral contact between the employer and an employee, under which the employer pays contributions to the provider and provides a payroll deduction service for the member’s own contributions, but this does not make the employer a party to the scheme.
For all
practical purposes final salary or other salary related pensions are provided
only through an OPS (trust based), but money purchase benefits can be provided
by either type. Many employers, who have
provided salary related benefits through an OPS, have continued to use the OPS
structure to provide money purchase benefits.
Employers starting their first pension scheme or changing to money
purchase are sometimes advised to use an OPS.
My purpose in this note is to suggest that it is likely that a contract
based scheme is to be preferred, except perhaps where the economies of scale of
a very large OPS might give better value for money than a contract based
scheme.
I set out overleaf a table comparing some of the advantages or otherwise
of the two types. Advantages are shown
as “yes”. Although there are many more possible examples, the advantages
of contract based schemes can be reduced to two, which are that:
a)
there are no trustee
responsibilities (and corresponding liabilities); and
b)
the regulatory requirements of the
pensions legislation apply, for the most part, only to OPSs and not to contract
based schemes.
An
important example of (a) is that, in a final salary scheme, the trustees’ duty
of care in making investment decisions is owed mainly to the employer, who must
pay increased contributions if poor decisions are made. As the trustees or a majority of them are
appointed by the employer, and the employer is likely to be a party to the
investment policy, there is a close relationship in which the trustees are
unlikely to be sued by the employer. It
is very different with a money purchase scheme.
Here the duty is owed solely to the members, who have no loyalty or
other ties to inhibit them from making claims against the trustees for
unsatisfactory investment results.
|
topic |
OPS |
GPPP
etc |
|
freedom from
principal employer’s responsibilities |
no |
yes |
|
freedom from
trustees’ general responsibilities |
no |
yes |
|
freedom from
trustees’ responsibility for investments |
no |
yes |
|
freedom from trustees’
responsibility for annuities |
no |
yes |
|
freedom from
trustee knowledge and training |
no |
yes |
|
freedom from
winding up expenses |
no |
yes |
|
freedom from
red tape |
no |
yes |
|
company
booklet, employee care |
yes |
yes |
|
member’s ownership
of benefits (“portability”) |
no |
yes |
|
choice of
indexed or flat rate pension |
yes |
yes |
|
company’s
contributions |
yes |
yes |
|
employees’
contributions |
yes |
yes |
|
tax relief |
yes |
yes |
|
contracting out
if existing OPS contracted out (no need to change arrangements) |
yes |
no |
|
continuity
(avoidance of change and uncertainty on change of existing scheme) |
yes |
no |
Some
proponents of the OPS say, as a trump card, that an OPS shows a commitment to the
employees that is not existent with a contract based scheme. To this my answer is that commitment is shown
far more in how much the employer is willing to contribute and in its
communications with employees and scheme members. Generous contributions with a good
explanatory booklet, regular reports and clear forms are what the employees
see, and these can be provided equally effectively in either pension type. The
only real difference may be that, in many cases, the routine work to be done
and fees that an adviser can earn are likely to be higher in the case of an OPS
than a contract based scheme.
30
December 2005
©
Roderick Ramage
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