Finance Directors' Guide to Pensions
Rules and regulations
This section will focus mainly on the rules and regulations governing DB schemes.
DB schemes, most commonly "Final Salary" or "Career Average", provide pension and life assurance benefits to employees and their dependants. They provide a specific level of pension based on a pre-defined formula. A common example of how pension would be calculated in a final salary DB scheme is as follows:
(Years of Pensionable Service / Accrual Rate) x Final Pensionable Salary = Pension Entitlement
Benefits are funded by contributions from the employer and usually the employees. Typically employee contributions are fixed as a percentage of pensionable salary. The scheme's assets are held under trust and separated from the employer. The adequacy of these assets to provide the pre-defined level of benefits is assessed on at least a triennial basis. Where a deficiency is found between the assets and the scheme liabilities then deficit recovery contributions are payable by the employer.
As the employees' benefits are pre-defined, the risk of higher contributions payable due to poor investment returns on the scheme's assets or higher benefits paid because members live longer than expected usually falls on the employer.
DB schemes are set up under trust. This legal status ensures that they are eligible to receive certain tax concessions from the UK Government. Scheme benefits are governed by the scheme's Trust Deed and Rules (TD&Rs) and Trustees are responsible for the running of the scheme. We discuss their role and responsibilities below. The world of DB pension schemes has become very heavily regulated, especially in recent years. We also discuss the relevant legislation and powers of the Pensions Regulator in sections below.
The Trustees of the pension scheme are responsible for running the scheme. They have an overriding responsibility to act in the best interests of all the members of the pension scheme and to protect the security of accrued benefits. The TD&Rs will set out issues such as the minimum number of trustees required to run the scheme and how many will need to be present for their meetings to be quorate.
Conflicts of interest have become a big issue in recent years and company representatives who also act as a trustee should ensure that a suitable conflict policy is in place.
The Trustees will be advised by the Scheme Actuary and the corporate directors will usually take independent actuarial advice.
Trustees are also required to undertake and maintain a certain level of training (commonly referred to as Trustee Knowledge and Understanding). New trustees will find the Pensions Regulator's Trustee Toolkit a useful training resource. The Trustee Toolkit highlights the role and responsibilities of new trustees and details the expectations of their new post. The Pensions Regulator details trustee responsibilities.
There are broadly three types of trustee - Member Nominated Trustees (MNTs), Employer Nominated Trustees (ENTs) and Independent Trustees.
The TD&R set out how the scheme is administered and governed. It will include details of the role of professionals, how the contributions paid by employees and the employer are determined and the benefits payable by the scheme.
The Trust Deed contains the details of the governance of the scheme; that is the trustees' responsibilities and powers relating to investments, appointment of trustees, appointment of advisors and changing the benefits of the scheme. One of the key provisions of the Deed is the balance of powers between the employer and the trustees as this will affect the level of influence the employer can exert. A further key provision is the power of amendment as this states which parties are allowed to amend the Deed. The Deed will also cover the details of when a Section 75 debt (s75) is triggered. This can be especially complicated if the scheme contains or contained employees from more than one employer.
The Rules define the benefits payable to the beneficiaries of the scheme. It will include the level of benefit accrual, what age members are able to retire at, the rate pension increase and so on.
TD&Rs are often subject overriding legislative changes or change in benefit provision over time. This can lead to complicated benefit structures as previous versions of the TD&Rs can continue to apply to certain members in certain scenarios.
A wealth of legislation applies to occupational pension schemes. The most recent pieces of prominent pension legislation are the Pension Acts of 1995, 2004, 2008, 2011, 2014 and 2015 though a number of other relevant bills exist that affect issues such as age and sex discrimination, pension sharing on divorce, and employer debt. Summaries of the main relevant pieces of legislation are provided below:
Sets out three categories of pension: occupational, personal and State Pension. Initially contained information on indexation of benefits but the majority of the main legislation was overridden by the Pensions Act 1995.
Set up the Occupational Pensions Regulatory Authority (OPRA) which was a pre-cursor to the Pensions Regulator. It set out the Minimum Funding Requirement (MFR) although this has subsequently been replaced by the Scheme Specific Funding Regime. It also set up a compensation fund for pension schemes in the event of fraud, introduced the requirement for schemes to have MNTs, protected members against having their benefits reduced without their consent, required greater disclosure of information to members and set out the minimum level of increases to apply to pensions.
Established the Pensions Regulator in the place of OPRA. It also established the Pension Protection Fund (PPF) to protect members in the event of a sponsoring employer insolvency. It removed the MFR and set out the detail of the scheme-specific funding requirements and set the minimum number of MNTs to be one-third of the trustee board. The Act also set out details on pension sharing on divorce and civil partners as dependants. Section 251 of the Act also made it possible for the sponsoring employer to benefit from any surplus in the scheme subject to a resolution from the trustees.
The main aim was to facilitate wider saving in occupational pension schemes. Employees will now have to 'opt out' of occupational pension schemes rather than 'opt in'. There will be a minimum level of contributions required to be paid into a Qualifying Scheme. It also established the National Employment Savings Trust (NEST) aimed at low to moderate earners which will hopefully encourage them to start saving for their retirement. Please see the DC section for more information on auto-enrolment.
Facilitated the automatic enrolment of employees into a qualifying pension system, requiring employers to make contributions to that scheme. The Act also set out details providing for the indexation and revaluation of occupational pensions and payments from the Pension Protection Fund.
Sets out provisions to implement the single-tier pension, replacing the current basic State Pension and additional State Pension. Brings forward increases to the State Pension Age (gradually rising from 66 to 67 between 2026 and 2028) and implements a framework for regular review of the State Pension Age. In addition the Act introduces the 'pot follows member' concept to help individuals consolidate their pension saving.
Introduces a new category of pension scheme known as 'shared risk' also known as Defined Ambition. Also introduces the concept of 'collective benefits', which could be a feature of a Shared Risk or a Defined Contribution scheme. Sets out a framework for the pension guidance service.
The Pensions Regulator (the Regulator) is the UK regulator for all pension schemes made available to employees. These include all DB and DC occupational schemes as well as stakeholder and personal pension schemes. It replaced OPRA and was established under the Pensions Act 2004. The Regulator's objectives are set out in legislation and include the following:
In order to meet its objectives, the Regulator tends to concentrate on schemes which it believes present the greatest risk to the security of the greatest number of members. This is detailed in the Regulator's 2015-2018 Corporate Plan.
To achieve its objectives, the Regulator has a number of powers which allow it to take action against a scheme's sponsor or trustees if it believes the scheme is being mis-managed. These powers fall into three main categories; namely its investigative powers, corrective powers and anti-avoidance powers.
These powers allow the Regulator to build up a database of scheme information through a number of forms, in order to meet its objectives. They include placing duties on certain individuals to report on breaches relating to specific occupational pension scheme events. The means of collecting scheme information are listed below:
These provide the Regulator with a number of powers where it believes that the law has been broken or the security of the members' benefits is in jeopardy. They include the following:
These give the Regulator the power to act against those deliberately avoiding their pension scheme obligations. They are also known as his "moral hazard powers". Clearance applications are an option for sponsors who wish to obtain assurance from the Regulator that it will not exercise his anti-avoidance powers in respect of a particular event or transaction. More information is available in the Corporate Activity and TPR section.