Bringing your pensions under one roof

Pension transfers can be complicated and you should always seek professional financial advice before going ahead. Remember, whether a transfer is suitable or not will very much depend upon your individual circumstances and objectives.

There are a number of different reasons why you may wish to consider transferring your pension(s), whether this is the result of a change of employment, poor investment performance, high charges and issues over the security of the pension scheme, or a need to improve flexibility.

You might well have several different types of pension, including a final-salary related scheme(s), which pays a pension based on your salary when you leave your job and on years of service. Your previous employer might try to encourage you to move your occupational pension away by boosting your fund with an ‘enhanced’ transfer value and even a cash lump sum. However, this still may not compensate for the benefits you are giving up, and you may need an exceptionally high rate of investment return on the funds you are given to match what you would receive if you remained in the final-salary related scheme.

Alternatively, you may have a defined contribution (money purchase) occupational scheme or a personal pension. These pensions rely on contributions and investment growth to build up a fund.

If appropriate to your particular situation, it may make sense to bring these pensions under one roof to benefit from lower charges, make fund monitoring easier and aim to improve fund performance. But remember that transferring your pension will not necessarily guarantee greater benefits in retirement.

You will need to consider that your pension(s) might have or had other valuable benefits that you could lose when transferring out, such as death benefits or a Guaranteed Annuity Rate (GAR) option. A GAR is where the insurance company guarantees to pay your pension at a particular rate, which may be much higher than the rates available in the market when you retire.

In addition, some pensions may also apply a penalty on transferring out. These can be significant depending on the size of your fund, so it is important to check if one applies in your case.

It is also important that the investments chosen are appropriate for the level of risk you are prepared to take. Obtaining professional financial advice will mean that you are fully able to understand the risks and potential benefits of the different funds and investments and can make an informed decision about the level of risk you are prepared to take.

Transferring your pension overseas

The ability to transfer a pension from the UK to another country formed part of the pension reform known as A-Day, introduced on 6 April 2006. Under these changes people no longer resident in the UK, but who have UK pensions, are now allowed to transfer their pensions across to a Qualifying Recognised Overseas Pension Scheme (QROPS), provided they meet certain conditions.

Transferring your pension overseas into a QROPS, which has been approved by HM Revenue & Customs (HMRC) to accept a pension transfer from a UK pension scheme, is an important decision that may give you extra benefits.

It is vital that you understand all aspects of any QROPS pension transfer, which is why you should seek professional financial advice to evaluate your personal situation and to understand the process in full.

With reference to HMRC rules, a transfer into an offshore pension scheme qualifies as a benefit crystallisation event. This means that your UK pension is given a valuation against your Lifetime Allowance. The allowance currently set is £1.8m for 2010/11.

The possibility of transferring a UK pension into a QROPS can be extremely beneficial to expatriates living abroad in Europe and the rest of the world. A QROPS pension transfer can also be of great interest for someone who has not yet left the UK but is in the process of planning to do so.

QROPS pension schemes are not just for UK nationals either. People of different nationalities who have accumulated a pension fund through working in the UK can also transfer their pension into a QROPS.

A new, simple, low-cost pension scheme

In December 2006, the former government published a White Paper outlining its workplace pension reforms, including proposals for NEST (the National Employment Savings Trust) – previously called Personal Accounts. This led to the Workplace Pension Reforms set out in the Pensions Act 2008. These reforms aim to increase individuals’ savings for retirement.

A new, simple, low-cost pension scheme, NEST will be introduced as part of the workplace pension reforms. The new employer duties under the government’s workplace pension reforms will be introduced over a four-year period from 1 October 2012. The staggered introduction of these duties is known as ‘staging’. Broadly speaking, the new duties will apply to the largest employers first, with some of the smallest employers not being affected until 2016. As part of the new duties, firms will be enrolled into NEST.

The former government established NEST as part of pension reforms aimed at tackling a lack of adequate pension savings among low- and middle-income UK workers. The NEST’s investment strategy will be low-risk and there may be a possibility that, after five years, savers will be able to move their money out of the NEST into other pension schemes.

The reforms include the stipulation that from 2012 employers either pay a minimum contribution of 3 per cent into the scheme or automatically enroll workers in existing pension vehicles. NEST will launch its scheme for voluntary enrolment in the second quarter of this year.

NEST will be a trust-based defined contribution occupational pension scheme. It will be regulated in the same way as existing trust-based defined contribution schemes and will provide people with access to a simple, low-cost pension scheme. The charges are a 1.8 per cent charge on the value of each contribution to cover NEST’s start-up costs, and an annual management charge of
0.3 per cent of the value of the fund.

The new two-part charge by NEST will work as follows: if a member has a fund of £10,000, they will pay £30, due to the 0.3 per cent annual management charge; if that same member makes a monthly contribution of £100, including tax relief, they will pay £1.80 on the sum, due to the 1.8 per cent contribution charge.

There will be an annual contribution limit of £3,600 (in 2005 earnings’ terms) into NEST. This will be uprated by earnings year on year. This limit will be reviewed in 2017.

Workers will be automatically enrolled into the default investment fund but there is likely to be a choice of investment funds, which may include options such as social, environmental and ethical investments. Those not wishing to make an investment choice will stay in the default fund.

Employers will need to automatically enrol their eligible workers into a qualifying pension scheme and make contributions to it.  Workers will be able to opt out of their employer’s scheme if they choose not to participate.

Workers who give notice during the formal opt-out period will be put back in the position they would have been in if they had not become members in the first place, which may include a refund of any contributions taken following automatic enrolment.

Anyone who joins NEST will be able to continue to save in the scheme even after they leave the workplace or move to an employer that does not use NEST. The self-employed and single person directors are not eligible for auto-enrolment but will be able to join NEST.

Options available when an occupational pension is not provided

Your employer is currently required to offer you the chance to join a pension scheme if they currently employ five or more employees. If an occupational pension is not provided, then this would normally be a Stakeholder Pension Scheme or alternative Personal Pension Scheme. The requirement for employers to provide access to Stakeholder Pension Schemes is regulated by the Pensions Regulator.

Your employer must offer you access to a Stakeholder Pension Scheme so long as both the following apply:

– you earn more than the National Insurance lower earnings limit

– there are five or more employees where you work

Your employer does not have to offer you access to a Stakeholder Pension Scheme if one of the following apply:

– you are able to join an occupational pension scheme

– you are able to join an alternative personal pension scheme where your employer pays in an amount equal to at least 3 per cent of your pay

Your employer must allow you to pay into your Stakeholder Pension Scheme directly from your wages through the company’s pay system. Many employers are prepared to pay into your Stakeholder Pension Scheme and pay the cost of the Stakeholder Pension Scheme provider’s administration charges. However, they are not required by law to do so.

If you leave your employer, or transfer your money out of the Stakeholder Pension Scheme to another scheme, you don’t lose the money your employer has already paid in.

If your employer offers you an alternative Personal Pension Scheme instead of a Stakeholder Pension Scheme, its terms must meet minimum standards set by the government. Your employer is obliged to contribute the equivalent of at least 3 per cent of your salary if they are offering it as an alternative to a Stakeholder Pension Scheme. But they don’t have to pay the administration costs of the pension scheme.

Your employer may arrange for a pension provider to set up a Personal Pension arrangement through the workplace. A Personal Pension Scheme (including a Stakeholder Pension Scheme) arranged in this way is called a ‘Group Personal Pension Plan’ (GPPP).

Although they are sometimes referred to as company pensions, GPPPs are not run by employers and should not be confused with occupational pensions. A GPPP is a type of Personal Pension Scheme arrangement where your employer chooses the financial provider on your behalf.

Some advantages of contributing to a GPPP arranged by your employer:

– your employer will normally contribute to your pension and if the GPPP is offered as an alternative to a Stakeholder Pension Scheme your employer must contribute an amount equal to at least 3 per cent of your basic salary

– if your employer has contributed to your pension and you leave your employment you do not lose the money they have contributed

– your employer will normally deduct your contributions from your pay and send them to your pension provider

– a GPPP is negotiated with the pension provider on behalf of a group of people and your employer may be able to negotiate better terms than you would get individually, for instance, they may negotiate reduced administration costs

– you will usually be able to continue making contributions to your pension if you change employers

Contributing a preferential sum into an employee’s pension plan

Salary sacrifice (sometimes known as ‘salary waiver’) in the context of retirement planning is a contractual agreement to waive all or part of an employee’s salary in return for the employer contributing a preferential (equivalent) sum into their pension plan.

Salary sacrifice is about varying the employee’s terms and conditions as they relate to remuneration, and is a matter for agreement between the employer and employee.

To be effective, a salary sacrifice must be ‘given up’ before it’s subjected to tax or National Insurance Contributions (NICs). This allows the employee to save the entire amount of their sacrificed income in their pension plan free of tax and NICs.

There are also savings for an employer, as they don’t have to pay NICs on the employee’s sacrificed income. If the employer passes some or all of these savings on to the employee, they’ll benefit from even larger tax and NICs-free at no extra cost.

For these reasons, salary sacrifice could significantly enhance the long-term value of the employee’s pension plan, as well as allowing them to enjoy considerable savings.

However, salary sacrifice may not be appropriate for individuals with earnings of £150,000 as, in accordance with new pensions tax relief regulations for high earners, any amount of employment income foregone by salary sacrifice in return for an equivalent pension contribution, where the agreement was put in place on or after 22 April 2009, will be considered relevant income and could result in the application of a Special Annual Allowance charge that reduces the tax relief available.

How the new rules could affect your retirement provision

From 2011, private sector Final Salary Pensions need only be uprated in line with the Consumer Prices Index (CPI) rather than the Retail Prices Index (RPI). Typically, CPI runs below RPI and, consequently, over time this could mean some final salary members experience a reduction in their retirement income.

This may not apply to all schemes. Some schemes may specifically state in their rules that they will uprate benefits in line with RPI. It’s also worth bearing in mind that, although the government sets what the minimum inflation-linking schemes must provide, it’s perfectly possible for a scheme to provide increases in excess of this level.

If your scheme does intend to adopt CPI uprating, this could have a negative impact on the income you can expect to receive from the scheme. Ultimately, this depends on the RPI and CPI levels and how they differ, but historically CPI has trailed behind RPI. The impact on your income will also depend on when you built up benefits, because the inflation protection afforded to final salary scheme members has changed over the years.

Tax is not applicable on the money you are paid out on retirement. But from April 2011, if you earn more than £150,000 you will have to pay a tax bill based on your age, length of service and salary.

Joining your employer’s scheme

Occupational pension schemes vary from company to company. Your scheme is likely to be one of two general types, Final Salary related or Defined Contribution Scheme.

Occupational pension schemes are pension arrangements that employers set up to provide retirement income for their employees. The employer sponsors the scheme and a board of trustees ensures that benefits are paid.

Public-sector occupational pension schemes are different in that they are established by an Act of Parliament, which lays down the scheme rules.

Final Salary Schemes
Final Salary Schemes are also known as Defined Benefit Schemes. With these, the amount you receive on retirement depends on your salary when you leave the company or retire, and the length of time you have been a member of the scheme.

It is usually paid at the rate of one-sixtieth of final salary multiplied by the number of years of scheme membership (the accrual rate). So someone who has been a scheme member for 40 years would retire on two-thirds of final salary.

Your pension will depend on your final earnings and not on stock market conditions over your working life. But these schemes are becoming rarer, and many companies are changing their plans from Final Salary to Defined Contribution Schemes.

When you leave a company, you normally have the choice of leaving the money where it is to claim on retirement or transferring it to a new company’s occupational scheme or to a Personal Pension Plan. And if you leave a firm within two years of joining its pension you can have your own contributions, minus tax relief, returned to you, if the scheme’s rules allow.

Defined Contribution Schemes
Defined Contribution Schemes are also known as Money Purchase Schemes. With these you know what you are contributing towards your pension, but what you receive when you retire depends on the performance of your pension fund(s) over the years and on economic conditions when you actually retire.

On retirement, the money would normally be used to purchase an annuity (a regular income for life) which pays an income until you die. You do not have to accept the annuity offered by the company running your scheme. You have the right to choose the open market option, in other words, you can shop around for the best annuity rates.

Joining an occupational pension scheme
Your employer is required to offer you the chance to join a pension scheme. If you work part-time and your employer has an occupational pension scheme, you will usually be allowed to join it.

Before you join an occupational pension scheme, you should check:

– how much you will have to pay

– what contribution your employer is going to make

You receive ‘tax relief’ on the money you pay into your pension scheme. This means you pay less tax because your employer takes the pension contributions from your pay before deducting tax (but not National Insurance Contributions).

Contributions you can make HM Revenue & Customs (HMRC) sets a limit on the contributions you can make into occupational pension schemes. For Defined Contribution Schemes, the limit is on how much can be paid in total in a tax year. For Final Salary Schemes, the limit is on the value put on the increase in your pension gained during the tax year.

The annual allowance for the tax year 2010/11 is £255,000. If you pay more than the annual allowance into such a pension scheme, or the value of your pension exceeds the allowance, you will be charged tax at 40 per cent on the excess. The annual allowance does not apply in the tax year when you start to draw retirement benefits.

There is also a limit on the value of retirement benefits that you can draw from an approved pension scheme before tax penalties apply. This limit is called the Lifetime Allowance.

The Lifetime Allowance is £1.8m in the 2010/11 tax year. When you start to draw your pension, HMRC will apply a recovery charge to the value of retirement benefits that exceed the Lifetime Allowance. The amount will depend on how you pay the excess.

Increasing your benefits
Occupational pension schemes usually require you to make a regular contribution based on a percentage of your salary.

You may also be able to increase your benefits by making Additional Voluntary Contributions (AVCs).

Money Purchase AVC – One of the ways you can do this is by paying into an Additional Voluntary Contribution (AVC) arrangement run by your scheme trustees. The majority of these are money purchase, which means that your contributions are invested, usually with an insurance company, to build up a fund. An AVC arrangement run through your employer’s pension scheme is known as an ‘in-house’ AVC scheme. The employer normally bears the cost of administration of this scheme and so costs tend to be lower than topping up pensions through other means.

Added Years – If your scheme allows you to buy added years, this will enable you to increase the number of years of service you have in your main scheme. The extra service will increase both the amount of pension that you will receive and your tax-free cash allowance, irrespective of when you started contributing. How much you pay as voluntary contributions will be worked out by your main scheme. The cost will depend on how many years you want to buy and certain factors such as your age and salary for pension purposes.

Free-Standing AVC (FSAVC) – It may be possible for you to pay into a FSAVC arrangement. This is similar to a money purchase AVC but is provided by external providers. Since 6 April 2006, it has no longer been compulsory for occupational pension scheme trustees to offer an AVC facility to its members.

If you joined your occupational pension scheme during or after 1989, you were restricted on how much you could put into the scheme. However, following changes to pension rules in April 2006, you can now save as much as you like into any number and type of pensions. You are able to do this at any age. You also receive tax relief on contributions of up to 100 per cent of your earnings (salary and other income) each year, subject to an upper ‘Annual Allowance’.

Savings above the Annual Allowance and a separate ‘Lifetime Allowance’ will be subject to tax charges. These allowances will be restricted if you become unemployed and wish to continue to pay into your pension scheme.

Having an occupational pension does not affect your Additional State Pension entitlements. But you will lose some or all of your Additional State Pension if your company pension scheme is contracted out.

Your pension scheme administrator can provide you with an estimate of:

– how much you will receive when you retire
– the value of any survivor’s benefits that may become payable
– how much you will receive if you have to retire early due to ill health

Up until April 2006 you could not draw your pension from an occupational scheme and continue to work for the same employer. Following the 6 April 2006 changes, you are now able to do this, providing your particular scheme allows you to. Also, if you leave your employer, it’s important to find out what your occupational pension scheme options are.

All employers currently with five or more employees have to offer access to a pension scheme. If your employer doesn’t offer a pension, there are lots of pension providers for you to choose from and you should seek professional financial advice so that you can make an informed decision about which pension option is right for you.

From 2012 employers will need to automatically enrol their eligible workers into a qualifying pension scheme and make contributions to it.

Planning for your retirement years

There are three types of non-State pension. Some are offered by employers and some you can start yourself. They are:

– Occupational Final Salary Schemes – offered by some employers

– Occupational Defined Contribution Schemes (also called Money Purchase Schemes) – offered by some employers

– Stakeholder Pension Schemes and Personal Pensions – offered by some employers, or you can start one yourself. You may also be offered a group personal pension at work (also called Money Purchase Schemes).

If you work for a business employing fewer than five employees, your employer does not currently have to offer you access to a pension scheme. However, the government is planning changes that will mean all employers will have to offer and contribute towards a pension in the future. From 2012 employers will need to automatically enrol their eligible workers into a qualifying pension scheme and make contributions to it. Employees will be able to opt-out of their employer’s scheme if they choose not to participate.

Workers who give notice during the formal opt-out period will be put back in the position they would have been in if they had not become members in the first place, which may include a refund of any contributions taken following automatic enrolment.

Although you don’t have to join any pension scheme offered through your employment, it usually makes sense to join an occupational pension scheme if it’s available because:

– your employer normally contributes

– often you also receive other benefits, such as life insurance which pays a lump sum and/or pension to your dependants if you die while still in service; a pension if you have to retire early because of ill-health; and pensions for your spouse and other dependants when you die.

Not all pensions offered by employers are occupational pensions. Your employer may offer a Stakeholder Pension or a Personal Pension through a Group Personal Pension arrangement. These pensions are not called occupational pensions, even though the employer may contribute.

Comparable benefits in return for lower National Insurance Contributions

In 1988 it was possible for employees to contract out of the State Earnings-Related Pension Scheme (SERPS), now called the State Second Pension (S2P), where their work scheme did not do this for them already, and set up a form of Personal Pension Plan called ‘Protected Rights’.

Protected Rights are pension funds built up with contributions paid by the government into a Money Purchase or Defined Contribution pension scheme when an employee decides not to participate in S2P (or its predecessor SERPS).

Occupational Final Salary schemes (also known as Defined Benefit schemes) have been able to do this for a much longer time period. Such a scheme provides comparable benefits to the Additional State Pension in return for lower National Insurance Contributions.
Companies could also contract out via a Money Purchase scheme on a similar basis. The scheme would then be called a Contracted Out Money Purchase Scheme or COMP Scheme.

However, from 1988, contracting out was also possible for employees who were either in a contracted-in occupational scheme or in a personal pension.

Employees who contracted out paid the full National Insurance rate as normal and the Department for Work and Pensions repaid some of it in the following tax year, to the plan of the employee’s choice.This money was invested as the employee chose from the range of funds made available by the insurance company they were using.

Building up your entitlement to an extra pension

If you are in work, you may also be building up entitlement to the Additional State Pension. The Additional State Pension, or State Second Pension (S2P), is paid in addition to the Basic State Pension. Your entitlement to the Additional State Pension, whether from SERPS (State Earnings-Related Pension Scheme) or S2P, is calculated when you claim the Basic State Pension.

The Additional State Pension is based on your earnings in tax years from April 1978 up to the last complete tax year before you reach state pension age.

Between April 1978 and April 2002, this extra pension was called SERPS. Since April 2002 it has been called S2P. The calculation of S2P is more generous for low and moderate earners, who receive proportionately more from the S2P. Also, since April 2002, it has become possible for people who are carers, or have a long-term illness or disability, to qualify for the Additional State Pension.

All employees who earn more than the lower earnings limit for the relevant tax year qualify for the Additional State Pension unless they join an occupational or personal pension scheme that is contracted out.

If you are a carer, you can build up your entitlement to Additional State Pension – for example, if you receive Child Benefit and look after a child under six years old; if you are entitled to Carer’s Allowance; or if you look after a sick or disabled person and are receiving Home Responsibilities Protection.

Self-employed people do not qualify for Additional State Pension.

‘Qualifying years’ credited throughout your working life

The Basic State Pension is a government-administered pension. It is based on the number of qualifying years gained through National Insurance Contributions (NICs) you’ve paid, are treated as having paid or have been credited with throughout your working life.

The full Basic State Pension is £97.65 a week (2010/11). The current state retirement age for men is age 65, and for women it is changing. The state retirement age gradually increases to age 65 for women born between 5 April 1950 and 5 April 1955. This change started on 6 April 2010 and finishes on 5 April 2020.

This also has an effect upon Pension Credit for both men and women, as it moves the Qualifying Age (QA) to 65 over the next ten years from 6 April 2010.

The state retirement age for men and women will change again from 6 April 2024, moving everyone’s retirement age gradually to 66, then in 2034 towards 67 and in 2044 towards 68. The rules for building up your Basic State Pension have also changed for those people retiring after 6 April 2010.

From 6 April 2010, men and women who reach state retirement age now need 30 qualifying years to obtain the maximum Basic State Pension. If you have less than 30 years, you receive a proportion, for example, 15 years equals 50 per cent of the maximum pension.

A qualifying year is a year when you paid enough NICs or were credited with NICs, for example, if you were receiving jobseeker’s allowance or child benefit.

From 6 April 2010 there is now no minimum number of qualifying years. Before this date you were required to have at least 25 per cent of the maximum requirement to qualify for any pension.