Buyer’s guide to contract-based DC pensions

Focus on facts

What are contract-based DC pension schemes?

These are group pension schemes in which ownership and responsibility lie with the provider. The schemes, which are set up by employers, include group personal pension plans (GPPs), stakeholder schemes or group self-invested personal pensions (Sipps). Both the employer and the employee can make monthly contributions to the pension pot. The relationship is between the individual member and the pension provider.

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What are the origins of contract based DC schemes?

Most new DC schemes were set up by employers between 1980 and 1999. GPPs were introduced in 1988, when the government replaced retirement annuity plans with personal pensions. Stakeholder pensions were introduced
by the government in April 2001 aimed at employees on low incomes as a means of saving for retirement.

Where can employers get more information and advice on contract based DC plans?

The Society of Pension Consultants is the representative body for pension providers and can be contacted on 020 7353 1688.

The Pensions Advisory Service offers free information and guidance on pensions. It can be contacted on 0845 601 2923.

The Pensions Regulator supervises the pension industry and employers that administer pension schemes. Call 0870 6063636.

Nuts and bolts

What are the costs involved?

A member typically pays the costs involved in contract-based defined contribution (DC) pension schemes. There is an ongoing cost of the annual management charge (AMC) applied to members’ funds, which will cover services
such as access to investments, administration, and phone support. The AMC is normally around 0.5%, depending on the number of members, and funds selected.

What are the legal implications?

Employers need to be aware of the changes coming in as part of the 2012 pension reforms, such as ensuring any new scheme will be compliant with auto-enrolment.

From 2012, all employers will also have to make minimum compulsory contributions for staff. Where a scheme does not exist, employers will have to set up access the national employment savings trust (Nest) for employees.

What are the tax issues?

Employer and employee contributions are both eligible for tax breaks on their pension contributions. From April 2011, tax relief on pension contributions for those earning over £150,000 has been reduced from relief on £255,000 to £50,000 a year.

In practice

What is the annual spend on contract-based DC schemes?

According to figures from the Association of British Insurers (ABI), at the end of 2010, new premiums totalled £2 billion for GPPs and £513 million for employer-sponsored stakeholder pension schemes.

Which contract-based DC providers have the biggest market share?

There are no figures available, but the biggest providers include Aegon, Aviva, Friends Provident, HSBC
Workplace Retirement Savings, Legal and General, Prudential, Scottish Widows, Standard Life and Zurich Life.

Which providers increased their share the most over the past year?

The providers that have increased their share the most over the past year include Scottish Life, Aegon, Blackrock and Fidelity.

This year’s tax changes and next year’s pension reforms are changing the landscape for employers providing contract-based defined contribution pension schemes, says Tynan Barton

There are currently three million members of defined contribution (DC) contract-based pension schemes, according to figures from The Pensions Regulator. But the number of people saving into DC schemes, both trust- and contract-based, will rise because of the 2012 pension reforms, which will introduce auto-enrolment to workplace schemes.

Contract-based DC pension plans are group pensions in which the ownership and responsibilities of running a scheme fall to the provider. The structure and governance of contract-based schemes, such as group personal pension plans (GPPs), stakeholder schemes and group self-invested personal pensions (Sipps), differ from trust-based pensions, which have a trustee board for governance and monitoring. Among other things, the trustees are responsible for how benefits are paid, contributions are managed and investments offered. Trust-based schemes are also required to have audited reports and accounts each year.

A contract-based scheme, meanwhile, is the grouping together of individual policies, says Jamie Jenkins, head of corporate marketing at Standard Life. “They are not one legal entity, they are individual contracts, usually between the provider and the employees, whereas under a trust-based scheme, the contract is between the trustees and the employer,” he explains.

The types of scheme also differ in their legal structure. In contract-based plans, the provider runs the legal framework and there is no requirement for an employer to take on governance on behalf of members, removing many costs that are required in trust-based schemes. Daniel Smith, head of DC full service sales at Fidelity, says: “Employers do not have to pay for a pensions lawyer to set up the trust, for reports and accounts, or for the audit of accounts.”

But the differences between the types of scheme will not affect members’ experience, because many elements are common to contract- and trust-based schemes. “You can have open architecture, a wide range of investment funds, web access, modelling tools and the ability to manage accounts online,” says Smith.

Set up a governance committee

A current trend in the market is employers operating contract-based DC schemes looking to set up a governance committee to perform a similar function to that of trustees. “They could set up a governance committee that performs a similar function, albeit not legally charged, in a contact-based scheme,” says Standard Life’s Jenkins. “It is not a legal requirement, more best practice, and is typical of larger schemes.”

The pensions market is currently being driven by the 2012 reforms, which will require every employer to offer staff access to an occupational pension scheme or the national employment savings trust (Nest). Jamie Clark, business development manager at Scottish Life, says: “Larger employers tend more towards trust-based schemes because of the scale of economy for larger schemes, but there is no reason why a GPP cannot do the job.”

A key difference between contract- and trust-based schemes is the ability to offer refunds. At the end of January 2011, in preparation for auto-enrolment in 2012, the government launched a review of the regulatory differences between occupational and workplace personal pension schemes. Under a trust-based scheme, if a member leaves within two years, a refund can be taken, so they get their money back. It is not legally possible to take a refund under a contract-based scheme, but this difference may be resolved under the 2012 reforms.

Scottish Life’s Clark says: “We will probably see the market go towards a level playing field, with the national employment savings trust (Nest), private provision, trust and contract, with no legislative differences between them, which will be ideal for auto-enrolment.”

Government review to assess best practice

The government’s review will also assess best practice for default investment funds and will specifically include contract-based schemes. “It is clear that the Department for Work and Pensions wants to start including contract-based plans in governance, and looking at the default funds of DC plans, how they are monitored in comparison to Nest,” says Clark.

Next year’s reforms are also causing most employers to look at their pensions offerings to ensure they are fit for purpose. “Auto-enrolment has become a reality,” says Jenkins. “Employers are starting to think of it within their accounting and planning horizons.”

Providers expect Nest to drive costs in the marketplace, so are reviewing and adapting their offerings. “Some providers have said that they will do direct-to-market offerings, which look and feel like Nest at the same cost base,” says Clark.

There is also some apprehension in the industry that the introduction of the Financial Services Authority’s (FSA) retail distribution review (RDR) in 2013 will shake up the contract-based market. The RDR will end the remuneration of corporate advisers and employee benefits consultants by commission paid by pension providers, and will ensure the cost of investment advice is agreed up-front.

There is a market trend among larger employers to consider commission payments, when normally they may not have entertained the idea, says Steve Watson, head of DC at Alexander Forbes. “There are budgetary constraints and pressure internally in organisations to look at their cost base. Larger employers realise RDR puts a sell-by date on commission-based contract-based schemes.”

Another key issue in the contact-based DC pensions market is the reduction in tax relief on pension contributions for high-earners.

From 6 April this year, the amount of tax-free contributions employees can pay into pensions each year has been reduced from £255,000 to £50,000. Employers may therefore look to other vehicles for high-earners to save for retirement, or other forms of remuneration for these employees, such as individual savings accounts (Isas), which have an increased allowance of £10,200 in stocks and shares (see also Rich Pickings, page 22).

Jenkins adds: “It is an interesting time because the industry is thinking about what to do for these people, as there is not a product that everybody will agree is the next best tax-efficient vehicle. You have a range of things that could be used, depending on your attitude to risk. Things like offshore or onshore bonds, maximum investment plans and venture capital trusts. It means providers are forced to innovate and look at delivering a range of products.”
With pension reforms and tax changes currently shaping the pensions landscape, employers and providers are seeking to ensure employees have access to an engaging proposition that will be valued.

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