Ready for stakeholder pensions?

Summary

Stakeholder pensions will be available from 6 April 2001, and employers will be required to provide employee access to a stakeholder pension scheme from 8 October 2001, unless they are covered by exemptions set out in the Stakeholder Pension Schemes Regulations 2000.

We provide a concise overview and summary of the implications for employers of stakeholder pensions, written for non-specialists and largely based on guidance from the Occupational Pensions Regulatory Authority (OPRA).

By October 2001, employers that are not covered by exemptions will have to:

  • designate a stakeholder scheme that is registered with OPRA (designation does not mean an employer has to set up a separate scheme for its employees);

  • provide employees with information about the designated scheme to enable them to contact the scheme provider; and

  • make deductions from employees' pay for their pension contributions to the designated scheme if they so wish.

    Employers will have to offer employees access to stakeholder pensions within three months of each employee starting work, and will be required to consult with relevant employees and any organisations representing them before designating a scheme. "Relevant employees" are defined as those who would be eligible to join the scheme.

    Some employers will be exempt from the requirement to provide access to a stakeholder scheme. This includes those:

  • with fewer than five employees (this will be reviewed after three years);

  • offering a personal pension (in some instances);

  • whose employees all earn below the national insurance lower earnings limit;

  • offering occupational schemes that all staff are eligible to join within a year of starting work (except those aged under 18 or within five years of retirement); and

  • offering a group personal pension to all staff to which the employer makes contributions of at least 3% of its employees' earnings (an additional requirement will be that there should be no exit charges, and this will be reviewed after three years).

    For employees, membership of a stakeholder pension scheme will be voluntary rather than compulsory. Many may yet decide against joining. Actuaries Lane, Clark & Peacock have calculated that a person now aged 30 who manages to contribute £100 a month into a stakeholder pension for the next 30 years could end up with just £50 a week on retirement.

    Occupational pension schemes have long been an important feature of remuneration, and are often seen as a decisive influence on recruitment and retention. But they are not provided to all participants in the labour market. Although occupational pensions form a major element of provision for retirement, over and above the basic state retirement pension, and represent more than a quarter of the value of all personal wealth in the UK, only one-third of people of working age are members of such schemes.

    Over the first half of the 21st century, the number of people above state pension age in the UK is forecast to increase by more than one-third. This is due to the baby booms of the early 1950s and 1960s, and significant improvements in life expectancy.

    According to the Government, there are currently three people in work for every pensioner. By 2040, the ratio is likely to be two-to-one, and, if the pensions policies of the past few years were to remain unchanged, an increasing number of pensioners dependent on the state for their income in retirement would face a poverty-stricken old age.

    To meet this challenge, the Government says that it wants to encourage more people to make provision for their retirement. To this end, stakeholder pensions will be available from 6 April 2001. Employers will be legally required to provide employee access to a stakeholder pension scheme from 8 October 2001, unless they are covered by exemptions set out in the Stakeholder Pension Schemes Regulations 2000 (See Final version of stakeholder pension scheme Regulations )1.

    Here, we provide a concise overview and summary of the implications for employers of stakeholder pensions, largely based on guidance from the Occupational Pensions Regulatory Authority (OPRA)2. Detailed legal guidance on the requirement on employers to provide employees with access to a stakeholder scheme will appear in a future issue of Industrial Relations Law Bulletin.

    A stake in the future

    Stakeholder pensions have been designed specifically for people without access to employer-sponsored pension arrangements. They are intended to provide a low-cost, privately funded supplement to the basic state pension. Under the stakeholder scheme, contributors will buy a stakeholder pension from a private company. The value of the pension they receive will depend on how much they save and what income this will buy at the time of retirement.

    Stakeholder pensions are targeted at people earning between £10,000 and £20,000 a year. However, they will be available to almost everybody - including fixed-term contract workers, the self-employed and people not actually working. It will also be possible to contribute to someone else's stakeholder pension - for example, an individual will be able to make contributions to their non-working partner's stakeholder scheme.

    The Welfare Reform and Pensions Act 1999 requires employers to offer their employees access to a stakeholder pension scheme, unless they are exempt. The Regulations, referred to above, set out the requirements that need to be met by any organisation wishing to set up a stakeholder scheme. The new tax regime for stakeholder pensions is set out in the Finance Act, which received Royal Assent on 28 July 2000. An individual will be able to invest up to £3,600 (including tax relief) in a stakeholder pension each year.

    To qualify as a stakeholder pension, a scheme must satisfy a number of minimum conditions:

  • it must be a money-purchase scheme - also known as a defined-contribution scheme - whereby retirement benefits are based on the money invested by the employer and/or employee;

  • charges in each year must not amount to more than 1% of the value of the fund;

  • any additional charges over and above this 1% must be optional, and must be offered under a separate arrangement with clearly defined costs for the services being offered;

  • the scheme must accept transfers-in from stakeholder schemes, and there must be no additional charge for transferring to a different stakeholder pension;

  • the minimum contribution to a stakeholder pension cannot be set at more than £20 (schemes may set a lower minimum contribution if they wish) and contributions can be weekly, monthly or at other intervals, or can take the form of single, one-off, contributions;

  • to look after the interests of their members, schemes must have trustees or stakeholder-scheme managers;

  • for trust-based schemes (where a body of trustees is responsible for managing the scheme), one-third of the trustees must be independent;

  • schemes must appoint a scheme auditor or a reporting accountant to check the annual declaration, made by the trustees or managers of the scheme, that states that the scheme complies with the charging regulations;

  • a statement of investment principles must be made for all schemes; and

  • schemes must have a default investment option.

    Trust or contract schemes

    Stakeholder pensions can be set up under a trust, or based on a contract between the scheme member and a stakeholder manager - which may be an insurance company, bank, building society, independent financial adviser and so on.

    Schemes set up on a contract basis are not allowed to restrict membership in any way, but trust-based schemes can restrict eligibility for membership of the scheme - for example, to members of a particular trade union or profession.

    Trade unions have shown considerable interest in participating in trust-based stakeholder schemes. In July 2000, the Trades Union Congress announced that it had chosen Prudential as the commercial partner for the TUC Stakeholder Pension Scheme. Full details of that scheme are due to be announced at the organisation's forthcoming congress, which will take place in Glasgow from 11 to 14 September.

    Announcing the decision in July, TUC general secretary John Monks said: "Our goal is to ensure that the TUC Stakeholder Pension Scheme is the best on the market - the one against which other stakeholder pension schemes will be judged."

    According to the TUC, over half a million trade union members work for an employer that does not run an occupational pension scheme; now, the TUC scheme will give such people the chance to save for a cost-effective pension for the first time. A further five-and-a-half million trade union members earning less than £30,000 a year will be able to use stakeholder pensions to top up their existing occupational pensions.

    Unions are not the only organisations that will be able to establish their own schemes. Employers wishing to set up their own stakeholder pension schemes, as opposed to designating a scheme offered by an outside provider, will also be able to do so. These will have to be trust-based rather than contract-based schemes.

    Regulation: OPRA and FSA

    Stakeholder schemes that satisfy registration conditions and have tax approval from the Inland Revenue must be registered with OPRA. The register of stakeholder pension schemes will be available on the OPRA web site from October 20002. OPRA is responsible for enforcing the conditions that allow a stakeholder pension to be registered and can fine trustees and providers not adhering to those conditions. In extreme cases, it can withdraw stakeholder registration and order the winding-up of a scheme.

    Stakeholder managers - those providing contract schemes - must be authorised by the Financial Services Authority (FSA) to carry out stakeholder business. The FSA will regulate the marketing and promotion of all schemes, including any occupational pension schemes that are set up as stakeholder pension schemes.

    Last month, the FSA published a consultation document on its proposed regulatory regime for stakeholder pensions, which sets out detailed rules and guidance for the conduct of stakeholder pensions business and the training and competence of providers3.

    To help guide people through the issues they should consider when they are deciding whether or not to take out a stakeholder pension, the FSA, along with the Department of Social Security (DSS), has worked with industry experts and consumer panels to develop "decision trees". These are designed to help consumers make a choice, where they reasonably can, without having to pay for advice, and to help identify instances in which advice or further information is necessary. The FSA's proposed rules specify that:

  • where stakeholder pension providers have taken consumers through the decision trees, the outcome of the use of the trees will have to be confirmed in writing, with a copy of the "route" taken through the trees included; and

  • where there is an advised recommendation to buy a traditional personal pension (including one linked to a group personal pension) the suitability letter will have to explain why this was considered to be more suitable than a stakeholder pension.

    The FSA does not consider that the employees of stakeholder pension providers, who will be responsible for taking purchasers through decision trees, need to be qualified advisers - provided their role is restricted to giving information. But, together with administrative back-office staff, they will need to be trained and properly supervised.

    The DSS is currently working with the FSA and OPAS, the Pensions Advisory Service, to provide a stakeholder pensions telephone helpline, which is due to be up and running by October 2000.

    There will normally be tax relief on any payments into a stakeholder pension, and stakeholder pension contributions must be deducted from employees' pay after tax4. The provider will then reclaim the basic-rate tax from the Inland Revenue. People who pay income tax at the higher rate (40%) will be able to claim back the tax difference from the Inland Revenue at the end of the tax year.

    If an individual contracts out of the state earnings related pension scheme (SERPS), or the state second pension that will replace SERPS in April 2002, using a stakeholder pension plan, a rebate of national insurance contributions will be paid into their stakeholder plan.

    Employer duties

    The legislation and Regulations on stakeholder pensions impose a number of duties on employers. This month, the DSS is due to publish specific advice for employers on providing access to stakeholder pensions. As we go to press, this advice is about to be made available on the department's web site (www.dss.gov.uk).

    Employers will be required to designate a registered stakeholder pension scheme, having consulted with relevant employees; provide employees and organisations representing them with basic information about the scheme; offer payroll deductions from employees' earnings; and maintain records of employee deductions and payments to the scheme.

    However, some employers will be exempt from the requirement to provide access to a stakeholder scheme. This includes those:

  • with fewer than five employees (this exemption will be subject to review after three years);

  • offering a personal pension (in some instances);

  • whose employees all earn below the national insurance lower earnings limit; and

  • offering an occupational scheme that all staff are eligible to join within a year of starting work (except those aged under 18 or within five years of retirement).

    In addition, OPRA advises that an employer may be exempt if it is a term of each employee's contract that the employer will contribute at least 3% of basic pay into a personal pension on the employee's behalf and a payroll deduction facility is offered to members of such a scheme, provided that the scheme imposes no penalties on employees who transfer out of it or stop making contributions.

    There are various categories of employee for whom employers will not need to provide access to a stakeholder pension. These include those:

  • who can join an existing occupational scheme within 12 months of starting work with the employer;

  • who have been continuously employed for less than three months;

  • whose earnings have not equalled or exceeded the national insurance lower earnings limit for at least three consecutive months;

  • who cannot join their employer's occupational pension scheme because they are under the age of 18 or they are within five years of the normal pensionable age for the scheme; and

  • who are ineligible to make contributions owing to a restriction imposed by the Inland Revenue.

    However, employers that are not required by law to provide access to a stakeholder pension are free to do so on a voluntary basis.

    Designating and consulting

    "Designation" is the term used to describe the process whereby an employer formally selects a stakeholder pension scheme and informs employees of their right to join. Employers wishing to identify suitable schemes will find the OPRA list of registered stakeholder pension schemes particularly useful.

    Having identified a stakeholder pension scheme, the employer must make sure the scheme is registered with OPRA and then consult with employees and their representatives about the choice of scheme. Employers need only consult "relevant employees" - that is, those who would be eligible to join the scheme.

    Although the employee consultation process is not laid down in the Regulations, it is clear that employers must consult with relevant employees and any organisations representing them before designating a scheme.

    Employers not covered by other exemptions, and who have five or more staff throughout the three months up to 8 October 2001, must designate a stakeholder pension scheme by that date. Those whose staff numbers increase to five or more during the three months prior to 8 October 2001 will have three months to comply from the date at which their staff numbers reach five or more. After 8 October 2001, an employer that was previously exempt will have three months to comply from the time it becomes liable under the Regulations.

    An employer that ceases to be liable, and then becomes liable again, will have three months to designate a scheme from the point of becoming liable once more. For example, an employer with six employees is liable to comply; if two people leave, the employer no longer has to comply. However, if that employer subsequently recruits a new employee, it will once again be obliged to provide access to a scheme.

    If an employer decides to withdraw from the designated stakeholder scheme, it must designate a new scheme before withdrawing from the previous one. If its designated scheme has its registration withdrawn, the employer will have four months to designate a new scheme.

    Don't provide advice ...

    An employer will be able to provide employees with help and guidance, give additional information or interpret the information, but should be careful not to advise employees. The provision of financial advice is controlled by the FSA.

    If an employee is unhappy with the designated scheme, they will be able to choose their own scheme, but, in this situation, individuals will be responsible for making their own payments to the chosen scheme. If a new employee is already contributing to a different scheme, they may continue to pay the provider themselves, or transfer to the employer's designated scheme to benefit from payroll deductions.

    If requested by the employee, the employer must deduct contributions from the employee's salary for payment into the designated scheme, or any previously designated schemes to which at least one employee is still contributing. However, it may choose to help its employees by paying into any scheme of the employee's choice.

    ... but do deduct contributions

    Where an employer provides access to a stakeholder pension, it must also offer the facility to deduct employee contributions from pay. However, employees may choose to pay pension contributions directly to the scheme. Employees will be free to join any scheme, but may only request payroll deductions relating to the employer's designated scheme.

    OPRA recommends that, before choosing a registered scheme provider, employers should look at their payroll and accounting systems to assess how easy it will be to manage the deduction of contributions. If this is not going to be straightforward, it might be worth selecting a provider that can set up payroll deduction facilities as part of the service.

    Once a scheme has been designated, the employer will have a responsibility to check periodically that the scheme is still registered with OPRA. However, an employer will not be liable for the performance of the designated stakeholder scheme.

    Level of contributions

    Employee contributions to a stakeholder pension scheme will be voluntary. Once the employer has designated a scheme, employees wishing to contribute will have individually to decide how much they wish to contribute, and how often.

    Each scheme will be responsible for setting its own minimum contribution, with the restriction that it cannot be set at more than £20. Contributions may be made weekly, monthly or at other intervals. One-off payments may be made at any time.

    The contribution amount deducted from pay could be a fixed sum or a percentage of pay, and will have to be agreed between the employer, the employee and the scheme provider. For calculation purposes, "pay" may be defined to include additional elements such as overtime. On the other hand, it may be defined to exclude such payments. There are no defined methods of payment: it is for the employer and the scheme provider to agree the method.

    Once an employer has designated a scheme, it will have to continue to provide a payroll deduction facility for that scheme for any employees who have chosen to contribute to it - even if the employer later decides to offer a different stakeholder pension scheme.

    When an employee joins an employer's designated stakeholder pension scheme, the employer must explain the process and rules for employees requesting a change to the amount they contribute. No charge may be made for changes to the amount contributed to a stakeholder pension. The amount may be changed at the individual employee's request. However, an employee cannot request more than one change every six months - unless the employer agrees to more frequent changes.

    There will be set time limits for paying employee contributions - and any employer contributions - into stakeholder pension schemes. The employer must pay the employee's contribution to the scheme provider within 19 days of the end of the month in which the deduction was made. For example, deductions made in February will have to be paid by 19 March at the latest, regardless of the frequency of the deduction. Failure to do so will be an offence, which could result in a fine.

    Employers will have to keep up-to-date records of the amounts and dates of employer and employee pension contributions. A copy of the payment schedule should be given to the trustees or managers of the pension scheme. This will enable the scheme provider to monitor the payments to ensure that they are correct, and have been made on time.

    Where an employer contributes to an employee's stakeholder pension, the due date for the direct payment arrangement is defined as the last day in accordance with the payment schedule. If a contribution is not received by the due date, the trustees or manager must inform OPRA within 30 days of the due date and the employee within 90 days of the due date (unless payment is made within 30 days of the due date, in which case no notice need be given to the employee).

    Employees who are members of stakeholder schemes will be entitled to annual benefits statements. These will show the amounts and dates of payments made through direct payment arrangements.

    What will they buy?

    A leading firm of consulting actuaries last year calculated that a person now aged 30 who manages to contribute £100 a month into a stakeholder pension for the next 30 years could end up with just £50 a week on retirement (IRS Employment Trends 673). This amount, according to Lane, Clark & Peacock, could be reduced still further if investment funds perform badly or if the individual is only able to invest less than £100 a month.

    Stakeholder pensions do not include any guarantees, and individuals remain at the mercy of the stock market, the effects of inflation and the prevailing price of annuities at the date of retirement. If underlying investments do "exceptionally well", say the actuaries, the pension of the person in their example could rise to £100 a week. On the other hand, if the investments do poorly, it could dip below £30.

    1"Stakeholder Pension Schemes Regulations 2000", SI 2000/1403, and "Welfare Reform and Pensions Act 1999 (Commencement No.4) Order 2000", SI 2000/1047 (C.29), are both available on the Stationery Office web site at www.hmso.gov.uk

    2OPRA currently provides guidance on the provision of stakeholder pensions at www.opra.gov.uk/stakeholder

    3"The regulation of stakeholder pensions", available from the Financial Services Authority, 25 The North Colonnade, Canary Wharf, London E14 5HS, tel: 020 7676 3232, free. Also available at www.fsa.gov.uk/pubs

    4"Personal pensions - a guide to tax", Inland Revenue leaflet IR78, available from tax offices and Inland Revenue local offices.

    Demography and retirement

    • Over the first half of the century, the number of people over state pension age in the UK is forecast to increase by over one-third. This is due to the baby booms following the Second World War and in the 1960s, and significant improvements in life expectancy due to better health. In general, because of their greater longevity, women can expect to spend more years of their lives as pensioners than men.

    By 2040, there are likely to be around 30% fewer people of working age per person over state pension age. Broadly speaking, while there are over three people to support every pensioner now, by 2040 there will be closer to two.

    Although the change will largely come about at a steady rate, there will be a sharp increase in the number of pensioners between 2020 and 2030. However, demographic pressures in most other industrial countries are greater and more imminent than they are here. Their ability to pay for pensions will be affected to a far more significant extent.

    Since 1981, the gap between the richest and poorest pensioners has grown. The incomes of the poorest 20% of single pensioners have risen by 21% in real terms, compared with 60% for the richest 20%. The pattern is similar for pensioner couples. Women tend to fare worse than men because of their different working patterns and greater longevity. The Government's Women's Unit is undertaking a detailed analysis of existing research into women's incomes, including the factors affecting income in retirement. The results of this will help to inform future government thinking.

    If we do not change current policies, serious problems will persist for pensioners who are dependent on the state for their income in retirement. By 2025, without reform, well over half those reaching retirement age could have to rely on income-related benefits in their retirement. After 2025, average pensioner incomes are expected to fall relative to earnings, reflecting that, for today's 20- to 40-year-olds, SERPS will be of lower value, and the basic state pension, though keeping its real value, will make up a smaller part of people's retirement incomes.

    The current pension system needs to be modernised if the problems of the poorest pensioners are to be addressed, and those who can are to be encouraged to provide a decent income in retirement for themselves.

    Source: "A new contract for welfare: partnership in pensions", Department of Social Security, available from Welfare Reform (WRO), Freepost (HA4441), Hayes UB3 1BR, tel: 020 8867 3201, free. Also available at www.dss.gov.uk