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Types of approval

Under section 590 of the Income and Corporation Taxes Act 1988 (ICTA 88) an approved scheme must receive approval from the Pension Schemes Office (PSO). The strict conditions of approved schemes as set out by ICTA 88 means most employer pension schemes will seek more flexible benefits through an exempt approved scheme granted by the PSO under the occupational pension scheme practice notes (IR12 (1997)).

An approved scheme will be granted approval if:

It is established under irrevocable trust;
The scheme, company and administrator must be resident in the UK;
The employer pays at least 10% of the total contributions;
the contributions and benefits are within Inland Revenue maximums;
no pension income will allow total commutation to a tax free lump sum;
The maximum retirement benefits payable to the scheme member or as a widows pension can exceed the 1/60th accrual rate;
The eligible employees must be informed in writing of the terms and conditions of the scheme.

To be recognised as exempt approved schemes they must:

Be established under irrevocable trust;
Have a UK resident administrator;
Have employer contributions to the scheme;
The scheme must comply with the Practice Notes.

Retirement age

A scheme member who retires before the normal retirement date (NRD) of an occupational pension scheme is recognised as taking early retirement. The Inland Revenue will allow early retirement and the taking of a pension income from the age of 50 for men and women with the latest date to take a pension being 75. An employers pension scheme will have rules that determine the generosity of the pension benefits payable to members on early retirement.

An individual could retire early voluntarily and this means that the accrued members pension rights within a final salary scheme will usually be scaled down, typically between 4.0% to 6.0% by each year early retirement precedes the normal retirement age. If early retirement is due to ill health many schemes will pay benefits the member would have received at normal retirement age based on the current pensionable earnings and without scale down.

If early retirement is compulsory such as in the case of redundancy, the scheme may pay an early pension based on accrued retirement benefits without scale down and possible enhancements such as half the years to retirement.

In terms of an employers treatment of men and women in an occupational pension scheme and since the Barber Judgment of 17 May 1990, the European Court of Justice (ECJ) has ruled that men and women must have equal rights to join employers pensions and that occupational pensions earned from service must be equal for men and women. The Barber Judgment established the equal-pay-for-equal-work Article 119 (now Article 141) of the Treaty of Rome that if an occupational pension scheme does not contain an equal treatment rule shall be treated as including one.

This means that if a scheme member of opposite sex is employed in similar work, or work of equal value, then the benefits to both sexes must be the same including the retirement ages, unless the trustees can prove that the inequality is due to a factor that is not sex related. Regulations made under the Pensions Act 1995 have required occupational pension schemes to treat the sexes equally since January 1996. Also, under section 126 of the Pensions Act 1995 the state retirement age for the state basic pension will be equalised to 65 for both men and women.

Scheme funding requirements

Under section 56 to 61 of the Pensions Act 1995 the minimum funding requirement (MFR) was introduced to help occupational pension schemes such as a final salary pension to offer the members more security. MFR in general will not apply to an occupational money purchase scheme unless that scheme also provides other salary related benefits that are subject to MFR.

On the discontinuance of the scheme, MFR is designed to ensure that the scheme will have sufficient assets to secure all pensions in payment to pensioners as well as pay a cash equivalent transfer value (CETV) for all active members and deferred members not yet in receipt of a pension income.

The minimum funding requirement was effective from 6 April 1997 and the scheme trustees must put in place a scheme that covers the next five years from the date of the actuarial valuation showing that the contributions made are sufficient for the scheme to be 100.0% funded. There is a transitional period of 5 years that ends on 5 April 2002.

Where the valuation shows the scheme to be below 90.0% funded to the MFR level the schedule must show that the scheme will be at least 90.0% funded by one year after the transitional period, or 5 April 2003. Where the valuation shows funding of 90.0% to 100.0% the transitional period is extended by 5 April 2007. In certain circumstances a seriously underfunded scheme can apply to the Occupational Pension Regulatory Authority (OPRA) to have these time limits further extended.

Where the scheme is in surplus OPRA will require the employer not to make contributions. If the scheme is seriously in surplus the employer may establish the pension non contributory scheme for a period of time in which case the employees will not need to make a contribution.

MFR requirements increase the burden of a final salary pension on the employer as the assets of these schemes are usually equity based, reflecting the younger age of the workforce and longer term expected to retirement ages. It also means that the schemes will experience a cash inflow as few payments would be made to pensioners.

As a final salary pension scheme matures, the situation could be that benefits paid exceed contributions received and the scheme trustee would have to apply a more conservative strategy with more investment in fixed income securities to meet cash outflows.

Minimum funding requirement may force the scheme to sell equities and buy fixed income securities and meet the valuation targets. The government has recognised the problems an employers occupational pension scheme has with MFR and announced in September 2001 that it proposed to reform MFR requirements, with an interim solution of extending the time limits and in the long term to replace MFR with a scheme specific funding standard.

Ending existing schemes

For an employers pension scheme a bulk transfer of the assets and liabilities other than on winding up could occur if; the employer closes a scheme such as a final salary pension to new entrants in favour of a money purchase scheme and offers an existing scheme member with accrued retirement benefits the option of a pension transfer; or if part of the business is sold to a new employer the members pension rights will be protected by regulations although any future retirement benefits may not be maintained at previous levels.

Ending a final salary scheme in favour of a money purchase scheme would mean a significant change for the members future pension planning. Whereas a defined benefit scheme would pay an inflation proofed income based on a final salary, a money purchase scheme requires the member to purchase an annuity from the available pension accumulated from stock market growth, which is a less certain route. At retirement the individual must use the pension fund to buy pension annuities and has the option to search for the highest annuity rates using an open market option. Before making a decision at retirement, learn more about annuities, compare annuity rates and secure a personalised annuity quote offering guaranteed rates.

Where a sale takes place the consent of the scheme member is required although an individual could instead choose a pension transfer to a personal pension, section 32 policies or no transfer at all. If the scheme is in surplus, on a bulk transfer the new scheme trustees will take responsibility for this amount. If the new scheme is underfunded, this surplus would help the scheme to meet the minimum funding requirement. A bulk transfer could be achieved without the consent of members, however rarely occur due to the restrictions of the Preservation of Benefits Regulations 1991 and the restrictions imposed by the scheme rules.

Alternatively, an employer of an occupational pension scheme may decide on winding up, due to the increasing administrative costs and obligations, rather than consider a bulk transfer of the assets and liabilities to another scheme such as stakeholder pensions. On winding up there is a priority rule for schemes subject to the MFR as stated in section 73 of the Pensions Act 1995 where certain liabilities take priority such as pensions in payment, members in deferred retirement, additional voluntary contributions (AVC) and guaranteed minimum pensions (GMP).

Unless stated in the scheme rules the scheme trustees have discretion as to how to distribute a surplus after providing limited price indexation (LPI) for all pensions. Under the Social Security Act 1990 if the scheme is underfunded the employer must meet this obligation on winding up. The scheme will also have to meet the schemes liabilities and satisfy the equalisation rules as per the requirements of the European Court of Justice.

Role of the trustees

This can be an individual, a number of people or independent institution that are responsible for the management of a trust in accordance with the Trust Deed. Scheme trustees have the power to select any investment they wish in order to adhere to the Trust Deed. The activities of scheme trustees come under the jurisdiction of OPRA that has extensive powers set out in Part I of the Pensions Act 1995.

A failure of a scheme trustee to comply with their duty is likely to be of material significance to the functions of Occupational Pension Regulatory Authority. Therefore there is a statutory duty called whistle blowing imposed on the actuary or auditor appointed to an occupational pension scheme such as a final salary pension or money purchase scheme to immediately give a written report to OPRA if they have reasonable cause to believe there is a material problem with the employers pension scheme.

The Trustee Act 2000 came onto force on 1 February 2000 establishing a new statutory duty of care for trustees when carrying out their duties under trust deed of the Trustee Act. The Trustee Act 2000 only applies to England and Wales and gives trustees, including pension scheme trustees, wide investment powers.

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