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The Origins of a workplace pension

To understand the future of pensions it is important to understand the history of pensions and why and how they came to fruition.

As early as the 1590 a fund known as the Chatham chest was established to pay a pension to disabled sailors. This is commonly regarded as the first UK Occupational pension scheme.

In 1671 a scheme was established for customs officials who required members to make pensions payments to their immediate predecessors and in 1686 a central fund was born to which employees would make a regular contribution which shows similarities to a modern day occupational pension. Moving forwards to 1838 the great western railways provident society was established which was the first pension was for railway workers.

Through parliament, the 1916 Finance Act gave tax relief to all contributions to pension schemes and the 1921 Finance Act established certain pension principles which are used today in a modernized format. It stated that:-

  • All contributions are fully tax exempt (employees and employers)Automatic enrolment was introduced to plug the gap between the lack of pension saving and the potential liability on the public purse
  • All investment gain by the pension scheme are exempt from capital gains
  • Pensions once in payment are taxed as earned income.

Moving forwards to today there are three main sources of pension provision in the UK

  • Occupational pension schemes
  • Personal or contract based pension schemes
  • State pensions.

Modern Occupational Scheme

A modern occupational scheme is constituted by either irrevocable trust or statute.

In the private sector, a scheme is formally established by the execution of a trust deed and the scheme has a series of rules which determines who is eligible to join, how the scheme is to be funded and the benefits that are to be paid and under what circumstance. A trust is a legal concept unique to English law and is an equitable obligation binding a person who is called a trustee to deal with property over which he has control over for the benefits of persons who are the beneficiaries. A trustee may be a beneficiary and may enforce obligation.

Establishing a pension under trust has some key benefits:-

  • HMRC will only grant tax concessions to schemes established in this way.

  • A trust has its own identity in law keeping its property separate from any employer.

  • It allows benefits to be provided to third parties such as spouse and other dependents.

  • It places assets in the hands of the trustees.

The other way of constituting pension is through statute. This applies to most public sector pensions such as the police and NHS. Statutory schemes are unfunded and paid on a pay as you go basis through taxation.

There are two main occupational schemes which are Defined benefit and Defined contribution.

Defined Benefit Scheme

A defined benefit pension value is determined by a formula set out in the schemes rules. Final Salary arrangements are expressed as a fraction of the members salary are often are 60th or 80th schemes but other schemes do exist. Each year the employee earns a fraction towards his or hers pension. For example 20 years service can be expressed as 20/60ths in a 60th scheme. The pension is typically then based on the employees earnings in the last 12 or 36 months of scheme membership.

Other less generous schemes such as a career average related earnings scheme (CARE) provides pension benefits based the average earning of the employee rather than their final salary. CARE schemes are re-valued each year to take into inflation and earnings.

Defined Contribution Scheme

A Defined Contribution scheme is also known as a money purchase scheme and the members and employee have a set contribution to make. This money is invested and the fund will eventually buy an annuity. This makes it very difficult to judge what pension will be due in retirement as fund performance and annuity rates cannot be predicted accurately in advance.

In addition to occupational schemes there are a number of private pensions available to the public. A personal pension was originally referred to as a retirement annuity contract and originated in 1956. The modern version of personal pensions has been available since 1988.

All personal pensions are defined contribution but there is a technical difference in the way tax relief is granted between a personal pension and its occupational counterpart. With a personal pension the contractual relationship is between the member and pension provider and there are no board of trustees. Employers who offer these types of personal pensions to their employees set up group personal pensions which in reality are just a series of singular pensions with the chosen pension provider.

Today a common personal pension would be a stakeholder which was introduced by the government in 2001 in an attempt to provide a low cost pension. To be a stakeholder pension the scheme must adhere to specific rules:-

  • Annual management charges must not exceed 1.5% in the first 10 years of the plan and may not exceed 1% thereafter.

  • Stakeholders must accept transfers.

  • The minimum contribution cannot be set higher than 20 pounds.

  • Contributions can be made ad hoc

  • Stakeholders must have a default fund which offers life styling near to retirement.

Until 1st October 2012 employers with 5 or more employee must have offered a stakeholder pension. This has now been superseded by automatic enrolment however workplace commitments towards a stakeholder must be continued until the employers staging date.

States pensions were introduced in 1908 with the Old age pensions Act and came into force in 1909. Today the basic state pension (BSP) is paid from state pension age (SPA). This is currently 65 for men and woman, although there is a transitional period for woman born in the 50s.

The pension act 2011 will raise state pension age from 66 by 2020, to age to 67 by 2036 and 68 by 2046. Currently you have to work 30 years and make national insurance contributions for this period (unless exempt)to qualify for a full state pension.