Company Pension Schemes

Overview

Employer's pension schemes, superannuation, occupational schemes, defined benefit schemes, company pensions. All these names refer to the same thing. Many of the UK 's working population are members of a company pension scheme, and it often represents the most important benefit an employer offers.

The reason is simple. A good company scheme can offer the best retirement benefits available, at the lowest cost to the employee. Though it should be pointed out that, a poor scheme offers little more than the employee would have received from the state.

Eligibility

Eligibility to join a company scheme varies form company to company. Either some allow their employees to join straight away or very soon after joining the company, whilst others put in place conditions before an employee can join, such as a minimum 2 years service, or upon reaching a certain age. These conditions are usually applied by companies who are susceptible to high turnover of staff, such as firms with many young employees.

There are two main types

There are two main types of company scheme:

1. Final Salary
2. Money Purchase

They differ greatly in what they offer and how they work. At present final salary, schemes are the most common in terms of number of members, but many large firms are now switching over to the money purchase type because they are cheaper for the employer to fund.

Final Salary Schemes

With a final salary scheme, the pension you receive at retirement is directly related to your final salary before retirement. This is a benefit because it means you will have a very good idea of what your pension income will be before you actually retire.

A final salary scheme can pay up to two thirds of your final salary when you retire, up to a maximum of £105,600. It can also provide a tax-free lump sum at retirement, again up to a maximum of one and a half times your final salary. Taking the lump sum will normally reduce your pension.

Benefits included

Many final salary schemes have a host of additional benefits such as death in service benefits of up to four times annual salary. Widows & dependent children's pensions, known as death in retirement benefits & often long-term disability benefits all in addition to the salary related pension already mentioned.


Many companies increase the actual pension payments by approximately 3-5% per annum. This very valuable benefit would be costly with a money purchase type scheme.

Money Purchase Schemes

How they Work

Unlike final salary, money purchase schemes do not give any guarantees about level of income. In other words, they do not provide a pension that is linked to your final earnings before retirement. Contributions made by you & your employer (if it's contributory) are invested and allowed to grow. The resultant fund is 'allocated' to you & upon reaching retirement age; you use the money that has built up in your pension to purchase an annuity within Inland Revenue limits. It's the annuity, which then provides you with income in your retirement. Therefore, it follows that the value of the pension at retirement, is dependent upon:

1. How much money has been paid in over the life of the plan,
2. How well the money has grown
3. What annuity rates your pension fund purchases when you retire?

In other words a money purchase pension is just a long term savings plan (albeit a very tax efficient one) that has designed to produce a lump sum at retirement. This then purchases an annuity, which in turn provides the retirement income. It follows that unlike a final salary scheme, you are unable to predict with any accuracy, what pension you will receive before your retirement date.

The benefits

The benefits that come with money purchase company pensions tend to be not as good as the ones associated with final salary schemes. Widows & dependent children's pensions, death & disability benefits are all quite rare in money purchase schemes. However, some employers offer them as options you can pay towards.

Executive Pensions

Executive Pension Plans are Occupational Pension Schemes, which are effected by the Employer and are operated on its behalf by Trustees (normally the directors) for the benefit of individual or small groups of directors and senior staff.

Although arranged on a 'money purchase' basis (i.e. the fund at retirement depends on the growth of the contributions invested) they are subject to 'final salary' scheme limits. The Employer agrees to contribute a predetermined percentage of salary and the employee may contribute up to 15% of the salary "cap", currently £105,600 for the tax year 2005/06. Both qualify for tax relief at the highest rate payable. The employer must contribute at least 10% of the total premiums payable.

However, an individual who has for example, Schedule D self-employed earnings in addition to concurrent Schedule E employed earnings, would be subject to the earnings cap separately in respect of each source of income.

Similarly, an individual who has multiple concurrent Schedule E employments will be able to fund for pensions up to the ceiling of the earnings cap in respect of all such employments, provided the employers are not associated.

Security

Every occupational pension scheme must be set up under Trust as a company sponsored retirement benefits scheme designed for approval as an exempt approved scheme under the Income and Corporation Taxes Act 1988.  The scheme will be set up under irrevocable trust and will be governed by a Trust Deed and a set of Rules.  This is essential to obtain the Inland Revenue approval on which the tax advantages depend.  The advantages of this structure are that the assets of the pension fund are separated from those of the company and in the event of the company going into liquidation, the creditors would normally have no claim against the pension fund assets.

The Schemes investments would not be subject to UK Taxes once the scheme has been approved.  The investment returns available are thus enhanced.

Tax Efficiency

The taxation advantages that contribute towards increasing the overall investment returns are summarised below:

1. Contributions by the Company qualify for relief against corporation tax as an expense of the business.

1. Members may contribute up to 15% of taxable remuneration and be eligible for relief at their highest marginal rate of income tax on their contributions.  Moreover, contributions paid by the company are not treated as a benefit in kind for tax purposes.

1. Investment income of the pension scheme is currently free from all UK taxes although pension funds can no longer reclaim tax credits on dividends

1. Benefits - within Inland Revenue limits cash sums payable at retirement are free of income tax and cash sums arising on death are normally free from Inheritance Tax. 

1. Pensions payable to members and their dependants are treated as earned income.

Small Self-Administered Schemes

What is a Small Self-Administered Pension Scheme (SSAPS or SSAS)?

A Small Self-Administered Pension Scheme (sometimes just called a Small Self-Administered Scheme or 'SSAS') is a special type of pension scheme that is usually restricted to the shareholding Directors of limited companies. A SSAS is run by a Pensioneer Trustee together with the Managing Trustees in accordance with legislation and the Trust Deed & Rules .

The establishment of a SSAS enables Company Directors to provide for retirement in a highly tax and cost efficient way, whilst providing advantages to their business in the form of a flexible use of capital and reductions in taxation.

The Benefits a SSAS Can Provide

In accordance with Inland Revenue regulations, a SSAS must ultimately be used to provide retirement benefits consisting of a pension of up to 2/3rds of Final Pensionable Remuneration , part of which can be taken as a tax-free cash lump sum of up to 1½ times Final Pensionable Remuneration.

SSASs may also provide dependants' pensions and a lump sum benefit on death-in-service.

Whilst Inland Revenue regulations currently stipulate that the payment of pensions must be secured by the purchase of an annuity contract from an insurance company, this may be deferred until the pensioner's 75th birthday, with the pension being paid directly from the pension fund prior to the purchase of the annuity .

Thus, a Member may 'retire' at age 60, draw a pension from the fund and then convert their fund into an annuity at any time up to 15 or more years later. This means that the pension can be secured when annuity rates are most favourable, and if a Member dies before an annuity has been purchased, the capital remaining in the SSAS can be used to provide dependants' or other benefits.

The Benefits of Inland Revenue Approval for a SSAS

Receiving Inland Revenue Approval for a UK pension fund means it enjoys the following tax advantages:

•  No tax on income, other than equity dividends

•  The ability to reclaim some tax deducted at source on income

•  No tax on capital gains.

In addition, permitted contributions to the fund attract relief for the Company against corporation tax, and lump sum benefits payable on death and at retirement are usually free of all taxes (including inheritance tax on lump sums payable on death)

Approved Investments for a SSAS - Home

As both a Member and Managing Trustee , you can take a far more active role in the management of the assets of a SSAS than would be possible via an insured arrangement. For example, the range of assets in which a SSAS is able to invest includes the following:

•  Non-residential property

•  Commercial loans, including to the Company

•  Debt, i.e. the SSAS borrows to fund investment

Property Purchase through a SSAS

The advantages of purchasing a property through the SSAS are as follows:

•  Rental income received by the SSAS is not subject to any tax

•  Any gains in the market value of the property will not be liable for capital gains tax

•  If the Company is financially healthy at the time of the transaction (i.e. it is not done to deliberately defraud creditors), should the Company subsequently run in to financial trouble, the property is out of the Receiver's hands

If the SSAS purchases a property already owned by the Company and then leases it back to the Company, the Company has further advantages as follows:

•  The Company's corporation tax liability will be reduced as rent (which is not taxable as income to the SSAS ) will be an allowable expense in the Company's accounts

•  The Company will have a huge cash injection which it could use either to repay any outstanding loans (including those to Directors), as a source of working capital or to expand the Company's activities

•  Protection from creditors, as above.

Note: A small self-administered scheme is not permitted to purchase a property within 3 years of it having been owned by a connected individual. Therefore, the purchase of any property currently owned by a connected individual (which includes members of the SSAS and their immediate family, but not the Company) must be made by the limited company in the first instance and subsequently, in three years time, by the SSAS. In this case, careful planning would be needed to transfer the property into the tax-free environment of a SSAS over the next three years.

Loans to the Company from a SSAS

A SSAS is permitted to make loans to a Company not exceeding:

•  within 2 years of the establishment of the SSAS , 25% of contributions paid in

•  thereafter, 50% of the total value of the funds accumulated

Loans can be made on an unsecured basis but must be properly documented, at arm's length, for a normal commercial purpose and with interest (NB - the interest benefits the Members , not a bank).

SSAS Borrowing to Finance Investments

Within prescribed limits, a SSAS is permitted to borrow money to finance its investments. A specific example would be to finance a property purchase.

The maximum permitted level of borrowing is:

1. 45% of the market value of the assets from the money paid in by the Company
   
   plus
2. 3 times the average of the Ordinary Annual Contributions paid in the previous 3 completed SSAS accounting years (or the annual average since the SSAS was established if this is less than 3 years).

Contribution Levels to a SSAS

The levels of contributions which are permitted to a new SSAS are usually far greater than would be permitted to a Personal Pension Scheme.

The Company may be permitted to pay a Special Contribution in respect of a Director's service with the Company to date. If so, the ongoing maximum annual contribution will be reduced to take account of this.

Although the Company should make regular contributions to the SSAS , in any Company financial year it is permitted to contribute any amount not exceeding the maximum allowed, including not paying anything at all.

The Fees Involved with a SSAS

The costs incurred in the management and administration of a SSAS are fixed - irrespective of the size of the funds. On the other hand, an insured scheme is likely to be subject to a flat annual administration and 3 yearly actuarial charges, plus an annual percentage charge for an amount of money which, typically, has to be invested with them.

Thus as a scheme grows, having a SSAS becomes increasingly cost effective in comparison to an insured scheme .

Maximum Benefits

The level of contributions is determined with reference to the maximum benefits permitted up to the salary cap (see the Introduction above). These are that at retirement, a tax free lump sum of 1.5 times final salary.  This is based on a minimum of 20 years service.  If less, the amount is reduced pro rata.

The balance of the fund (if any) will be used to provide a pension for the member (and spouse).  The pension which the fund could have provided, had the lump sum not been taken, may not be more that 2/3rds of final salary.  Again, this is based on a minimum of 20 years service with pro rata reduction.

For controlling directors, the only acceptable definition of final remuneration (except when considering death-in-service benefits) is. "the yearly average of the total emoluments from the employer which are assessable to income tax under Case I or II of Schedule E, and upon which tax liability has been determined, for any three or more consecutive years ending not earlier than ten years before the relevant date".

The scheme may in addition provide death-in-service benefits, based on annual salary these may be a lump sum of up to 4 times and a widow's pension of 4/9ths. Finally, an invalidity pension may be provided.

Employer's Contributions

The employer must contribute to the scheme. The employer's annual contribution is allowable as a business expense in the year of payment, giving rise to a reduction in either income or corporation tax as appropriate.

It designates all or part of its initial contribution as an 'ordinary annual contribution'. This is paid annually or monthly. Any significant decrease in the first three years of the initial contribution (or any subsequent increase) could lead the Inland Revenue to spread Corporation Tax relief over more than one year.

A special contribution is also allowable in the year of payment if, when aggregated with any other such payments to the same scheme in that accounting year, it is less than £500,000. If the total is more than this, relief is spread on the following basis: £500,000 or over but less than £1m spread over 2 years £1m or over but less than £2m spread over 3 years, £2m or over spread over 4 years.

Flexibility at Retirement

The member is free to choose the format of their benefits within the limits shown above. Decisions as to widows pensions, increases in payments, guarantees etc. are made at retirement to reflect actual needs at the time. Retirement age must be between the ages of 60 and 75. Benefits can however be taken from age 50 onwards by non-controlling directors, provided that the individual has left service.

Pensions are intended as long term investments. If you withdraw from this investment in the early years, you may not get back the full amount invested. Past performance is no guarantee of future returns and the value of units and the income derived from them can fall as well as rise. This information is based on our current understanding of tax law. Tax relief referred to are those currently applying and their value depends in the individual investor and/or the funds involved. Levels and bases of taxation, and tax relief are subject to change. Investment income of pension schemes is currently free from all UK taxes although pension funds can no longer reclaim tax credits on dividends