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Under auto-enrolment, employers are required to automatically enrol eligible employees in a qualifying pension scheme. Non-eligible employees do not have to be enrolled automatically, but are eligible to join and if they do so the employer must make minimum contributions. Entitled workers do not have to be enrolled but are entitled to join a workplace pension scheme, but the employer does not have to contribute.
There are various options for providing a work-based pension scheme. Work-based schemes in the private sector are personal or occupational schemes for which the employer operates a direct payment facility (a facility to collect personal contributions by deduction from pay and pass them to the pension scheme).
The Pensions Act 2015 redefined the categories of pension scheme, introducing a third category of scheme — that of shared risk, and amending the definitions of “defined benefit” and “defined contribution” schemes.
Under the Pensions Act 2015 the category into which a pension scheme falls depends on what is promised to members while they are saving as regards what they will get when they access their pension savings or receive their retirement income. The categories offer different levels of certainty as to the pension which the member will ultimately receive.
A “defined benefit” scheme offers a full promise while members are saving for their pension about what their income will be from that pension. A final salary scheme may fall into this category.
A “shared risk” scheme (which is also known as a “defined ambition” scheme) offers a promise about some of the outcome from the scheme, but not about all of it. For example, it might promise some but not all of the income a member may receive, or it may make a promise as regards the level of savings that they will accrue based on a particular contribution level or about the rate of income that their savings will buy. A shared risk scheme is something of a halfway house — it offers less certainty than a defined benefit scheme but more certainty than a defined contribution scheme.
A defined contribution scheme does not offer a promise while members are saving for their pension about what their income from the pension will be. Under a defined contribution scheme (which may also be referred to as a money purchase scheme), the contributions will be fixed (for example at a set percentage of salary), but the pension savings available to provide a pension will depend on the contributions made and the returns on the investment of those contributions.
Provision is also made in the Pensions Act 2015 to enable workplace and personal pension schemes to provide “collective benefits” by allowing the scheme to be run in such a way that risk is shared among members by pooling their assets. This means that when a member retires, he or she can receive income from the shared assets of the scheme.
Workplace pension schemes provide employees with the following benefits on retirement.
An income stream (referred to as a pension or annuity) that will come into payment to the individual near or at the end of his or her working life and then continue in payment for the rest of that individual’s life. This pension is taxable as earned income while in payment.
A one-off lump sum payment that will be available to the member (currently free of tax under current tax legislation) which, in the case of a defined benefit occupational pension scheme, is calculated based on the member having chosen in exchange to give up part of his or her pension rights. In the case of a defined contribution scheme the calculation is based on an amount up to 25% of the member’s own “pension pot”. The lump sum is known as the pension commencement lump sum.
Some also provide benefits in the event of an employee’s death, as follows.
A one-off lump sum (currently free of tax) payable to one or more dependants or to the member’s estate upon the death of the member usually when an employee dies while in the service of the employer, but in some instances after a member’s pension has come into payment.
A pension payable to a financial dependant of the member upon the death of the member, whether this is before or after the member’s pension has come into payment. This pension would usually be paid to a spouse, civil partner or dependent children under a certain age, but in some circumstances can also be paid to another person who is financially dependent upon the member.
Legislation introduced by the Pension Schemes Act 2015 and the Taxation of Pensions Act 2014 introduced pension freedoms to flexibly access pension savings in a defined contribution scheme on reaching age 55. This took effect from 6 April 2015. Savings accessed in this way will be taxed at the taxpayer’s marginal rate of tax to the extent that they exceed the permitted 25% tax-free lump sum.
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