Types of Pensions
Occupational Scheme
Occupational pensions are pensions provided by your employer. There are two main types of occupational scheme.
Defined Benefit Schemes
A defined benefit scheme pays its members a guaranteed amount of pension, which increases each year in retirement, where the initial amount of pension payable is a proportion of (typically) 1/60th or 1/80th of a scheme member’s ‘career average’ or (more commonly) their ‘final’ salary at or near retirement, for each year's pensionable service.
Defined Contribution (Money Purchase) schemes
Occupational Schemes set up on a defined contribution basis are commonly referred to as money purchase schemes. Under this type of scheme, the contributions paid by the employer and employee (where appropriate) are 'defined' and invested in a fund which benefits from tax free growth. In a money purchase scheme, the return on your investment is not guaranteed and the eventual benefits payable will depend on the size of the pension fund created by the contributions made.
Stakeholders
Stakeholder Pensions are low charging individual money purchase schemes that were introduced in 2001 as an alternative to personal pensions in order to encourage more people to plan for retirement. All Stakeholders must meet certain minimum standards, the most notable one's being that there are no initial charges, no ongoing charges (other than an Annual Management Charge (AMC) which cannot exceed 1.5% in the first 10 years) and no penalties for stopping contributions or transferring to a new provider.
At retirement, up to 25% of the fund can be taken as a tax-free cash sum with the balance being used to purchase a pension which would be taxed as earned income.
Personal Pensions
A Personal Pension plan is also an individual money purchase scheme, but unlike a stakeholder it is not subject to the same strict charging criteria, although there are a number of Personal Pension plans on the market that offer 'stakeholder friendly' terms. However, unlike a Stakeholder plan, the providers of Personal Pension plans reserve the right to amend the charging structure in respect of their personal plans in the future if they so wish.
Like a Stakeholder, at retirement up to 25% of the fund can be taken as a tax-free cash sum with the balance being used to purchase a pension which would be taxed as earned income.
Self-invested Personal Pensions (SIPPs)
SIPPs are a type of personal pension designed for people who want to manage their own investments. Most SIPPs allow investment in a very wide range of funds as-well as investments in assets such as commercial property, offices, shops, or factory premises. SIPPs often have higher charges than stakeholders and personal pensions and it is for this reason that they may only be suitable for more experienced investors with large funds.
Like a Personal Pension or Stakeholder, at retirement up to 25% of the fund can be taken as a tax-free cash sum with the balance being used to purchase a pension which would be taxed as earned income.
Section 32 buyout
First introduced in 1981, the paid-up pension rights and entitlements in respect of a previous employer's occupational pension scheme can be transferred to section 32 buyout policies.
Where the scheme member is transferring guaranteed minimum pension (GMP) rights from a contracted-out scheme to a S32, the GMP must be retained and revalued following the transfer. The S32 provider must then meet its liability for paying the GMP from age 60 (for women) or 65 (for men), although benefits can be taken earlier from age 55 as long as there are sufficient funds within the S32 at that time to cover the GMP re-valued to 60/65.
This is therefore different to the situation on transfer to a PP or Stakeholder scheme where the cash equivalent transfer value of the accrued GMP rights are instead converted to a money purchase fund and the right to a GMP is forgone. However, whereas 25% of a money purchase fund can be taken as a tax-free cash sum, a GMP cannot be commuted to pay tax free cash. For some people, this could be an important consideration.
Non-Profit Deferred Annuity
When a defined benefit (e.g. – a final salary) pension scheme is wound up, the proceeds are often used to buy annuities from an insurance company which match the pensions that the members have earned in the scheme. This 'deferred annuity' replaces the guaranteed pension that would have been paid by the previous scheme and increases both before and during retirement in accordance with the former scheme’s rules.
Investment considerations for those with a SIPP or Small Self-Administered Scheme (SSAS)
Permitted investments
The fact that the concept of prohibited investments no longer applies means that pension schemes can - in theory anyway - invest in whatever they like. However, there are controls over pension scheme investments that restrict investment options in practice and direct investments in things like residential property, works of art, vintage cars and fine wine will incur heavy tax charges.
Connected Transactions
The ban on connected party transactions has been lifted although HMRC will monitor this for any possible abuse after 5 April 2006. This ban being lifted should be a big boost to the self-employed (and particularly solicitors, accountants, and other partnerships) who prior to 6 April 2006 were not able to sell a business property from themselves or their partnership to their pension scheme.
Taxable Property
The taxable property rules heavily tax and therefore effectively prohibit investments in the two areas that created so much excitement and press coverage in the build up to the pension simplification changes that took effect from 6th April 2006 - residential property and most tangible moveable assets. Tangible moveable assets are anything that you can touch and move and therefore includes a wide range of assets such as works of art, antiques, jewellery, fine wine, classic cars, yachts, and plant and machinery. To date, only Gold Bullion has been specifically excluded from the definition of a tangible moveable asset.
Investing in the shares of the employer
No more than a maximum of 5% of the market value of an occupational scheme’s assets can be invested in the shares of the sponsoring employer or an associated company with an aggregate restriction of no more than 20% if the shares are held in more than one sponsoring employer or an associated company.
Loans to a Sponsoring employer
Loans to the employer from the pension fund is one way a pension scheme can be used to raise finance for commercial purposes whilst simultaneously providing an investment return to the fund which will benefit the pension scheme. Loans to members of a pension scheme (or any person who is 'connected' to a member of the scheme) are not 'permitted' and would therefore give rise to an unauthorised payment tax charge. A loan from an occupational scheme to a sponsoring employer can however be made subject to certain criteria being met.
Borrowing
Pension schemes can borrow for any legitimate purpose which is intended to benefit the pension scheme such as to help fund the purchase of a new asset or improve an existing asset. Since 6 April 2006, the level of borrowing has been simplified and is now a maximum of 50% of the net asset value of the scheme.
Using a Pension scheme to purchase a commercial property
It is possible to use a pension scheme to purchase a commercial property. Using the pension scheme to purchase the property could provide an initial cost saving given that tax-exempt money would be used to fund the purchase. The market rate of rent paid by the company to the pension fund would also reduce the company's corporation tax liability and would be a tax-free receipt in the pension fund. Property is however an illiquid asset and can be hard to sell. Purchasing the property could also contribute to a lack of diversification within the scheme.
Past performance is not a guide to future performance. Changes in the exchange rate will affect the sterling value of your investment. The value of investments (including property) and the income derived from them may go down as well as up.