General principles: types of pension schemes
Pension schemes can be described in a variety of ways and some are specifically defined in the pensions tax legislation. Very broadly the main types are:
- occupational pension schemes
- public service pension schemes, and
- personal pension schemes
Occupational pension schemes
Section 150(5) Finance Act 2004
As the name suggests, occupational pension schemes are set up by an employer (known as a sponsoring employer) to provide benefits for or in respect of:
- its own employees
- employees of any other employer.
Occupational pension schemes may also provide benefits to or in respect of any other person who is not an employee of any employer in the scheme. Therefore, if the scheme rules allow it, anyone who is not an employee of any employer in the scheme may join the scheme (although this would be unusual).
Examples of occupational pension schemes
The following is a non-exhaustive list of examples of occupational pension schemes:
- an employer (or employers) establishing a pension scheme may specify, for example, that the membership is for employees in a group of companies plus self-employed individuals who work for them
- a representative body that is itself an employer may establish a pension scheme for people who are employees in a particular industry
- one or more employers within a geographical area may set up a pension scheme for employees of theirs within that geographical area.
Schemes treated as occupational pension schemes
Section 274B and paragraph 1(4A) Schedule 36 Finance Act 2004
Some pension schemes set up to provide benefits for employees of unconnected employers that do not meet the strict definition of an occupational pension scheme will, for the purposes of Part 4 Finance Act 2004, be treated as if they were occupational pension schemes. These schemes are:
- the National Employment Savings Trust (NEST) pension scheme, or any other scheme set up under section 67 of the Pensions Act 2008
- a Master Trust scheme. After section 3 Pension Schemes Act 2017 (PSA 17) has come into force this will be a Master Trust scheme whose operation would be unlawful if that scheme is not authorised under Part 1 PSA 17 (or corresponding Northern Ireland provision). In determining if a scheme needs to be authorised, the effect of any regulations made under section 40 PSA 17 (or corresponding Northern Ireland regulations) are ignored.
- schemes approved under chapter 1 Part 14 ICTA 1988 that are neither occupational pension schemes nor public service schemes.
Throughout this manual unless stated otherwise the term ‘occupational pension scheme’ includes such schemes.
Definition of sponsoring employer
Section 150(6) Finance Act 2004
Any employer who establishes or participates in an occupational pension scheme is referred to as a sponsoring employer in respect of the scheme. There may be more than one sponsoring employer in relation to an occupational pension scheme. The identity of the sponsoring employer(s) should be clear from the scheme documents.
There is no HMRC requirement about the way that any employer, that is not the establishing employer, is allowed under the scheme rules to participate in an occupational pension scheme. But the employer will be recognised as a sponsoring employer where one or more of its employees are members and the scheme benefits for those members are directly related to their employment with the employers in question.
Public service pension schemes
Section 150(3) and (4) Finance Act 2004
A pension scheme is a public service pension scheme if it is:
- established by or under an Act of Parliament
- specified in an order made by the Treasury, or
- approved by a Minister of the Crown or an appropriate UK, Scotland, Wales or Northern Ireland government body or department.
Examples of public service pension schemes include pension schemes for the civil service, the armed forces, NHS, and local government.
Personal pension schemes
These are money purchase schemes normally set up by a financial institution which are open to employees and the self-employed. Stakeholder schemes are a form of personal pension introduced in 2001. Retirement annuity contracts were the predecessor scheme type to personal pensions and are normally money purchase.
Types of benefits
The pensions’ tax legislation categorises the type of benefits a pension scheme will provide into the following four types:
- Defined benefit - these schemes should provide a set amount of benefit, where the amount of benefit does not depend on how much money is within the scheme. Final salary and career average schemes are examples of defined benefit schemes.
- Money purchase - also known as defined contribution. The amount of pension is not known in advance as it will depend on how much money is in the scheme. The size of the member’s pension pot in the scheme will depend on the amount that has been contributed to the scheme.
- Cash balance - these are a type of money purchase scheme. For the purposes of providing member benefits the rules are the same as for money purchase/defined contribution benefits. The difference between pure money purchase and cash balance is that the size of the member’s pension pot isn’t only dependent on the contributions that have been paid to the scheme.
- Hybrid - these schemes may provide either defined benefit, money purchase or cash balance benefits. Only when benefits are drawn will the form of the benefit be set.
The legislation recognises that a single scheme can provide different benefit types by splitting a scheme into ‘arrangements’. For example, a scheme may provide retirement benefits on a money purchase basis but also provide a member with a set (defined) level of benefits should they die while still in employment. In this example the member will have two different types of arrangement in the scheme:
- one or more money purchase arrangements for retirement benefits, and
- one or more defined benefits arrangements for death benefits.
Similarly, many schemes that provide defined benefits also offer members the chance to pay additional voluntary contributions (AVC’s) on a money purchase basis. Here, the member would be in a defined benefits arrangement for their main scheme benefits and in a money purchase arrangement for their additional benefits.