Changes in pensions legislation and practice over the past 20 years have led to an increasingly marked shift away from final salary or defined benefit plans in favour of money purchase or defined contribution policies. This trend has been stimulated largely by employers' desire for greater cost control and the additional burdens placed on administrators and trustees. With the provisions of the Pensions Act 1995 beginning to bite, the trend looks set to continue.
While some of the larger legal practices may still be inclined to provide benefits linked to final salary, the idea of issuing what is effectively a promissory note is rarely attractive – or appropriate to the structure of small-to-medium-sized firms. Nevertheless, the combination of altruism and commercial enlightenment motivates many firms to seek an effective solution to pension provision without writing a blank cheque.
The choice they have, therefore, is between an occupational money purchase plan or a group personal pension plan (GPP). The key deciding factors are likely to be the desired level of involvement by the partners as employers, ease of administration, considerations relating to the State Earnings Related Pension Scheme (Serps) and flexibility.
Even small occupational money purchase plans are subject to many of the requirements of the Pensions Act 1995. These include the appointment of member-nominated trustees, setting up internal dispute procedures and providing limited price indexation on pensions accrued after April 1997. They are also required to provide actuarial valuations, prepare annual reports and accounts, and maintain and update plan documentation.
GPPs, on the other hand, are free from all the requirements outlined above and offer additional flexibility. They also avoid the need to maintain records and communicate with former employees.
GPPs are very easy to set up and run. Each employee is issued with his or her own personal pension plan policy by the providing institution. Contributions can be made by both the employer and employee, up to the maximum level allowed by the Inland Revenue which is on a sliding scale from 17.5 per cent up to 40 per cent of earnings depending on age. (Personal pension contributions are subject to the Inland Revenue earnings cap, which is currently £82,200, rising to £84,000 from 6 April 1997.)
Apart from advising the pension provider of changes and passing on information to members, the firm's only responsibility is to collect employees' contributions each month and send them to the provider, together with its own contributions. Employees' contributions are deducted from their pay net of basic rate tax and allowance for higher-rate tax relief is made by an adjustment to the employee's personal tax code.
Contracting out of Serps is also simpler with a GPP because the firm does not have to take account of employees' different National Insurance contributions. These are simply paid to the Department of Social Security which ultimately recycles them to the credit of the employees' pension plans at the end of the fiscal year.
Perhaps the most significant factor in terms of simplicity is the absence of the need to appoint trustees and all that that entails. Also, there are no Social Security Act 1985 requirements and the plan does not need to be registered. The choice of who joins the plan, when and at which contribution level is entirely up to the employer.
Although 'normal retirement age' is determined by the employer, the flexibility of GPPs enables individuals to retire at any time between the ages of 50 and 75; and because each member has an individual plan, anyone leaving service can take it with them and maintain it as part of his or her continuing retirement arrangements.
The relative advantages of occupational money purchase plans and GPPs are summarised in the tables.
One disadvantage shared by both occupational money purchase plans and GPPs available from conventional providers is the potential conflicts of interest when the provider fulfils all the management roles, particularly that of fund manager. With the recent development of Flexifund, these functions have been 'unbundled', with Winterthur Life providing the contract shell and administration, Capital Pension Trustees providing trusteeship and Sedgwick Noble Lowndes managing the fund managers – monitoring their performance and adjusting the balance of the portfolio to optimise returns for plan holders.
As with so many aspects of financial planning, consideration of individual requirements – in this case those of both partners and employees – is an absolutely vital element of pension planning for medium-sized and smaller firms. The flexibility and all-round simplicity of GPPs provide plenty of scope to develop effective solutions to varying needs.