Plan the right route

With personal accounts and auto-enrolment due in 2012, employers may review their defined contribution pensions, says David Woods

Rarely a week goes by without pensions hitting the headlines for one reason or another. When faced with defined benefit pension scheme deficits, many companies have opted to cut their losses and close the schemes, providing defined contribution (DC) schemes in their place. They have had to choose from an assortment of different types of DC schemes, making sure that whatever they opt for helps them reduce their exposure to risk, while also providing a perk that is still valued by staff.

However, with the arrival of a national pensions savings scheme in the form of personal accounts in 2012, employers may review their options again. Employees will have to be auto-enrolled into either a personal account or an equivalent suitable occupational pension scheme, into which they will be required to contribute 4% of salary, and employers 3%, with the government adding an additional 1% in the form of tax relief.

It is perhaps understandable that employers looking at DC can become bogged down in the options available in ascertaining which type of plan will best suit both their workforce and organisational strategy.

Chris McWilliam, principal consultant at Aon Consulting, explains: “There will be more pressure [on employers] in the next 10-to-15 years to become more competitive with their pensions.”

One of the first considerations for employers looking at their DC options is to decide whether they want to offer a contract-based plan, such as a stakeholder scheme or a group personal pension (GPP), a group self-invested personal pension (Sipp), or a trust-based scheme.

The latter type is managed by a board of trustees made up of individuals employed both within the company and from outside of it. These trustees meet regularly to govern how the scheme is operated, administered and invested.

Organisations that wish to adopt a paternalistic approach to pensions provision may be more inclined to opt for a trust-based scheme, according to David Marlow, director at financial services company Alexander Forbes. “Trust-based schemes mean employers may be more engaged with the scheme and, for certain employers, this may well be more appropriate,” he explains.

Trust-based schemes may also be viewed as being more effective by employers than contract-based plans when it comes to recruitment and retention. This may be because employees perceive that employers offering trust-based schemes have made a stronger commitment to pensions provision. Jamie Clark, occupational pensions marketing manager at Scottish Life, says: “There’s an argument that trustees should be the ones to set the default option for scheme members, rather than the employer, which would invariably be the case in contract-based DC [schemes]. As such, from an investment point of view, trust-based schemes may have the edge.” He adds that another advantage of trust-based schemes is that staff can be auto-enrolled in them, enabling employers to offer these as an alternative to personal accounts.

The design of trust-based plans, however, means the trustees are liable for the pension funds and will therefore need to have a degree of expertise in issues affecting investment. In addition, the costs of running a trust-based scheme can be higher for employers.

Contract-based schemes, on the other hand, require employers to select a third-party provider for the plan. The contract is then held between the provider and each individual employee, although employers can still make contributions to the scheme.

McWilliam explains that, although a contract-based scheme can still be company branded, it will require less management on the part of employers, lowering their costs.

One potential issue for some employers which offer a contract-based scheme, however, is that they have little control over fund management and employees are generally left to select funds. Although this can be off-putting for more paternalistic employers, others prefer this type of plan for this reason, as it lowers their exposure to risk.

Marlow believes that employers do not have to hand over the running of a contract-based scheme completely. “I think that [a company with a contract-based scheme] can still have a board of people who it can appoint to take an active review of the scheme. That would be a quasi-trust arrangement.”

A further alternative for employers is to offer a scheme that has elements of both trust-based and contract-based provision, known as a master trust. Although this type of scheme is essentially trust based, the role of the trustees is taken on by the pension provider which will manage funds for the employer. Nigel Aston, senior business development manager at Standard Life, says: “The master trust is coming into vogue for employers [which] don’t want the onerous responsibility of a trust-based scheme, nor do they want the laissez-faire ‘everything goes on to the member’ attitude of a contract-based scheme.”

Once employers have ascertained which type of scheme is best for their organisation, those that have opted for a contract-based plan will have further decisions to make about what form they wish this to take.

A stakeholder scheme is often seen as a relatively cheap and cheerful option for employers because the management costs are low and they can contribute as little as they want into members’ investment funds. An added advantage is that the risk lies with the pension provider rather than the employer.

Although a more complex option than stakeholder schemes, GPPs are still very common. If offering a GPP, employers must contribute at least 3% into an employee’s pension fund once they have been with the company for three months, regardless of that employee’s own level of contribution.

However, legislation paving the way for auto-enrolment has resulted in some uncertainty for stakeholder schemes and GPPs. Under the terms of the Distance Marketing Directive, staff cannot be auto-enrolled into either type of plan. Aon’s McWilliam, however, is confident the industry will find a way around this by the time the new UK pensions legislation comes into effect.

Group Sipps

At the other end of the scale of DC pensions is a group Sipp. This type of scheme offers employees much greater control over their pension and provides them with the option of investing in stocks, shares, unit trusts, managed funds and even property.

According to Darren Laverty, benefits consultant at advisers Secondsight, there is a relatively small market for group Sipps as they are designed for employees who are “highly paid and financially aware”.

A group Sipp is often offered by employers which provide a share incentive plan (Sip), so that employees can invest the value of their shares after a vesting period. This means staff can benefit from tax relief twice – for both their share scheme and their pension scheme.

However, McWilliam says: “Sipps to a certain degree have been over-hyped. They would only be suitable for people who want to take a more proactive view of their investments and want a wider range of funds. Sipps have an important place to play in the market, but ideal candidates are few and far between.”

Once a DC scheme is up and running, employers may find that it is still necessary to review, and in some cases, change their provision. This may involve moving from a trust-based to a contract-based scheme, or from one type of contract-based scheme to another.


Although the latter can be relatively straightforward if employers are not making any changes to the design of the scheme, moving from a trust-based to a contract-based scheme, or vice versa, can be more difficult to achieve. The board of trustees, for example, will need to be started or disbanded, which can be complicated.

“Employee communication is [also] needed, as staff will be concerned about the big change. This is when employees begin to wonder what it will mean to them. If the pension scheme formed the basis of an employee’s original contract of employment, [which] specifies the nature of the scheme, [the] employment contract will need to be adapted accordingly. There is then the problem that staff may be reluctant to accept a new employment contract, so adequate communication will be necessary to reassure them,” explains Marlow.

Employers that are paying management charges for a pension plan will want to ensure that the maximum number of staff are taking an active interest in their finances in order to maximise a scheme’s value.

Laverty, therefore, believes communication is key to increasing staff take-up. “All the structure and features [of DC pensions] are secondary to education. We have to educate individuals specifically about their own future,” he explains.

No matter how well thought through a pension scheme is, therefore, members need to be kept informed of what the benefit is so they understand their own financial responsibility.

Key points


  • Trust-based schemes can be more expensive to run and require more active involvement from employers.

  • Employers which offer trust-based schemes are responsible for employees’ pension pots even if they leave the firm.

  • Small and medium-sized organisations are more likely to opt for contract-based schemes because they are thought to be more cost effective.

  • Employers offering contract-based schemes are less involved with staff investments as the contract is between employees and the pension provider.
  • Case study: BDO offers trust-based salary sacrifice plan

    BDO Stoy Hayward offers a trust-based defined contribution (DC) scheme, into which staff can make contributions on a salary sacrifice basis through the company’s flexible benefits scheme.

    Staff can make additional voluntary contributions on top of those made from their flex allowance. Those who do so also receive a ‘special employer contribution’ of 10% into their pension, which was introduced last November. This comes from the 12.8% national insurance saving the employer makes when staff pay pension contributions via salary sacrifice.

    The scheme provides employees with a range of 12 funds, which have been selected by the trustees. The range is designed to cover all the major asset classes and encompass different investment styles. For example, an ethical fund and a lifestyling option for members approaching retirement age are included.

    Support is given to help staff understand and make investment decisions via written communications, the firm’s intranet site and roadshows. Richard Tewkesbury, director at BDO Stoy Hayward Investment Management, who is responsible for running the plan, says: “Although contract and trust-based schemes have advantages and disadvantages, BDO decided retaining and improving its trust-based scheme was the best arrangement for staff.”