Defined contribution schemes

Defined contribution (DC) schemes are occupational pension schemes where your own contributions and your employer’s contributions are both invested and the proceeds used to buy a pension and/or other benefits at retirement. The value of the ultimate benefits payable from the DC scheme depends on the amount of contributions paid, the investment return achieved less any fees and charges, and the cost of buying the benefits.

A DC scheme has a set contribution for the employee and a set contribution for the employer. For example, in some DC schemes, the employer and the employee each contribute 5% of the member's earnings, or 10% in total.

Some DC schemes allow members to choose the level of contribution they wish to pay, with a related employer contribution.  Contributions are invested on behalf of each scheme member.

The retirement benefits for each member depends on how much money has been built up by the member's retirement date and so it is not possible to know in advance what pension benefits a member will receive.

Qualifying recognised overseas pension schemes (QROPs)

‘QROPS’ stands for ‘qualifying recognised overseas pension scheme’. A QROPS is an overseas pension scheme that HM Revenue & Customs (HMRC) recognises as eligible to receive transfers from registered pension schemes in the UK. To qualify as a QROPS the scheme must meet the requirements set by UK tax law, such as being available to residents in that country and not being accessible before age 55 unless under special circumstances. To check if a pension is a QROPS you can check the list of schemes that have told HM Revenue and Customs (HMRC) that they meet the conditions to be a recognised overseas pension scheme (ROPS).

Why might you consider having a QROPS?

If you live overseas or are thinking of moving abroad then you may consider transferring to a QROPS.  You may want your pensions to be in the country that you retire to so you are not receiving income in pounds and spending in a different currency, as exchange rates can fluctuate.  You may also find it easier to keep track of tax and regulation changes if they happen in the country that you reside. You may be working outside of the UK for an employer that offers a QROPS and you like the benefits offered. In all cases it is recommended that you should take regulated financial advice before transferring to a QROPS and you should consider any guarantees or other benefits that you might lose by doing so. Standards of advice can vary in different countries, so make sure you are confident of the professional standing, qualifications and experience of any adviser that you talk to. Please be aware that transfers to QROPS can be subject to a number of tax charges as listed in the next sections. 

When does the 25% overseas transfer tax charge apply?

From 9th March 2017, transfers to QROPS attract a 25% tax charge but there are exceptions. You will still be able to make a transfer tax free if you are transferring to a qualifying recognised overseas pension scheme (QROPS) and formally requested your transfer before 9 March 2017 or one of the following apply:  you are resident in the country where the QROPS receiving your transfer is based you are resident in a country in the European Economic Area (EEA) and the QROPS you are transferring to is based in another EEA country the QROPS you are transferring to is an occupational pension scheme and you are an employee of a sponsoring employer under the scheme  the QROPS you are transferring to is an overseas public service scheme and you are employed by an employer that participates in that scheme the QROPS you are transferring to is a pension scheme of an international organisation and you are employed by that international organisation If the scheme you are transferring out of does not receive the correct paperwork then they are required to charge the 25% on transfer regardless and you will have to apply for a refund via your scheme at a later date. If you are exempt from the charge on transfer but then your circumstances change within 5 years such as moving to another country or moving your QROPS to another country then you may have to pay the 25% tax charge at that point.

QROPS and the Lifetime Allowance

There is a lifetime allowance of £1 Million that you can have in pension savings in the UK unless you have one of the forms of protection in place. If you are under 75 and transfer out of UK registered pensions into a QROPS the value of the transfer will be tested against the lifetime allowance and if it is in excess of your unused allowance, this could result in a tax charge of 25% on the excess. Conversely, if you are under 75 and transferring into a UK registered pension from a QROPS this will usually result in an enhancement to your lifetime allowance. If either of these situations would apply to you, we recommend that you speak to a regulated financial adviser.

What happens if I transfer to an overseas scheme that is not a QROPS?

If you transfer to an overseas pension and it is not a QROPS then usually you will be classified as making an unauthorised payment from your pension which could result in an unauthorised tax charge of 55% with the possibility of additional penalties. Such a transfer is also unlikely to be regulated and is likely to leave you without any recourse to compensation. You may also find yourself in investments that are not diversified or not suitable to your attitude to risk. In short – the worst that could happen is that you lose all of your money and still find yourself with a tax charge to pay. Be aware of scams, don’t act on the basis of an unsolicited contact and always deal with a regulated financial adviser. If you are contacted out of the blue and suspect a scam, contact Action Fraud http://www.actionfraud.police.uk/

Am I free of UK rules and taxes on my pensions if I transfer?

On transfer your QROPS will have a 10 year reporting requirement to HMRC so that if you breach the rules of a QROPS such as releasing funds before age 55 you could still be subject to a tax charge of 55% plus penalties. For those that have transferred to QROPS before 6th April 2017 you also have to be resident outside of the UK for 5 consecutive tax years by the time you come to retire or take benefits. The period of nonUK residence was extended to 10 consecutive tax years for those that transfer on or after 6th April 2017. UK tax rules can apply for the 5 full tax years after you have transferred to a QROPS regardless of how long you have been non-resident. If you are a UK resident when you take benefits from your QROPS this is likely to be subject to UK income tax. If you are resident abroad you will also need to check the tax rules for that country and the country where your QROPS is based. Before you transfer check what tax you will pay on the pension benefits.

Pension Freedoms and QROPS

Whilst pension freedoms were introduced for defined contribution pensions in the UK, QROPS remained subject to a test that 70% of the fund had to be used to provide income for the rest of your life. This test has now been removed for all QROPS* as of April 2017, and you are allowed to have the same options as members of UK registered pensions. There is also a retirement age test of 55 which has now been modified. The new regulations allow for the following payments before age 55: • a serious ill-health lump sum • a short service refund lump sum • a refund of excess contribution lump sum (where you pay too much into your pot by mistake) • a winding-up lump sum (where you have a small pot and the scheme is wound up) *Including international organisations such as the UN and the EU pension schemes.

Take a pause before transferring

If you move abroad, you do not have to transfer your UK pension pot. You can choose to leave it in the UK and then draw benefits from the UK. Currency risk and exchange commission can be managed by setting up a foreign exchange account and transferring money into your local denomination accordingly. If you are transferring your pension you should make sure you understand the features and options in the new plan you are transferring to and how it differs from your current pension. Look out for any charges you may pay on your current pension for transferring, and check what the set-up and ongoing charges are on the new pension. Since 2013 regulated advisers in the UK are not allowed to charge commission and have to be upfront about the fees they will charge you for pensions advice this is not true in every country. Other fees such as trail paying investments and switching charges need to be looked out for. Also find out how the QROPS will invest your money and whether you have any choice in the type of investments. Consider the level of risk you are happy with. You might be worse off if you transfer your pension abroad. You must get regulated financial advice if you want to transfer from most defined benefit pensions and from some defined contribution pension pots which include a guarantee on how much income you will receive. In some cases this may result in you taking regulated advice in both the UK and the country that you are transferring to.

Source: The pension advisory service

Guaranteed annuity rates (GARs)

“A locked in guarantee”

Guaranteed annuity rates

If your pension scheme provides you with a guaranteed annuity rate (GARs), the amount of income you receive could be much higher. This can be a significant benefit to you as the annuity rates offered under older pensions with GARS can be considerably higher than those currently available, thereby increasing your pension income.

It is, however, important that you check the terms and conditions attached to the guaranteed annuity rate, and that the annuity provided is suitable for your circumstances.

You can find out whether your scheme offers a guaranteed annuity rate and the terms and conditions that may apply by looking at the information you were given when you joined the scheme, or by asking your pension provider. Most schemes that offer a guaranteed annuity rate were marketed in the 1980s and 1990s, when market annuity rates were higher.

Some of the things you should look for when deciding whether to take up the guaranteed annuity rate are:

• When can the rate be taken? Some pension schemes only offer the rate at the scheme’s selected retirement date, not if you draw retirement benefits before or after this;

• If you want to include a continuing income for a nominated dependent, such as a spouse, does the GAR still apply?

• Does the GAR apply if you want to include escalation, so that your income increases each year to offset the effects of inflation?

It’s always a good idea to compare the income available if you take up a GAR with the income available if you shop around, especially if you may be eligible for an impaired life or enhanced annuity before you make up your mind.

Should you have a Guaranteed Annuity Rate applying to your pension it would be advisable to seek professional financial advice in order that you make the most of this important benefit.

Open markets option (OMO)

The Open Market Option (or OMO) was introduced as part of the 1975 United Kingdom Finance Act and allows someone approaching retirement to ‘shop around’ for a number of options to convert their pension pot into an annuity, rather than simply taking the default rate offered by their pension provider.

 The term OMO is now generally used to support a campaign, often led by the pensions industry and the media, to make sure people know the benefits of shopping around. The majority of people still don’t use the Open Market Option in large part because they don’t know they can or don’t realise the benefits of doing so. Retirees who don’t use the OMO and settle for the default deal offered by their pension provider, may be missing out on up to 20% more income from an annuity. This is especially important as retirees cannot change their annuity once it has been purchased.

 One of the main reasons that people can get more from an annuity if they shop around is that they may qualify for what is known as an Enhanced Annuity (sometimes known as an Impaired Life Annuity) which pays a higher income to people who suffer from a range of health conditions – anything from asthma to a serious heart condition. There are also other products available that may suit peoples retirement needs better than the default deal offered by a pension provider. One suggestion to make the most of the Open Market Option is to speak to an independent financial adviser who will explain the different options available at retirement.

 The Association of British Insurers has been working with the retirement industry to improve consumers' knowledge of the Open Market Option. This includes pensions providers making it much clearer to their customers that they can use the OMO and that they may get a better income by doing so. However, take up of the Open Market Option is still low and there are now calls from many to make it harder for a pension scheme to transfer into an annuity by default, thereby forcing people to consider their options.

Pension annuities

Pension Annuities - a guaranteed income

If you’ve saved into a pension during your working life, you need to think about how that money work can best for you in retirement. When you stop working, how will your pension provide you with the income you need?

One way is an annuity. This used to be the only option for most pensioners, but even now that more choices are available, annuities remain popular, even though annuity rates are at an all time low. So what are they, how do they work, and what are the pros and cons?

What are annuities?

An annuity is actually an insurance product. You pay a lump sum to a provider, who in turn agrees to pay you a regular income for the rest of your life. This income is guaranteed and does not depend on a limited pot of money, so if you live a long time you may get back more than you paid.

The big advantage of an annuity is its reliability: you will always have an income. The main disadvantage is that this income may be smaller than you could achieve by another method.

How much will my annuity pay me?

The size of the income paid to you by your annuity will depend on a number of things. The main factors are:

• How much you pay for it

• Your age

• The provider’s annuity rates at the time

• Your state of health

Other factors include whether or not you want the annuity to include guarantees or cover your spouse as well, or whether you want the income to increase with time. Even your postcode can be a factor. Annuity rates can also vary a lot between providers, meaning some may give you tens of thousands more than others over the course of your retirement.

An annuity that pays you more money due to health and/or lifestyle factors is called an enhanced annuity. 

It's hard to estimate how much you might receive each year without first speaking to an independent financial adviser. Your adviser can assess all your circumstances and search the whole of the market to find the best deal for you – as well as seeing if you qualify for an enhanced annuity or any guaranteed annuity rates.

Will my annuity cover my spouse?

A standard annuity will stop paying out as soon as you die. However, you can select a joint-life annuity, which means it covers both you and one other person (usually your spouse). This kind of annuity will continue paying out a smaller income (usually 50 per cent of the original amount) to your spouse until they die.

You can also choose an annuity with guarantees. A guarantee means the annuity will pay out for a minimum time period (e.g. five years), even if you die sooner.

What if I have a health condition?

If you’re considering an annuity, then for once it can be an advantage to have a health condition. There are a range of medical conditions that can qualify you for an enhanced annuity – meaning you’ll receive a higher annual income for the same money.

Qualifying conditions include cancer, high blood pressure, heart disease, diabetes and a long list of others. Lifestyle factors may also apply, such as being a long-term smoker. Even if you don’t think you’d qualify, ask your adviser to check for you – as many as 60 percent of annuity customers could be eligible.

Should I always shop around for the best annuity?

Usually, you can achieve better value from an annuity by looking beyond your existing pension provider. Finding a better product can often give you a significantly bigger income over the course of your retirement. However, always check with your adviser before switching to a new provider. Some pension pots come with a guaranteed annuity rate (GAR), which may entitle you to a very favourable annuity rate (some are worth many thousands more per year than standard annuities).

Often it isn’t easy to tell if your pension has a GAR – not every provider will draw your attention to this fact. Ask an adviser to find out whether you’re lucky enough to have one.

Is an annuity right for me?

There are many advantages to having an annuity, including predictability, security and simplicity. However, your income may not be as much as you hope for, and you won’t have the option of varying it if you suddenly find you need more money. You may want to ask your adviser to help you compare annuities with more flexible options.