Pensions: trust or contract?
The distinction between contract-based and trust-based pensions might seem unimportant. But it can affect how much control you have over your retirement nest egg. Guest blogger Richard Butcher, from Pitman Trustees, explains what pension trustees do.
The other day I had to get across London. For reasons that I won’t bore you with, I had to do this by car. That said, I was still left with a choice: to drive or to get a taxi.
I’m not a good passenger. Quite aside from becoming a little queasy, I hate the ritual of small talk and I really hate not being in control. I stab at an imaginary brake in the passenger footwell and I swear under my breath at small unexploited gaps in traffic on roundabouts.
That said, I know I’m not the world's best driver. I’m too easily distracted by anything, clouds, advertising hoardings, pretty girls. I know I don’t give the job the attention it needs. The outcome could be better than taking a taxi but the reality is it’s usually not. I arrive later than I might and, occasionally, with a red face and a new, small, dent to admit to.
The world of work-based pensions has a similar choice: “contract based” pensions versus “trust based”.
A contract based pension scheme (CBS) is one where there is a contract between an individual and a pension provider. The contract is owned by the individual and he or she has enforceable rights against the provider. A CBS will always be a defined contribution scheme.
A trust based scheme (TBS) is one where an individual joins a trust. He or she has enforceable rights against the trustees (who are the “directors” of the trust). A TBS could be a defined benefit scheme or a defined contribution one.
If we ignore all the bells, knobs, whistles, rules and regulations, the two kinds of pension do the same thing. They are both vehicles for saving money for the future, they both have the same tax breaks (albeit delivered slightly differently) and they both provide the same types of retirement benefits.
That apparent simplicity, however, hides a number of very significant differences that can have a massive impact on the benefits you receive.
The principle difference is “who is in control?”
In a CBS, the individual is in control. This gives the advantages of greater freedom of choice for example, on how to invest the money in the pot, when to retire and how to take benefits. It also, however, places the onus on the individual to make decisions. There is no one else doing it for them. They are the driver.
We did a survey of CBS members earlier this year. Amongst other things we asked them “who is responsible for choosing and monitoring your pension investment fund?’. More than 80% answered “my employer” . They were wrong. The correct answer was “ I am”.
In a CBS, it is the individual who must decide if the funds they are in are correct for them, if the administration of the scheme is being done properly, whether the charges are fair and competitive and whether they are getting a good deal when it comes to taking retirement benefits.
In a TBS, the trustees are in control. They must make decisions on behalf of the members. When they make these decisions they must have the members’ best financial interests in mind. The member can sue if they fail.
This means that the trustees can move money amongst investment funds if they believe there is a need to do so, either because a new fund is more appropriate or it's better performing. It is the trustees’ responsibility to ensure that the scheme is being properly administered, that charges aren’t excessive and that you get a good deal at retirement. The trustees are the driver.
This ceding of control to trustees, however, needn’t be total. Most schemes will allow member choice as well.
For example, they will allow members to select the investment fund from a range of funds (which can be extensive), most will allow members to set their own level of contributions (perhaps subject to a minimum), all will allow the member to choose the form of their retirement benefits. The trustee may be driver but they’ll put their foot down when you ask them to!
Generally, when you join an employer you are not given a choice between TBS or CBS. The employer will have already chosen which they will offer. It is, however, important that you understand which you are in. If you don’t, you could find yourself in heavy traffic with no one at the wheel.
Richard Butcher is managing director of Pitman Trustees
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