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Defined Benefit Pension Schemes: Questions and Answers: Guidance
Defined Benefit Pension Schemes: Questions and Answers: Guidance
Guidance
Contents
Introduction
1. What is a defined benefit pension scheme?
2. What is a defined contribution pension scheme?
3. What are employers’ legal obligations for providing pension schemes?
4. How will the employers’ legal obligations change in 2012?
5. What is Financial Reporting Standard 17?
6. Who Regulates Pension Schemes?
7. What are the funding requirements for defined benefit pension schemes?
8. What is the situation with defined benefit pension schemes that are in deficit?
9. What is the Pensions Regulator doing to help employers in the current
economic recession?
10. Does the Charity Commission produce any guidance for charities regarding
pension schemes?
11. What is the Pension Protection Fund?
12. Can charity assets be charged to reduce levy contributions?
13. What issues arise for an unincorporated charity considering incorporation?
14. Can similar issues are when two or more charities merge?
15. Does the Charity Commission have any role to play in these cases?
16. What are the issues with regard to multi-employer pension schemes?
17. Does the Charity Commission have any powers which would be of assistance in
these circumstances?
Introduction
In recent years a number of charity pension schemes have reported significant deficits. This is because
the value of scheme assets has fallen at the same time as a combination of increased longevity of
scheme members, low interest rates and lower than expected returns have contributed to a rise in the
value of scheme liabilities. Pension legislation also affects how existing pension arrangements can be
restructured, and affects charities’ restructuring through incorporation or merger.
Careful planning and advice in relation to any proposed restructuring of a charity, such as on incorporation
or merger, is now likely to be necessary to avoid large cash outflows.
The Pensions Regulator has published guidance for employers (including charities) that sponsor
pension schemes about the potential problems they may face in funding these schemes in times of
economic difficulty.
Our guidance Charity Reserves and Defined Benefit Pension Funds explains the risks attached to a
charity’s involvement in a defined benefit pension scheme for its staff. It also looks at the accounting
implication of membership of the scheme, the role of the various regulators and the potential liabilities
for trustees.
Some employers prefer to run a defined contribution pension scheme rather than a defined benefit
scheme, as it is usually less costly to them and results in a predictable cash outflow. In a defined
contribution scheme the level of benefit depends on the contributions made, rather than contributions
needing to catch up with the actual benefits as in the case of defined benefit schemes.
7. What are the funding requirements for defined benefit pension schemes?
Most defined benefit pension schemes need to meet a statutory funding objective, known as technical
provisions, which assesses the required levels of funding a scheme requires to provide benefits for its
members. Employers need to work closely with the trustees of the pension scheme to agree what
the technical provisions for the scheme should be and set out a schedule of contributions to meet and
maintain this level. Regular valuations, at least every three years, are required to check whether the
statutory funding objective is met; where it is not, trustees and employers will need to agree on a
recovery plan.
Employers and scheme trustees should obtain advice separately from appropriate professionals, such as
actuaries and lawyers, to inform their decision making.
The Pensions Regulator has issued a code of practice on funding defined benefits.
8. What is the situation with defined benefit pension schemes that are in deficit?
A large proportion of many final salary pension funds are held in equities and face deficits in periods
of significant falls in the value of stock markets. The Pensions Regulator studies pension funds’ triennial
valuations and can require any employer whose fund is in deficit to take action to rectify the situation.
Where the statutory funding objective is not met resulting in a deficit in the pension fund, the employer
and pension scheme trustee have to agree a recovery plan setting out the steps to be taken to put
things right.
10. Does the Charity Commission produce any guidance for charities regarding
pension schemes?
The Pensions Regulator is the regulator of all work-based pension schemes in the UK. It provides practical
guidance for trustees, employers (including charities), administrators and others on complying with the
requirements of pension law.
The Commission does not publish separate guidance on the application of pension law as it applies no
differently to charities than to other entities. We do however provide guidance on particular issues that
impact on the charity reporting framework. Recommendations on accounting for pension and other
retirement benefits are contained within the Charities SORP.
The Commission has also produced guidance on Charity Reserves and Defined Benefit Schemes explaining
how a charity’s reserves policy might address pension deficits. The guidance also contained information
about the possible liabilities of charity trustees.
There is a clearance procedure, established by the Pensions Act 2004, which allows an application to be
made to the Pensions Regulator to obtain assurance that the Pensions Regulator will not use its powers in
relation to the transaction after it has gone ahead. Further guidance on making a clearance application is
available on the Pension Regulator’s website.
14. Can similar issues are when two or more charities merge?
Yes, a merger may often result in the creation of a new separate charitable legal entity and/or the winding
up and removal of an existing charity. There are similar issues to be considered as with incorporation.
15. Does the Charity Commission have any role to play in these cases?
The Commission is able to advise on the charity law aspects of incorporation or merger but is unlikely
to need to be involved in obtaining clearance in relation to pension arrangements unless some action is
required on the part of either the unincorporated charity, the new incorporated charity or in the case of
a merger, the successor charity which might otherwise not be within the powers of the charity. In such
circumstances, if the Commission is satisfied that the proposed action is expedient in the interests of the
charity, it may be able to authorise the charity to take the action. In the context of incorporation, there
have been issues about additional liabilities arising in respect of the pension scheme and charity trustees
being concerned as to how reasonable it is for them to take on such liabilities.
Similar issues may also arise in the context of mergers or other transfers of staff, activities and assets on
the winding up of a charity.
16. What are the issues with regard to multi-employer pension schemes?
Changes to the law on multi employer pension schemes were brought in by Statutory Instrument in 2008
(The Occupational Pension Schemes (Employer Debt and Miscellaneous Amendments) Regulations 2008).
A number of charities have established defined benefit multi-employer pension scheme for their
respective employees. This may be more viable than each charity establishing its own scheme. In multi-
employer schemes additional liabilities can become payable if an employment-cessation event occurs. An
employment-cessation event occurs at the time an employer ceases to employ at least one person who
is an active member while at least one other employer continues to employ active members.
However there is a period of grace which is designed to prevent employers with a small number of
employees and scheme members from inadvertently triggering a debt when they intend to enroll more
members in the scheme. An employer can be treated for a 12 month period as if it employed a person
who is an active member of the scheme, if they notify trustees that they intend to employ someone in
the next 12 months who will join the scheme. If at the end of the 12 month period the employer still has
no active members a cessation event will be deemed to have occurred as at the date that the employer’s
last active member left.
When an employer ceases to participate in a multi-employer scheme, their share of the liabilities –
including any orphan liabilities (benefits in the scheme which are not related to any current sponsoring
employer) will be calculated on a buy-out basis. In most cases it will not be necessary to pay this liability
in full at the time. It will instead be modified in one of four ways depending on the circumstances,
subject to the agreement of the parties involved.
Full details of these arrangements are in the Pensions Regulator’s guidance for employers, scheme trustees
and advisers ‘Multi-employer withdrawal arrangements’, which can be downloaded from its website.
17. Does the Charity Commission have any powers which would be of assistance
in these circumstances?
The Charity Commission recognises the seriousness of the issues confronting the sector in respect of
defined benefit pension schemes. It would wish to assist in identifying good practice and facilitating this
to the extent it is able to do so.
As has been indicated, the Commission can authorise charity trustees to take certain actions which may
not otherwise be within their powers. Where trustees are concerned that they may be exceeding their
powers, they can apply to the Commission for advice under section 29 of the 1993 Act or for an order
under section 26.