What is the difference between Pension Trusts and Contract Pensions?
The short answer to “What is the difference between pension trusts and contract-based pensions” is that a Trust Pension is established by a settlor, and the assets within are set up in trust, whereas a Contract Pension involves an individual contract between an employee, or an individual and a pension provider. In both cases, the pension schemes are most likely to be defined contribution (DC) pension schemes, as these are the dominant form of pension type in the UK.
What is a contract based pension?
Contract-based pension schemes are individual contracts between the member and the pension provider. The pension provider is often an insurance company or an investment platform, although there are also a number of independent providers.
What is a trust-based pension?
A trust-based defined contribution scheme is a workplace or a personal pension scheme run by a group of trustees that the employer or an individual appoints rather than by a large pension provider.
Related: Are Trusts Safe?
The differences between Pension Trusts and Contract Pensions
See the table below that describes the difference between Pension Trust and Contract Pensions Schemes.
|Contract Pension *||Trust Pension|
|Contract PensionSubject to Regulation in the country in which the scheme is domiciled.An Independent Governance Committee (IGC), which members are involved in, oversees how the scheme is operated. IGC members approve the assets bought and sold.The IGC can recommend changes to the provider’s board and can report a provider to the appropriate regulator if they think insufficient progress is being made.||Trust PensionSubject to Regulation in the country in which the scheme is domiciled.A board of Trustees is jointly and severally liable for everything that happens with the scheme.Governance is independently audited if the scheme is a master trust and is included in the list of authorised master trusts and their Master Trust Quality Assurance list from the regulator.|
|Contract PensionThe appointed IGC team decide on the asset range made available to members.This could be a default, wider governed range and further self-select range.||Trust PensionThe Trustees, with the help of professional investment advisers, decide on the range of assets that are made available to members.The Trustees must carry out ongoing governance on every asset they approve.|
|Contract PensionInitial set up cost (varies) plus annual flat fee or based on an Assets Under Management (AUM) model.The IGC must also report on the value for money provided to members by all of a provider’s work.||Trust PensionInitial set up cost (varies) plus annual flat fee or based on an Assets Under Management (AUM) model.The Trustees must report on the value for money provided to the scheme’s members when compared with alternative options available in the market.|
|Contract PensionTax concessions are considered to be given by way of reductions of the income tax rate from 20% to Corporation Tax at 19%, as well as there being no CGT & IHT once assets are within the scheme.Subject to Regulation in the country in which the scheme is domiciled.||Trust PensionTaxpayers get no tax relief on the way in. There’s no need to make a claim from HMRC, but non-taxpayers don’t get anything from the government.Tax concessions are considered to be given by way of reductions of the income tax rate from 20% to Corporation Tax at 19%, as well as there being no CGT & IHT once assets are within the scheme.Subject to Regulation in the country in which the scheme is domiciled.|
|Security and sustainability|
|Contract PensionContract-based QNUPS are not included in Solvency II calculations that are provided to the Prudential Regulatory Authority (PRA).This is a measure of the capital insurers need to hold to reduce the risk of insolvency.All scheme administrators carry Professional Indemnity insurance.||Trust PensionTrust-based schemes aren’t subject to Solvency II requirements.The FSCS doesn’t protect members’ benefits unless the Trustees invest in an investment product provided by an insurer. All Trustees carry Professional Indemnity insurance to protect member assets and interests.Master trusts will have to submit evidence that they have a sustainable business plan and sufficient reserves to ensure that member benefits are protected if the scheme should fail.|
QNUPS – Pension Trusts and Contract Pensions
All of the Soteria’s Retirement Plans meet the criteria laid down by HMRC for being a QNUPS – A Qualifying Non-UK Pension Scheme.
A QNUPS is a pension scheme based outside the UK that qualifies for an exemption from UK Inheritance Tax (IHT). In particular, QNUPS are attractive for additional retirement savings where individuals have reached the permitted limit of their domestic UK pension contributions and utilised all of the tax reliefs available.
Benefits drawdown – what to expect to form your Trust and Contract Pension QNUPS
All QNUPS schemes have rules around when you can drawdown / take money from them. Depending on where the QNUPS is set up, the earliest is age 55, and at that point, you can take up to 30% of the total value as a tax-free lump sum.
The remaining 70% has to be used to provide a regular income which can be taken monthly, quarterly, half-yearly or annually. The amount that can be taken as income each year is determined by the size of your fund, your age at withdrawal and the Government Actuarially Determined or GAD rates. This process is an HMRC stipulation and part of any schemes qualification and acceptance by them as a QNUPS.
You are allowed to take out as much as 150% of the published GAD rates, which is generous by comparison to calculations used for other scheme types, and normally plenty for members to enjoy a comfortable lifestyle each year.
The Government Actuarially Determined or GAD rates and how they affect your retirement income from QNUPS
To give you an example, if the GAD rates for a 60-year-old, which are based on the 15 year Government Gilt rates* of the day, would be £47 per 1000 of a fund or 4.7%. Under different circumstances where gilt yields have been higher, those rates have been up at 8.9%, so a fund of £1,000,000 would provide an income of £89,000 per year to the retiree. The GAD rates increase the older you get, so retiring at 65 would push them to 6.6% & 9.5% and at age 70 to 7.5% & 10.4%. These calculations are based on the 100% GAD numbers, the max available in retirement is up to 150% of GAD.
*Gilts are bonds issued by the UK Government. The term gilt is often used informally to describe any bond with a very low risk of default and a correspondingly low rate of return.
Summary: A Pension Trust or a Contract Pension?
Both Trust and Contract-based pensions allow the sale or any assets placed within them at any time. The sale proceeds of the assets must go back to the pension and from there can be used to buy the same or different asset classes within the pension.
There are thousands of members who have used Trust Pensions and happily transferred their properties in so that they would sit outside their Estate for IHT purposes at death. Contract pensions are becoming more and more popular, the main reasons being this increase in popularity are 1: they are easier to understand and 2: the member retains an element of control over the assets as an IGC member, whereas in a trust scheme once the assets are passed into the trust the member loses all control as they become the legal property of the Trustee, who is afforded discretionary powers over them.
“Contract pensions do have one tax advantage over Trust pensions when it comes to the rate of tax it pays on any income it produces.”
Both scheme types have very similar overall benefits and are subtly different in the way they are administered. They get to the same CGT & IHT efficient place by taking a slightly different route, but there is no overwhelming reason to place Trusts above Contracts or vice versa.
Tax jurisdiction matters
The choice of jurisdiction and with it the selection of a Trust or Contract pension is ultimately influenced by things such as the member’s nationality, their country of residence, the type of law their country of origin operates under, as well as the intergovernmental agreements that exist. The final choice is often down to the member’s personal preferences and the system they are most comfortable having their assets administered under.
If set up in the right jurisdiction, contract-based pensions, like in the case of the Soteria Plan in Guernsey, can offer annuity payments for life while being income-tax free. This is a superior option for those who want to have a steady, additional retirement income, which they can enjoy without having to pay taxes on (subject to T&C). As in the example of the Guernsey-based plan, which is also a QNUPS, it also offers IHT tax efficiency by being transferable upon death to your beneficiaries and remaining outside of your estate.