Why would anyone set up a trust-based scheme today?

The format is pretty simple: a board of trustees takes responsibility for investing your money, manages the audit of the scheme, and the administration of the fund on your behalf.

Individuals do not take comfort from being part of a great corporate entity in the way they did 30 or 40 years ago

But in the 1980s a new breed of pension burst onto the scene: the contract-based defined contribution scheme.

The shift toward contract-based schemes has been gradual but they are becoming increasingly popular.

In fact, if you were to give a company a blank piece of paper to design a scheme today, it is unlikely they would entertain the idea of the trust-based format.

Having said that, governance is an area where trust-based schemes have an advantage, albeit a small one.  

In a trust-based scheme, trustees shoulder responsibility for looking after members’ money, investment performance and meeting investment managers.

While this can be seen as an advantage, is it enough of a draw for employers, especially when some people consider this a disadvantage?

Ask any insurer and they will all say the same thing: the biggest movement of money is going from trust-based to contract-based schemes. But why?

Cost and flexibility issues

For a start, flexibility. The trust-based scheme is the slow-turning super tanker to the contract-based speedboat.

Transferring money from trust-based schemes is complex and getting hold of the information you need is difficult.

Furthermore, the role of the trustee is complicated and comes with a lot of responsibility. As a result, persuading willing volunteers to take up the role can be difficult.

On top of that, trust-based schemes are, typically speaking, relatively opaque. All of the processes behind managing your employees’ money are carried out by other people, meaning it is easy for employees to become disengaged with the process.

Moreover, as trust-based schemes grow in size, they can become incredibly expensive. This is because employers must pay the sizeable administration costs for ex-members who do not transfer their cash to another scheme.

By contrast, contract-based schemes offer the benefit of fixed costs to employers: you simply pay the contributions you are required to pay. Aside from that, there are no extra costs – a key attraction for scheme owners.

When it comes to governance, there is nothing stopping a contract-based scheme creating a body to check the arrangement is still offering value for money to members or that the default funds remain appropriate.

These governance committees have the same responsibility as trustees in terms of oversight and governance; however, they cannot move a member’s money without their consent. Because there is no liability for a member of a governance committee, it is much more appealing to be a part of one. 

Members want control of their money

Therefore, as an employer you gain the benefit of flexibility that surpasses that of trust-based schemes, while the level of governance is nearly on par.

We must also remember that the world has moved on from the trust-based scheme’s heyday of the 70s and 80s.

Today’s world values individualism and free choice. People want to take control of their money to ensure it is being deployed correctly for the best long-term gains.

Individuals do not take comfort from being part of a great corporate entity in the way they did 30 or 40 years ago.

Added to that, today employees are faced with arguably more retirement options than ever before. That has made retirement a complex business.

Encourage individuals to engage

To combat this, the government allows employees to use a small portion of their pension pot to pay for advice.

A sizeable chunk of an employee’s pension pot is made up of free cash from the government, in the form of tax relief and employer contributions, so why not let them use a little of it to fund quality advice?

And yet most trust-based schemes have not changed their rules to allow people to pay for financial advice using their pension.

Given these drawbacks, it is not surprising that insurers are investing the most in their contract-based, workplace pensions rather than their DC platforms.

More modern contract-based schemes are nimbler, offer greater flexibility and are more personal.

We should be encouraging individuals to engage with their pension through innovative workplace education rather than relying on a small board of trustees to make decisions on behalf of the masses.

Matthew Mitten is a partner at Secondsight