XPS pensions, also known as executive pension schemes, are a type of defined benefit pension arrangement set up by employers to provide retirement benefits for senior staff such as directors and senior managers. They work similarly to final salary pensions in providing a guaranteed income in retirement based on the member’s salary and length of service.
What are the main features of XPS pensions?
Some key features of XPS pensions include:
- They are set up under trust law, with assets held separately from the employer.
- Benefits are linked to final salary.
- They provide a tax-free cash lump sum and annual pension at retirement.
- Pensions can be provided for the member’s spouse.
- The normal minimum retirement age is 55.
- Members contributions are usually quite low or zero.
- The employer pays the bulk of the costs.
- There is no lifetime allowance test on benefits.
Who can join an XPS?
XPS pensions are aimed at senior staff such as:
- Directors of limited companies.
- Senior managers.
- High earning employees.
- Members of an owner-managed company.
They are typically targeted at a select group of senior individuals rather than being open to all staff. The employer decides on scheme eligibility.
How do XPS pensions calculate benefits?
Benefits are calculated based on a member’s final salary and length of service. Commonly used formulas include:
- 1/30th of final salary for each year of service.
- 1/60th of final salary for each year of service.
- 2/30ths of final salary for each year of service up to 10 years, and 1/30th over 10 years.
Other benefits like tax-free cash, death benefits and spouse’s pensions are also calculated as a fraction of final salary.
What are the annual and lifetime allowances?
Unlike most pension plans, XPS benefits are not tested against the annual allowance for tax relief or lifetime allowance for tax penalties. This gives XPS plans more scope to provide generous benefits.
How are XPS pensions funded?
An XPS is funded by contributions from the employer and member and the returns from investing those contributions.
- The employer contributions are tax deductible business expenses.
- Member contributions typically attract full tax relief.
- The funds build up free of capital gains and income tax.
This tax structure allows substantial funds to accumulate to pay the promised benefits.
What are the investment options?
The trustees of the XPS pension scheme control the investment strategy. Common investment approaches include:
- Actively managed portfolios of equities, bonds, property etc.
- Passive indexing approaches.
- Liability driven investment focused on matching assets and liabilities.
- Delegated solutions outsourcing decisions to a fund manager.
- A mix of active and passive approaches.
The strategy aims to maximise returns within acceptable risk tolerances to ensure there are sufficient assets to pay the promised benefits.
What are the death benefits from an XPS pension?
Typical XPS death benefits include:
- A lump sum of 4-5x annual salary.
- A spouse’s pension of up to 2/3rds of the member’s pension.
- Children’s pensions.
- The ability to pass remaining benefits as a lump sum through an expression of wish form.
As the benefits do not need to be tested against the lifetime allowance, very significant lump sums can be provided on death.
When can I take benefits from an XPS pension?
Members can usually take benefits at the following times:
- From age 55, even if still employed.
- On ill health grounds at any age.
- On leaving service.
- On the sale of the business.
- If made redundant.
There is no requirement to stop work in order to start drawing benefits.
What are the advantages of an XPS pension?
Key advantages include:
- Generous tax-free cash lump sum.
- High pensions with no lifetime allowance issues.
- Spouse’s pensions provided.
- Peace of mind from guaranteed benefits.
- Maximum contributions for company directors.
- Lump sums can be passed on through expression of wish.
- Flexibility to take benefits from age 55.
For high earners and business owners, the ability to contribute substantial amounts and get tax relief makes them very attractive.
What are the disadvantages of XPS pensions?
Potential disadvantages include:
- The cost of providing guaranteed benefits.
- Inflexibility if schemes need amendment.
- Risk the employer becomes insolvent leaving the scheme underfunded.
- Investment returns may be lower than expected.
- Life expectancy continuing to increase.
- More complex administration requirements.
These risks can make them less popular now for employers than defined contribution schemes.
How are XPS pensions taxed?
XPS schemes enjoy very favorable tax treatment:
- No limits on the amount that can be contributed or the size of benefits.
- Contributions get full tax relief.
- Funds grow free of capital gains and income tax.
- 25% of benefits can be taken tax-free.
- No lifetime allowance charge on benefits.
This enables substantial retirement funds to be built up over time.
When are XPS pensions set up?
Common situations when XPS pensions are established include:
- When a company is set up and directors require pensions.
- When directors are approaching retirement.
- When a senior employee is nearing retirement.
- When a key employee is recruited who expects this type of benefit.
- When a company is sold and the owners expect significant remuneration.
They are typically set up when certain individuals require flexible, generous pensions.
Can I transfer benefits out of an XPS scheme?
Yes, members can transfer out of an XPS plan, subject to certain conditions:
- Transfers must take place before benefits start to be taken.
- Transfers to other registered pension schemes are tax-free.
- The trustee and employer must agree to transfers being allowed.
- Transfer values reflect the generous nature of XPS benefits.
- Advice is needed as members will be giving up guaranteed benefits.
So transfers are possible but the advice requirement acts as a barrier to protect member’s benefits.
How are XPS pensions regulated?
XPS schemes are approved and regulated by HMRC to ensure they comply with pensions legislation. Key requirements include:
- Must be set up under an irrevocable trust deed.
- Assets held separately from the employer.
- Trustees running the scheme for members’ benefit.
- Following legislative rules on contributions, benefits etc.
- Submitting scheme returns to HMRC.
Trust law provides protection for members should the employer get into financial difficulties.
How do I know if setting up an XPS is right for me?
Important considerations include:
- Your expected retirement income needs.
- Maximising your lifetime pension contributions.
- Your attitude to investment risk.
- Whether you want to set benefits for spouse/children.
- If you want flexibility around accessing benefits.
- The cost implications for your business.
- Whether you will have resources to fund the scheme.
Advice from a pensions specialist is crucial before taking the decision to establish an XPS.
What happens when I die – who gets the XPS pension?
In the event of your death, XPS pension benefits would typically be paid as:
- A tax-free lump sum to your nominated beneficiaries.
- A regular pension income for your spouse.
- Pensions for eligible children.
You can indicate who you wish to receive any remaining lump sums by completing an expression of wish form. The trustees will take this into account when paying death benefits.
Can I change the benefits after an XPS is set up?
It is possible to change the benefits provided by an XPS but there are restrictions:
- Changes must be agreed by the trustees and employer.
- Benefits can’t be reduced once members have earned entitlements.
- Alterations need approval from HMRC.
- Changes apply prospectively not retrospectively.
So there is some flexibility to amend benefits going forward but accrued rights are protected.
What happens if my company sponsoring the XPS is sold?
If your company is sold, the XPS can continue to operate as before:
- The scheme assets are legally separated from the employer.
- The scheme would transfer to the new owners.
- The buyer would become the principal employer.
- Your benefits would be protected.
This demonstrates the security provided by XPS pensions even after major corporate transactions.
Conclusion
XPS pensions offer senior staff like directors and managers a flexible, tax-efficient way to build up substantial retirement benefits. They provide security through guaranteed incomes backed by the financial strength of the corporate sponsor. While complex to set up and run, an XPS scheme can be an attractive reward component for key individuals in smaller companies. Taking expert advice is vital to ensure an XPS delivers benefits tailored to your specific needs.
