Out-Law News | 07 Nov 2013 | 5:28 pm | 3 min. read
As set out in a new consultation paper, these so-called 'defined ambition' schemes could allow employers to continue to offer defined benefit (DB) schemes on a cheaper basis, or allow for defined contribution (DC) pensions that give savers more certainty about the benefits they will receive on retirement.
"Final salary pensions have been in long-term decline and if we do not act they could disappear altogether," said Pensions Minister Steve Webb. "We want to help the best employers offer good alternatives including new forms of salary-linked pensions."
"We have looked at the best pension arrangements around the world and want to give British workers the chance to join such schemes. Our proposals for defined ambition pensions are designed to reinvigorate workplace pensions, providing people with more certainty about what they will get in retirement," he said.
Pensions expert Simon Tyler of Pinsent Masons, the law firm behind Out-Law.com, said that the consultation paper opened up "a range of exciting possibilities".
"This consultation paper is a positive development," he said. "Employers and providers should consider whether any of the proposed options offer opportunities that are worth exploring, and members will welcome anything that gives them more certainty about their retirement income than plain 'vanilla' DC."
"The Government is thinking along the right lines. We hope that it is able to implement the proposals sooner rather than later, without introducing any undue complexity," he said.
DB pension schemes promise a set level of pension once an employee reaches retirement age no matter what happens to the stock market or the value of the pension investment. The percentage of open schemes has more than halved since 2007, leaving just 841 open today, as employers struggle to cope with the costs of providing pensions for longer against poor investment results.
By contrast, DC schemes are becoming increasingly popular as workers begin to automatically enrol workers into them to comply with new pension provision requirements. In a DC scheme, the final value of the pension a member receives depends on the performance of that member's individual contributions, meaning that it is the employee who bears the full risk of the pension losing value. Such schemes have therefore traditionally been less strictly regulated than DB schemes, although the Pensions Regulator has recently taken steps to address this.
Under the proposals set out in the consultation paper, the pensions legislation would be amended to enable schemes to be classed as one of either DA, DB or DC. A different governance, disclosure and funding regime would apply to each type; and schemes would be reclassified depending on how they are structured and what benefits and guarantees that they offer. The consultation looks at three proposed DA structures: 'flexible DB', 'guaranteed DC' and 'collective DC'.
Flexible DB would allow employers to offer pension scheme members salary-related benefits on a cheaper, more flexible basis than before; rather than offering a guaranteed retirement income linked strictly to salaries. Employers would be able to establish new DA schemes on these terms, or to make these terms available in respect of future service under existing DB schemes. Schemes would not need to provide any index-linked increases to pensions that are already in payment, but could choose to do so on a discretionary basis. Employers would also be able to increase the scheme's normal retirement date to take account of increases in life expectancy, provided that members had less than 10 years to go before their normal retirement date.
The consultation considers four different types of guarantee that could be applied to DC pensions to bring them within the scope of the new DA regime. Schemes could provide a money-back guarantee to the value of the contributions paid; could guarantee investment returns; or could guarantee a minimum level of income either through retirement income insurance or by awarding an amount of pension in return for each year's contributions. Under each of these models, the employer would remain liable to pay the level of contributions it had set in advance while the pension provider would be responsible for ensuring guarantees are met.
The fourth of these models offers similar advantages to the proposed collective DC schemes, under which assets are pooled to give trustees access to a wider range of investment opportunities. Such schemes are common in Denmark and the Netherlands, and studies have indicated that members are likely to achieve a significantly better retirement income than under a traditional individual DC scheme. The employer's liability to pay contributions would be the same as in a traditional DC scheme; however, pensions may be reduced if insufficient assets are available to pay them.
"Employers with DB schemes that are still open to accrual will wish to give serious thought to the opportunities for saving costs offered by the proposals," said pensions expert Simon Tyler. "They may well choose to flex their DB benefits in one or more of the three ways the Government is proposing. The Government is likely to introduce a statutory override to allow the required changes to be made, even if their scheme rules wouldn't otherwise allow it."