What are the proposed changes to UK pensions? - Pensions - News - Moneyfacts


What are the proposed changes to UK pensions?

What are the proposed changes to UK pensions?

Category: Pensions

Updated: 08/11/2013
First Published: 08/11/2013

This article was correct at the time of publication. It is now over 6 months old so the content may be out of date.

Yesterday the Government outlined its proposals to reshape the UK's workplace pensions system, with these changes being intended to improve security for individuals whilst ensuring employers are able to continue offering the best workplace pensions possible.

The decline of defined benefit (DB) schemes, where employees get a guaranteed income at retirement, combined with the uncertainty over defined contribution (DC) schemes has led pensions minister Steve Webb to look for alternatives, suggesting a number of possible solutions – known collectively as "defined ambition" – that could be fair for the individual as well as the employer.

The current system

As it stands, the majority of workplace pension schemes are of the defined contribution variety. Under this system the employer and employee will make contributions to the individual's pension pot which will be invested in the stock market to (ideally) generate a return. The employee then uses this pot to buy a retirement income, such as an annuity or income drawdown product, with the risk being placed entirely on the individual as they're responsible for generating their own retirement income.

Defined benefit schemes are different. Again, they involve both the employer and the employee making contributions to the pension pot, but this time the employer guarantees a fixed income based on the individual's work record and as such it will generally result in a higher retirement income being achieved than with more common DC schemes. In this case all the risk is placed on the employer (they'll be responsible for providing payouts throughout the worker's retirement) which means DB schemes are rapidly declining in popularity, with there being just 841 open schemes currently available.

The proposed changes – defined ambition

Under the defined ambition concept the risk will be shared between the employer and the employee, effectively making it a halfway house between DB and DC schemes. The consultation paper "Reshaping workplace pensions for future generations", published by the Department for Work and Pensions, outlined a number of possible solutions:

Flexible defined benefit.

This method focuses on making defined benefit schemes more attractive to employers by removing certain restrictions, namely the requirement for DB pensions to increase with inflation and provide survivors rights. This means the employer will still need to provide a pension income based on the individual's earnings but they won't have to provide annual increases and nor will they need to continue making payments to the worker's spouse should they die. The employer will still take on the risk of providing a retirement income, but the employee will be responsible for protecting themselves against inflation and providing for their partners.

Guaranteed defined contributions.

There are four separate options being considered under this model, all of which are designed to protect the value of a worker's pension pot so they have more to generate an income from.

  1. Money-back guarantee. Employers will guarantee that the value of an employee's pension pot will never fall below the amount that has been contributed towards it, protecting savers from poor investment performance.
  2. Capital and investment return guarantee. A third-party will buy a guarantee on a part of the employee's pension pot halfway through their working life, with the value of this portion being guaranteed and the remainder staying invested.
  3. Retirement income insurance. A proportion of the worker's pension pot will be used to buy income insurance products that can provide a guaranteed minimum income. When the worker retires they'll use their pot to buy an income drawdown product, and when the pot is empty the insurance will kick in so regular income can continue.
  4. Pension income builder. Deferred annuities would be bought using a portion of the worker's contributions each year, providing a guaranteed income but one that keeps in line with rate changes. The rest would be collectively invested with other members of the scheme for additional growth that can be used to purchase another retirement income.

Collective defined contributions

  • In this scenario, rather than employers and employees making contributions into individual pots, the funds would be invested into a collective pool with other employees. When they retire, the individual would receive a retirement income paid from the pool rather than picking a retirement product of their own, with the amount received being based on a pre-set target income. This system means individuals have the opportunity to invest in a wider range of products and would be better protected from downturns, but as risk is shared between members different age groups might end up with better retirement incomes than others (poor fund performance might affect target incomes for younger savers but those drawing down their income might not be affected, for example).

Pensions minister Steve Webb said:

"I want people to have the best pensions possible, where risks are shared between employers and their workers. Final salary pensions have been in long-term decline and if we do not act it could disappear altogether. We want to help the best employers offer good alternatives including new forms of salary-linked pensions.

"Our proposals for defined ambition pensions are designed to reinvigorate workplace pensions, providing people with more certainty about what they will get in retirement."

The consultation closes on 19 December, after which the outcome could be decided.

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