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Pension tension

The far-reaching effects of the shift from defined benefit to defined contribution schemes

Various factors can be attributed to the upheaval in UK occupational pensions. The pensions “stealth tax” changes in 1997 in Gordon Brown’s first budget, stockmarket falls, employer contribution holidays in earlier years, the need to make good funding deficits, endless regulatory changes and improved pensioner longevity all conspired to threaten the existence of defined benefits (DB) schemes and has hastened the move to defined contribution (DC) schemes.

The moves from DB to DC now affect not only people joining a company but also existing scheme members – many of whom have seen either a reduction in the levels of benefits they previously enjoyed or are required to contribute more.

What have these changes meant for employers? The CBI and Mercer Human Resource Consulting published a survey of 355 UK companies in July giving an overview of the role of employers providing pensions for employees and how they are reducing costs and regulatory risks.

It showed that 65 per cent of chief executives now favour DC schemes while just 7 per cent prefer DB schemes (compared with 20 per cent in the 2004 survey), and that 20 per cent of the largest firms are looking to close DB schemes to existing members in view of rising costs. It also found that average contribution rates, including deficit funding, are now at 19.6 per cent of pay, with those in the top quartile paying more than 41 per cent. The increased cost of pension provision has also had a negative effect on company profits, resulting in reduced investment in the business and less money spent on other employee benefits.

Of companies with DB schemes, 68 per cent have increased members’ contributions and 60 per cent plan to do so next year.

Just under a quarter have changed the accrual rates in their DB schemes to 80ths and one in seven companies have increased retirement ages since 2004 with another 25 per cent expecting to do so in the next two years.

In the heady Eighties and Nineties people were encouraged to aim, and save, for early retirement, enabling the newly retired to have more time for leisure and perhaps a part-time job to keep the brain cells ticking over. The CBI survey shows that employees are still choosing to retire early – typically at around 62 – so the early retirement culture appears to live on. But can they afford to retire? It seems to be the case that people are often motivated more by a different lifestyle or self-employment rather than dropping out of the workforce altogether.

The Government, with its proposals to increase state pension ages. wants people to work for longer. Although the implementation of the EU equal treatment directive to outlaw age discrimination in the workplace has been delayed, the emphasis will be on allowing people the opportunity to continue working beyond the “normal” retirement age. The CBI survey found that the majority of firms now take a flexible approach so employees don’t have to choose between work and retirement.

While employers have to cope with more risks than in the past, in particular the effects of evolving regulation, the position for employees is even more uncertain. The DC world means having to make personal decisions about asset allocation, which investment funds to use, when to switch funds and when to buy annuities. Without education, regular information and, ideally, individually tailored advice employees are not equipped to make these decisions and this can lead to inadequate pensions at retirement. The ability to work beyond normal retirement age will become a necessity.

Another survey, the 10th IDS Pension Service survey on levels of pension in payment from occupational schemes, shows that the mean level of annual pension paid by 205 schemes has risen from £5,057 to £5,253 over the last two years. This low level of pension would indicate that as time goes by more people will want to take advantage of the Equal Treatment Directive allowing them to work beyond their normal retirement date on full salary rather than having to retire on less income.

Tony Reardon is principal at Reardon Consulting

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