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Pensions and retirement planning

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Know your DA DB DCs…

Ian Naismith

The Government’s ‘Reshaping workplace pensions for future generations’ outlines its proposals for defined ambition (DA) pensions. DA sits between defined benefit (DB), where an employer accepts all the risk, and defined contribution (DC), where risk sits with the individual.

‘DB minus’ could make DB provision palatable for employers by removing absolute guarantees. For example, increases to pensions in payment could become discretionary, or employers could adjust retirement ages to reflect changes to longevity. Another option would be to allow automatic conversion to DC for those leaving employment, with their pensions no longer guaranteed by the employer. Changes would not be retrospective.

‘DC plus’ could provide greater certainty in the DC world, perhaps by offering a money-back guarantee, which might be attractive to those starting pension savings. Later, there could be a guarantee of capital protection, with some growth, over a fixed period. Nearer retirement, income insurance could be bought in stages, allowing income to be drawn from the fund after retirement, with the guarantees kicking in if the fund runs out. Finally, it would be possible to adopt aspects of the Danish pension system, where part of each contribution buys a deferred annuity and the remainder is invested in growth assets.

The hope is that economies of scale and pooling of risk will make DC plus feasible and affordable.

Collective defined contribution (CDC) involves pooling contributions of members with a target level of benefit. Gains held back in good times act as a cushion for bad times, and there is the possibility of intergenerational cross-subsidy, removal of indexation and reductions pensions. Pooling of risk could allow greater investment in higher-growth assets, but CDC lacks transparency and could produce intergenerational unfairness.

The Government plans to legislate to allow DA structures, hoping for attractive solutions for employers and scheme members. 

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