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Pensions at what cost?

The Government’s reforms could spread provision very thin throughout the UK

The Government’s mission is to make sure that 10 million people who are not saving anything or not saving enough for retirement start doing so. It will do this by automatically enrolling all employees in their employer’s scheme or a personal account with a mandatory employer contribution of 3 per cent of band earnings.

But the Government has failed to consider fully the effect of these reforms on existing provision. Bringing in automatic enrolment for the majority of employees and all employers, regardless of size, is a very big move. The main risk is that employers will reduce what they currently offer.

For a defined-contribution arrangement, this will probably mean reducing contributions closer to the personal account default level of 3 per cent employer and 4 per cent employee, with tax relief added on. The Government appears to be comfortable with this risk.

It is more concerned with levelling down in defined-benefit schemes. This is evident in the fact that the White Paper proposes several ways to lighten regulation, including reviewing rules on member-nominated trustees and abolishing guaranteed minimum pensions. These proposals are unlikely to mitigate the additional costs of auto-enrolment and employers may have to consider other tactics.

There are three ways a defined-benefit scheme can level down. The first is not to extend auto-enrolment to the scheme and place new employees in alternative arrangements. The effect may take some time to show but take today’s rate of job turnover together with a 60 per cent chance that new employers will offer less generous pensions than previous employers and, in just over a decade, around half the population will be getting a worse pension deal.

The second way to control costs is to reduce future scheme benefits, for example, by stopping accrual for existing members or moving to career-average schemes although this can be administratively messy.

The final possible solution to avoid additional costs is the most controversial – allowing solvent employers to retrospectively reduce benefits already accrued within a scheme. When the National Association of Pension Funds mentioned this at its annual conference, it was met with general indignation. But it appears that the Government is giving this serious thought.

To my mind, this is a dangerous and regrettable suggestion, basically reneging on past promises to staff. It goes against the principle that pensions are pay and you cannot retrospectively reduce someone’s pay. It also has the potential to seriously dent the public’s confidence in pensions. If members distrust their employer enough to believe it could suddenly whip away the pension rug at some later date, it might lead to a stampede of members trying to get their money out fast. Of course, this could be exactly what the employer wants, since the transfer value paid will probably be substantially less than the true liability. But eventually, the former members will realise that they have lost out and will want recompense. Where they will seek this – at the hands of the employer, adviser or trustee – is not clear in advance.

In the end, we are faced with a bleak picture. Reform may mean pension provision on the whole increases but through more people saving smaller amounts, spreading provision very thin throughout the UK. It would be a shame if the price we had to pay to get people saving is to reduce the good existing pension provision we have currently, especially by sacrificing benefits already built up. There must be other solutions available.

It is unlikely that the Government will follow the course of its own convictions and retrospectively reduce accrued benefits for public-sector workers, including its own MPs’ scheme. This would only serve to highlight the ever-growing gulf of pension provision between the private and public sectors.

Rachel Vahey is head of pensions development at Scottish Equitable


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