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Redefined benefits might be the answer

Two Government initiatives involving pensions and employers are about to start their work. First is the Pensions Commission chaired by Adair Turner, which is charged with reviewing whether the voluntary regime for UK private pensions and long-term savings is on track and whether there is a case for moving beyond the voluntarist approach. In practice, this means some form of compulsion.

The second initiative is the Employer Taskforce on Pensions, which Sir Peter Davis will chair. The recent Pension Green Paper referred to the need to renew the partnership between individuals, employers, the financial services industry and the Government to ensure that people retire on the pension they expect. The Employer Taskforce on Pensions is being set up to develop the employer&#39s role in the pension partnership.

The two initiatives appear to overlap but no doubt the two chairmen will sort out their terms of reference. In the meantime, it is worth considering the backdrop to employer involvement in any form of pension provision for employees. For many low earners, the state pension will be their only pension, topped up with the pension credit. More fortunate individuals will have the benefit of employer pension contributions supplemented by their own pension contributions and other personal investments such as property.

What employers will provide in future is more difficult to foresee. Defined-benefit schemes are already in decline as a result of complex legislation from all points of the pension compass such as contracting out, preservation, the impact of anti-sex discrimination regulations and endless court judgments about the ownership of pension surpluses. A few years of poor investment returns and an end to contribution holidays make the case for defined-benefit schemes a difficult one to argue.

Few employers will wish to set up new defined-benefit schemes on the traditional basis of providing a pension of one-60th of final salary for each year of service and contracted out of the state second pension/Serps. The risks relating to investment returns and future mortality are too much for the employer to carry alone. The levels of National Insurance rebates for contracting out are too uncertain and the complexities in running a contracted-out scheme are too onerous.

But perhaps there is hope yet for the defined-benefit scheme in a simplified and scaled-down form, for example, a defined-benefit pension of, say, 1 per cent of final salary rather than one-60th and without the need for dependants&#39 pensions and/or post-retirement increases, as advocated by Alan Pickering last year.

Or how about setting up a straightforward defined-contribution scheme based on a reasonable employer contribution? What is reasonable will depend on the success of the employer but it would be conditional on the employee also paying a given level of contribution.

Contracting out of the state pension is too much of an unknown. The state second pension has replaced Serps but may become flat rate at some point. The pension credit may be payable during retirement depending on the resources of the individual. The employer should avoid close integration between what the state may provide and what the employer&#39s scheme may provide. The choice on contracting out should be left to the individual. If the individual&#39s circumstances change, the contracting-out decision can change too – an option that is not so flexible for an employer.

Employers should remind employees that they are able to obtain a statement showing their likely state pension in today&#39s terms. The annual statement of benefits under the employer&#39s scheme for the scheme member combined with the statement of state benefits should be an occasion for a review of the member&#39s overall financial arrangements, not just an invitation to file the statements in a safe place.

Of course, employers will be reluctant to be involved in the personal financial planning of their employees except at arm&#39s length but an annual meeting with a financial adviser would be the wake-up call that is needed for employees to start thinking about their retirement. That could be a way to renew the partnership between the employer and employee.


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