Despite the general air of negativity surrounding Alan Pickering's report on pension simplification, it provides a chance to develop greater choice for employees in the way that retirement benefits are taken.
Arguably, the key recommendation is the proposed change to the contracting-out regime. The requirement to provide a 50 per cent spouse's pension could be dropped, along with the need to index pensions in payment at the lower of 5 per cent or RPI (limited price indexation). These changes would also apply to protected rights funds built up in money-purchase schemes from rebate contributions.
The immediate reaction to these proposals from the Government and trade unions has not been encouraging. The conclusion reached by unions such as Amicus and the GMB is that employers will simply see this as an opportunity to cut costs by reducing benefits and pension contributions. But is this really the natural outcome of removing prescription over the type of pension benefit that must be paid?
Employers that have stuck by defined-benefit schemes will have considered the cost of funding for LPI and spouse's benefits. The suggestion that they would then seek to cut costs, if these benefits were no longer mandatory, ignores the effect this change would have on recruiting and retaining staff. This is backed up by a recent National Association of Pension Funds survey which found that 81 per cent of schemes would keep widows' pensions and 76 per cent index-linking, even if the requirements to do so were abolished.
Instead, these employers could offer a choice of benefits to employees, with each option being broadly equivalent in cost terms to the current level of benefit. This would allow those employees who do not want inflation protection or need a spouse's pension to opt for a higher initial pension benefit instead.
This move towards more flexible benefits could be accompanied by a change to allow benefits to be taken at different ages, perhaps on a phased basis. The table below sets out a simplified model of how this might work in practice.
The choice of benefit type would be made at retirement. So, for example, someone aged 65 who is not married and does not want a spouse's pension but does want inflation protection would qualify for an accrual rate of 1/50th. With 40 years of pensionable service, their pension would be 40/50ths or 80 per cent of final or average revalued salary.
This type of system would require changes to be made to Inland Revenue rules. Perhaps we may see a change along these lines when the Revenue publishes its long-awaited review of pension taxation in October?
Offering benefits over a range of retirement ages and on a phased basis will also require a change in attitude towards more flexible employment practices such as job sharing. But with many big employers now encouraging mothers back to the workplace, applying similar practices for those nearing retirement should not be an insurmountable problem.
This change would fit in well with the policy the Government is trying to encourage and avoid the current cliff-edge between work and retirement. As the number of economic-ally active people in the population is set to reduce as a result of the ageing of the baby boom generations, employers may, in fact, have no choice but to persuade the over-60s to come back to or stay in work.
Pickering's report acknowledges the need to be able to convert benefits to any new system on an actuarially equivalent basis. It follows that a 1/60th pension accrued by a 65-year-old male, with LPI and 50 per cent spouse's benefits, would be worth more like 1/30th without these benefits attached. This should be the starting point for negotiating the level of future benefits between employers, employees and their representatives. If the employer can clearly afford to continue funding at this level, employees should have a strong case for negotiating similar flexible accrual rates for future pensionable service.
For those employers with defined-benefit schemes who are seeking to cut costs, it is of little relevance whether benefits are expressed in a prescribed form or not. If the emp- loyer cannot afford to fund a 1/60th LPI pension with 50 per cent spouse's benefit, then the choice is simple – reduce the defined benefit in some way, for example, to 1/80th accrual, or switch to a money-purchase scheme at a level of contribution they can afford.
Removing the requirement to provide LPI and spouse's pension simply provides employers in this situation with more options. For employees and their representatives in this situation, their options may be more limited if the alternative outcome to lower employer pension contributions is fewer jobs or a financially weak employer.
Turning to money-purchase schemes, there are two situations where the proposed simplification would increase choice for employees:
The way in which protected-rights benefits are taken.
The way in which benefits from contracted-in or contracted-out money-purchase schemes and executive pension plans are taken.
Protected-rights benefits cannot currently be paid out before 60. In addition, a 50 per cent spouse's pension must be provided for if the member is married and the benefits must increase in line with LPI.
The practical effect of these restrictions is that employees with personal pensions need to take their benefits by purchasing two annuities, one for the contracted-out part and one for the fund built up from voluntary employee and employer contributions. Not only is this restrictive, it is also confusing.
Pickering recommends that these restrictions be removed, that all benefits become payable from 50 and that tax-free cash can be taken from protected rights. This will mean that benefits can be drawn in a form and at a time that suits the employee. This is a welcome proposal that reduces the costly practice of duplicating annuity set-up costs. It might also make contracting out a more attractive proposition.
It is also currently mandatory for benefits accrued from contributions paid to Cimps, Comps and EPPs since April 1997 to include LPI when the benefits come into payment. Again, this is unnecessarily restrictive. Employees with this type of pension may need to purchase three annuities at retirement – one from pre-April 1997 contributions, one from post-1997 contributions and one from protected rights.
Despite Pickering's limited remit, there are those around who clearly had inflated expectations about what this review could have proposed in order to cure the nation's pension ills.
Nevertheless, giving employees more choice by removing the differences between contracted-out and non-contracted-out benefits is one of the major prizes on offer from pension simplification, regardless of the findings from the review. The Government needs to find the courage to implement these proposals. In the meantime, it should be wary of those who seek to simplify the debate rather than pensions.