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Government sets out 'third way' plan for workers' pensions
Pensions minister Steve Webb has outlined his plan for a new breed of 'defined ambition' pension schemes.
by Michelle McGagh on Nov 23, 2012 at 09:00
The government has set out plans for a third way for company pensions that would guarantee employees’ money while limiting the risk for employers.
Currently so-called 'workplace' pensions are one of two types, either defined contribution (DC) or defined benefit (DB). The former puts the risk on the employee because the pension payout is determined by how much is saved and how much it grows, whereas the latter puts the risk on the employer because DB schemes pay out a set amount based on a multiple of years worked and final salary at retirement.
It is no surprise that DB schemes are in short supply as they are just too expensive for companies to run as people are living longer. However, employees are not saving enough into DC schemes so the government has outlined a compromise – the ‘defined ambition (DA)’ pension which splits the risk between employees and employers.
In a consultation paper, Reinvigorating Pensions, the Department for Work and Pensions (DWP) discusses the possible structure of defined ambition pensions. They could either be seen as ‘slimmed down’ DB pensions or beefed up DC pensions with added guarantees.
A slimmed down DB scheme could include a ‘core guaranteed benefit’ with additional benefits like inflation indexation – dependent on investment performance. While the core of the benefits would be protected the rest of the pension would come under a lighter funding regime.
A member of a DB scheme could also have their pension converted into a DC cash sum when the member leaves, retires or dies.
A slimmed down DB scheme would also see the retirement age linked to state retirement age so although the member would have some guarantee of what they would receive in retirement, they may find their retirement date increases.
Alternatively, looking at defined ambition pensions from a DC perspective could include a ‘money back’ guarantee to safeguard contributions and ensure that poor investment choices do not mean that pension savers end up with less than they contributed.
There could also be guarantees to cover the later years of retirement to ensure people do not run out of money, and guarantees for levels of fund growth provided by insurers.
A guaranteed retirement income could also be bought with part of the pension fund, again to ensure a certain level of benefit in old age.
The report, which was instigated by pensions minister Steve Webb, said: ‘We are seeking to achieve a fundamental shift in the culture and attitude of working age people in this country towards pensions. We recognise that this will take time – trust in pensions is low.
‘Individuals need to take responsibility for saving some of the money they currently earn for their retirement. We need employers to support them in this.’
The report also said: ‘Those that remain in workplace pensions need to be confident that they are saving in quality schemes that provide them with value for money…We are working closely with the industry to explore the scope for defined ambition schemes that share some of the risk and give people more confidence.’
On paper, the defined ambition pension sounds like the perfect solution but experts warn that it won’t be easy to implement.
Tom McPhail, head of pensions research at Hargreaves Lansdown, said: ‘The government can’t just wave a magic wand and expect the industry to conjure up transparent, low-cost, secure, guaranteed investment providing a good rate of return. If it was easy, then the industry would be doing it already.
‘In the meantime we believe that much more can be achieved by engaging investors in a sensible on-going dialogue around how much they are saving, where the money is invested, how it is performing, when they might be able to afford to retire and how they can draw their income,’ he added.
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