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Q&A: what is a 'defined ambition' pension scheme?

The government has set out plans for a new kind of company retirement scheme where employers and employees share the burden of pension saving.

 

by Michelle McGagh on Apr 11, 2012 at 00:01

Traditional final salary pensions have become unsustainable for companies – as people live longer and investment returns have fallen as interest rates have dwindled, companies are forced to pay out generous annual incomes they just can’t afford.

No companies in the FTSE 100 now run a final salary scheme for new employees since Shell closed its scheme to new members at the beginning of the year.

Many people are struggling to make the best of money purchase schemes. Not only do they have to take responsibility for their pension pot while they work, they also have to use the money to buy an annuity (which provides the pension income) when they retire. Workers have gone from having complete security over their pension to having none in the space of a few years, which is hardly encouraging them to save.

However, if the risk of a pension could be shared equally between employer and employee and some certainty given about what individuals will receive when they retire there is more incentive for people to save, ultimately easing the burden on the state.

What about the public sector?

A defined ambition scheme is a fair way to provide a decent pension for those working in the private sector. However, when compared to the defined benefit pensions offered to the public sector it is still inferior.

However, this is due to change and the coalition has already made clear that it plans to bring in changes to public sector pensions that were recommended in the Hutton Review.

Lord Hutton wants public sector workers to work for longer, contribute more if they earn over £15,000 a year and take a lower income in retirement.

Public sector workers will be moved to a career average pension scheme, which means that instead of receiving the equivalent of up to two-thirds of their salary in their last year at work they will receive a pension income based on two thirds of the average salary they earned during all their years at work.

The argument is that the private sector is being forced to contribute more and work longer for less retirement income, then so should the public sector, which the taxpayer funds.

What about auto-enrolment?

The announcement of a defined ambition pension is somewhat ill-timed as the government will this year auto-enrol millions of employees into workplace pensions if they are not currently saving into a pension.

Although the scheme is not compulsory people will have to be opt-out of the pension scheme if they do not want to contribute.

The government has also set up the National Employment Savings Trust (Nest) which employers that do not currently have a pension scheme can use as their employee pension scheme. Nest is essentially a money purchase scheme, so it would have been better to try and introduce a defined ambition option when auto-enrolling people into schemes.

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9 comments so far. Why not have your say?

Dennis .

Apr 11, 2012 at 14:35

I lost interest in the first sentence when I saw that a politician was involved. They should stick to what they know best like designing aircraft carriers.

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Philmo

Apr 11, 2012 at 15:23

Ha!

Aircraft carriers!!! LOL!

Neither HMG nor MoD know that!

They only know how to sit on their hands, incurring increased design and construction costs!

They even have difficulty working out, using the fingers on one hand, how many we really need!

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Calvin Allen

Apr 11, 2012 at 15:32

Michelle,

With corporate Britain sat on a £700bn cash pile, to what extent have DB pension schemes really become 'unsustainable for companies' and to what extent have companies closed such schemes because they can and/or because of a herd mentality among them?

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TruffleHunter

Apr 11, 2012 at 19:45

Quite a few FTSE companies have huge pension fund deficits, thanks to Dr(sic) G Brown and poor pension scheme accounting such as predicating 9% returns in an environment where 5 or 6% is more likely. The size of the pensions black hole is often considerably larger than the capitalisation of the companies themselves!

£700bn has accumulated to tide them over the Depression that we are in thanks to political mismanagement of the economy. In the 1930's the US Chemical Co accumulated sufficient funds to enable them to become "The Chemical Bank"- other corprates trusted them more than the banks of the day. This bank was eventually swallowed up by the Chase Manhattan Bank. A latter day example is perhaps Richard Branson's Virgin organisation setting up a new bank. History may not repeat, but it sure as hell rhymes!

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Calvin Allen

Apr 12, 2012 at 12:34

Quite a few mistakes have been made, by governments (including the 1992 (?) Social Security Act, which prevented companies building up surpluses in pension funds, since the government was concerned about companies squirreling money away in their pension funds to avoid Corporation Tax), as well as by companies themselves.

The collective deficit of private sector funds is about £200, according to the Pensions Protection Fund, thus alowing companies to clear the deficit and still continue to sit on £500bn, although that wasn't really the point I was making.

I'm just very suspicious when I see the language that 'things have become unsustainable'. There is always a choice - and companies are exercising that choice not to provide decent occupational pensions any longer. The reasons for that are manifold, no doubt. But we should be clear that it is a conscious choice being exercised.

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A. ISAKJEE

Apr 13, 2012 at 22:08

The biggest scandal is perpetuated by the governments, both past and present. I have a personal pension plan which is worth £40K. If I retire now due to ill health (I am aged 58 now) I would recieve £1300 per year pension and £10000 cash.I am not entitled to pension credit until I turn 65. if I die even one day after taking my personal pension , the pension company keeps 45% of the pension fund, and the taxman takes 55% and. my dependents get nothing! My average income over the last 25 years has been below £10000 per year. Since 1979, the UK economy had been based on the service sector, which is predominantly low skills and low wages for the vast majority of the population. How can people be expected to save on such low incomes? Employers have absolved their responsibility; the board of directors and non- executive directors of large companies together with the M.P.s have become greedy with their gold plated pensions.The Pensions Minister is just tinkering with the problem. The Daily Telegraph yesterday reported that 'the I.M.F. says the UK faces a pensions time bomb' - I totally agree.

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PensionsManager

Apr 15, 2012 at 04:27

Cash balance schemes are defined benefit - the defined promise being a lump sum in which you fund your retirement from - which could be an annuity and tax free cash, or draw-down if you had sufficient funds to make it worthwhile. Annuities are now optional, effectively.

Occupational schemes are still flourishing in their various forms, it's just that the amounts being saved in DC are usually inadequate. However, many DB schemes that were contracted-out actually masked the fact that most of the benefit was in fact in lieu of the State Second Pension/SERPS.

The reduced NICs payable by employer and employee should be taken into account when comparing with DC schemes that have been mainly not contracted-out, and now have to be.

The biggest scandal of the last 30 years by far is the mis-selling and high charges (almost a kind of private taxation) of personal pensions by the likes of the former employer of your very own columnist, Steve Bee, whose actions caused so much damage to private pension savers.

www.pensionsmanager.blogspot.com

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Dennis .

Apr 15, 2012 at 09:01

PensionManager, your comment "DB schemes that were contracted-out actually masked the fact that most of the benefit was in fact in lieu of the State Second Pension/SERPS." I have a document relating to my DB scheme from 1988 when the company decided to contract out. It gives comparisons of my projected DB pension + SERPS (at the time) as £12841 vs £11593 ie 10.7% it's hard to say how it finally panned out but the difference wasn't expected to be that large.

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PensionsManager

Apr 15, 2012 at 09:13

Much depends on salary growth and other factors, but the point I was making is particularly noticeable for average earners on steady incomes with 1/80th accrual. If you had good earnings growth, or were in a 1/ 60th or better scheme, then you would have most probably received a better outcome.

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