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Government criticised over final salary pension proposals

Final salary pension recipients could face changes under new Government plans to relieve the pressure of a £200bn bill: Micha Theiner
Final salary pension recipients could face changes under new Government plans to relieve the pressure of a £200bn bill: Micha Theiner

It’s a pillar of the grey economy and the envy of many a Millenial, but new plans could mean that gold-plated defined benefit pension may not be as water-tight in the future as you once thought.

Also known as final salary schemes, defined benefit (DB) private pensions are the old school way of funding workers’ retirement years with a guaranteed income based on your earnings and length of service to your employer, rather than, for example, how much you contribute.

Now being rapidly phased out, they were designed for the one-career-for-life generation and at their height in the 60s and 70s had around 12m members nationwide. Even back then though, it was clear the sums weren’t adding up and today they are eye-wateringly expensive legacies.

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In fact, current estimates suggest that with 11m members still out there, there’s a near £200bn shortfall between the amount businesses need to honour these pension promises, and what’s actually in the pot.

But with a balance to strike between being able to employ staff of working age and pay for their post work lives (not to mention shareholders’ rights and the pressures in the wider economy), this isn’t just an employer’s problem. You only have to look as far as last year’s BHS collapse for a stark example of when a pension scheme can help sink the entire enterprise.

This week, in a bid to relieve the pressure, the Government set out a series of proposals based on months of public debate that could change the rules of engagement - including the way such schemes are funded, their affordability, member protection and how they are consolidated as necessary.

‘Greenest of Green Papers’

Top of the list of potential changes, for example, is the way the income is linked to the rising cost of living, with suggestions that the current link to the Retail Prices Index (RPI) be scrapped in favour of the lower Consumer Prices Index (CPI). But it doesn’t stop there.

““The most worrying proposal is to allow certain schemes to ‘suspend’ annual pension increases if money is tight,” warns former Pensions Minister and Director of Policy at Royal London, Steve Webb, who feels the proposals don’t demonstrate any significant steps towards resolving the problem despite the discussions. “With rising inflation, annual indexation is an important part of protecting the living standards of the retired population.

“There is a significant risk that relaxing standards on inflation protection with the best of intentions for exceptional cases could be exploited and lead to millions of retired people being at risk of cuts in their real living standards.”

“Of particular interest will be the possibility of allowing struggling employers latitude to reduce the burden on the company of continuing to support their pension scheme,” adds Tom McPhail, head of retirement policy at Hargreaves Lansdown. “Defining a set of rules to achieve this whilst also minimising the risk of employers gaming the system will be challenging.”

Others, including Simon Nicol, Pensions Principal at Thomas Miller Investment, suggest a significant part of the solution could lie in the way the underlying funds are invested.

“The Green Paper rightly points to the current valuation and regulation system encouraging schemes to adopt short term and overly cautious investment strategy,” he says. “Any measures taken should be to address this issue along with other welcome initiatives such as consolidation of pension schemes to facilitate better investment outcomes.”

“The questions around regulatory clearance of corporate actions will need to strike a delicate balance between member protection on the one hand, and on the other allowing UK industry to conduct its business,” adds Mr McPhail. “It looks likely whatever else happens, we’re going to see a beefed up pensions regulator emerging the other side of this consultation.”

Have your say

Affected parties, including scheme members, trustees, and employers are being invited to respond to the discussion paper by sending an email to defined.benefit@dwp.gsi.gov.uk or a letter to DB Consultation, Private Pensions, 1st Floor, Caxton House, 6-12 Tothill Street, London, SW1H 9NA. The consultation will run until 14 May 2017.