UK plans to Reform “Defined Benefit” schemes trigger Alarm Bells
There are basically two types of UK Pension scheme – “Defined Benefit” and “Defined Contribution” (or “Money Purchase” if you prefer). The first type means you get a “guaranteed” amount in retirement, regardless of how much has been put into the scheme, because it is based on length of service not performance. Typically these are schemes for government employees (etc). The second type relies on performance – the more you put in and the more the growth, the higher the Pension.
That said, the UK government has suggested softening the rules on how defined benefit (DB) Pension schemes should adjust payouts for the impact of inflation in a new report on tackling challenges facing the sector. The 100-page green paper, entitled Security and Sustainability in Defined Benefit Pension Schemes and released last Monday, raises several questions about the current system though notes the vast majority of the UK’s nearly 6,000 private sector DB Pension schemes are currently running effectively (even if there is a huge question about whether they are funded enough to meet liabilities!)
“We recognise however that some people believe the system could be changed to deliver better outcomes or to increase confidence in pension saving,” said the UK Pensions Ministers Damian Green and Richard Harrington in a forward to the report. They add: “Some schemes and employers are struggling, and that some changes may be beneficial.”
There are currently around 11 million members of DB schemes in the UK, and the industry has about £1.5trn ($1.86trn, €1.75trn) under management. The average DB pension in payment is a little under £7,000 per annum. The green paper points out that the industry is shrinking, with the number of active memberships over the last 10 years declining by more than 50% while the proportion of DB schemes that are open to new members fell to 13% in 2016 from 35% in 2006. “Even a seemingly innocuous reduction in benefits could be viewed as the thin end of the wedge.”
But in terms of helping to reduce the burden of DB schemes on those employers that are struggling, the government makes the controversial suggestion that it could either allow all schemes to reduce inflation indexation to the statutory minimum, or to allow those schemes (around 75%) which have “Retail Price Index” (RPI) written into their scheme rules to move to the currently lower “Consumer Price Index” (CPI) measure.
It adds: “Allowing all schemes to move from RPI to CPI or to move to statutory minimum indexation only (including removing any pre-April 1997 indexation) would have significant impact on members’ benefits.”
This has raised warning bells from many industry observers. While allowing scheme sponsors to slash liabilities, possibly by switching from RPI to CPI indexation or suspending indexation altogether in certain circumstances, could preserve guaranteed pensions for more people, it would also more than likely reduce the value of these Pensions and potentially whip up a storm of protest from trade unions, and the like. Pension promises already built up have historically been sacrosanct, so even a seemingly innocuous reduction in benefits could be viewed as the thin end of the wedge and stir up controversy.
As such the Green Paper published avoids setting any firm direction of travel, and instead attempts to set the scene of what is likely to be a fierce debate on the future of DB pensions.
The proposal to allow certain schemes to ‘suspend’ annual pension increases if money is tight was the “most worrying” proposal in the report. 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.
The UK government will undoubtedly face a consumer and trade union backlash against this proposal. The government’s paper stimulates a much-needed discussion relating to the future funding of this type of Pension scheme in the private sector. However, the possibility of using a new measure of inflation or even allowing schemes to suspend inflation indexation altogether will be a contentious point. It would be likely to save money for businesses while at the same time reducing pensions for scheme members. Similar measures have been considered in the past but did not gain traction because there was concern about a backlash from millions of Pension holders.
Graham Vidler, director of external affairs at the Pensions and Lifetime Savings Association, said the Green Paper at least asks the questions necessary to move forward the increasingly pressing debate about the future of DB pensions in the UK.
The point here I think is this – are benefits going to reduce in the future for these type of schemes? Looks likely. So if you have one (or more of these), and you are no longer in the same employment, you should seriously talk to your Independent Financial Adviser NOW, especially as “Transfer Values” can sometimes be “enhanced” by the Trustees because they want you to consider moving your money away, to get rid of “huge liabilities that may not be able to be met” from their schemes. We all remember Robert Maxwell and the Daily Mirror, and more recently Sir Philip Green and British Home Stores……………
Do you have any “old Pensions” in the UK? Want to look at them now before their value goes down perhaps? Contact me now…………