Government has outlined proposed legislative modifications to the pensions system including changes to decumulation rules and daily pricing requirements, which could impact current defined contribution and defined benefit schemes.
The Department for Work and Pensions yesterday put forward the recommendations in a consultation paper that sets out the government’s proposals for defined ambition pension arrangements.
Pensions minister Steve Webb said a bid for the legislative changes would be made before the next general election expected in May 2015.
The idea is firms would be able to offer a pension that is linked to what people earn
Impact on defined benefit
The government proposes removing employers’ obligation to provide indexation of pensions in payment for future accrual.
“The idea is firms would be able to offer a pension that is linked to what people earn, say a percentage of their salary but with no other bells and whistles on top,” said Webb.
“At the moment if you want to offer a salary-related pension you have to provide indexation. My argument is that if you carry [the number of people with salary-linked pensions] down to zero, that’s not a protection worth having because there isn't going to be anyone in those schemes,” he said.
It is unlikely that DB schemes that have already stopped future accrual will rethink their plans on the back of the DWP paper, said James Patten, corporate pensions consultant at Aon Hewitt, but it will make employers thinking of closing their DB schemes due to low bond yields and the termination of contracting out aware of other options.
“Removing statutory pension increases might reduce the cost of future accrual by around 5 per cent of active DB payroll,” Webb said.
Changes to defined contribution
The government put forward four models, which take inspiration from the Dutch and Danish pension regimes: the money-back guarantee, capital and investment return guarantee, retirement income insurance and the pension income builder.
Since the retirement income insurance model provides a drawdown function with the guarantee kicking in when the fund has been exhausted, HM Revenue & Customs' decumulation rules would need to be changed.
These are designed to protect individuals falling back on state benefits by ensuring individuals never exhaust their funds.
However there are already similar products available called variable annuities that were brought over from the US five or six years ago, said Laith Khalaf, head of corporate research at Hargreaves Lansdown.
Variable annuities did not take off in the UK because they were very complicated in terms of understanding when the annuity would kick in and they were costly, sometimes charging members around 3-4 per cent a year, Khalaf said.
The government also proposes amending legislation around daily pricing requirements for contract-based DC arrangements, which it said may make it difficult for schemes to invest in illiquid investments such as infrastructure.
“The problem with that is that it sort of leaves these members neither here nor there so they don’t know what they’re going to get from their pensions,” said Khalaf.
However Nigel Aston, head of DC at State Street Global Advisors, said: “What you’re investing in is a long-term thing, why are we measuring it and why do we need to think about it with such short-term horizons?”
Collective defined contribution
The consultation paper lays out proposals for collective risk sharing between members. In a CDC scheme assets are pooled and when members retire their income is paid from the asset pool.
For employers with around 1,000 workers or more, CDC could be a key option that provides cost flexibility to the employer like a DC scheme would and more member stability, said Patten.
However Khalaf said where CDC has been implemented on the continent, it had led to instances where pensioners receive income cuts after they had retired and were unable to save more. This example signalled that CDC would not be a good option for the UK, he added.
