The turn of the year and indeed the decade that came to be known as the ‘noughties’ is a good moment to look back a few years and then forwards at the implications for imminent developments in pensions and where it is all leading us. Is retirement provision, for at least one generation of pensioners, headed towards the rocks, or is the lighthouse going to switch on at the last minute and direct us all towards a safe harbour in retirement?
Demise of DBFor those of us in defined benefit (DB) schemes, those rocks look fairly close at hand even if we cannot see them yet. Aon Consulting revealed that the combined deficit of the UK’s 200 leading DB pension schemes increased to £73bn during the second quarter of 2009, and is now escalating inexorably as a result of increased longevity – the much vaunted ‘demographic time bomb’.
At the same time, funds have lost value during the recession and larger provisions have had to be set aside to prop them up. So understandably, there is not a chief executive officer in the land that is not looking hard at how to reduce the rising debt burden created by their failing DB schemes.
One study of UK company pension schemes published by employer benefits consultancy Watson Wyatt – now Towers Watson – in August 2009, suggested that half of all DB schemes will close within the next three years. PricewaterhouseCoopers supported this by claiming in a separate study that 96% of UK businesses with DB schemes believed their schemes were unsustainable.
Indeed, the majority of the UK’s DB schemes are already closed (75%) to new members and firms are increasingly opting to exclude existing members as well. According to the report, 9% of companies have shut schemes to existing members, but the figure could rise to 50% by 2012.
If the DB demise happens as predicted by these experts, more than one million members of DB schemes will be transferring to defined contribution (DC) arrangements in the next three years. The transfer of so many employees into personal or group DC schemes is definitely a concern for DB scheme members. Until recently, they would have been looking at a very secure retirement future with a pension based normally on a healthy percentage of their final salary, and were once all index-linked so they were not undermined by inflation. It now looks highly likely that none of these schemes will be available to generation Y, and only those operating in the public sector and retiring in the next few years or so seem likely to get the full benefit of DB offerings.
Government response – auto-enrolment & NestEveryone also knows that once pension contributions start to become voluntary (as is currently the case with all DC schemes) then contribution levels fall inexorably as people find more immediate things to do with their money. Government studies show that the recommended levels of contribution to live a comfortable life in retirement is 20% of salary throughout your working life. But average DC contributions are well below this, perhaps as low as 3%. This would generate an average pension investment value of little more than £20,000 in total, and an annual income of probably less than £1,000.
The Pensions Commission has put some figures around the level of retirement under funding going on in the UK today. They estimate that up to 12 million people are undersaving based on the benchmarks they set out. To counteract this, the government is introducing a national pension savings scheme – the National Employment Savings Trust (Nest), formerly personal accounts, which plans to auto-enrol at least 12 million people by 2013 (yes, it’s just slipped by a year in the latest pre-Budget report – PBR).
Under the new system, all employees will be automatically included in a Nest pension scheme unless their employer already offers a suitable alternative pension. Importantly, employees will be compelled to contribute 4% of band earnings and employers will have to contribute 3%. A further 1% will be paid in the form of tax relief, creating a total contribution of 8% of band earnings, which will be paid into a Nest pension scheme from April 2013. 8% is commonly believed to be the minimum level that we need to be contributing today to avoid living below the poverty line when we retire, assuming we have no other income in retirement. The 8% contribution will have to rise as longevity continues to go up.
But the government is already backsliding on the original 2012 target, recognising that auto-enrolment will hit cash-strapped small businesses very hard and that it needs to avoid accelerating the resulting tax relief burden too quickly because of the parlous state of our public finances. It will also be difficult and expensive to police them, so it looks like the requirement will fall to less than 8% initially and will work up to this level by 2014 or later. Larger firms will be targeted for Nest implementation first, with smaller firms at the end of the process, according to industry insiders.
