Beset by complications
With DB in retreat and a conspicuous lack of public debate on the future of supplementary retirement provision, where now for UK pensions? Gill Wadsworth assesses progress, including the profound changes in the Pension Act 2008
Pension funds have faced a challenging 12 months in the UK as billions of pounds were obliterated from the value of retirement plans following the financial meltdown and the Lehman Brothers collapse.
Defined contribution (DC) pension statements made grim reading for millions of individual savers, while the spiralling deficits in defined benefit (DB) plans sent sponsoring employers into a spin. The latest figures from Aon Consulting reveal that £140bn (€165bn) has been wiped from DC plans since the credit crunch took hold, while the DB funding deficit of the UK's largest 200 companies has reached £73bn.
The dramatic fall in global fortunes could not have come at a worse time for UK pensions which appeared to be making some positive progress in funding levels following the market crash at the turn of the century.
"At a time when most of us hoped we were coming out of the succession of problems besetting pensions over the past few years, a situation caused by banks' irresponsible lending programmes and buying of toxic debt hoping to make a fast buck caused the wheels to come off this particular wagon," says Graham Brown, manager of the Barnardos pension scheme.
And the wheels have come off in spectacular fashion, with a spate of employers taking the hitherto unusual step of closing DB schemes to all future accrual. Closure of final salary plans to new entrants has been commonplace in the UK for many years as finance directors came to appreciate the full cost of provision. However, companies including Barclays (see panel opposite), Barratt Developments, Fujitsu and Morrisons are now moving existing DB members into DC schemes.
Mark Ashworth, director at independent trustee firm Law Debenture, says: "I fear that [the closure of major UK schemes] accelerates an inevitable trend. It makes closure to accrual thinkable where previously it may not have been."
While attempting to close a DB scheme is never a popular decision, Neil Carberry, head of pensions policy at the Confederation of British Industry (CBI), says such decisions are not taken lightly: "When it comes to making significant extra contributions to unaffordable and unsustainable schemes during a recession or protecting jobs, employers would prefer to do the latter."
With DC now firmly in the spotlight as DB starts its inevitable decline, employers and providers are under increasing pressure to ensure these alternatives are adequate. DC has long been considered the poor relation to DB, yet in recent years the industry has worked to improve the image of money purchase plans. In July The Pensions Regulator said it would turn its attentions to improving standards in DC provision focusing on employer engagement and communications, with chief executive Tony Hobman adding that the watchdog would "enforce better practice if we need to".
At the same time , the National Association of Pensions Funds (NAPF) is launching a ‘Quality Mark' to promote high standard DC workplace pension schemes.
A major step in encouraging workplace DC saving has come from government in the form of the Pensions Act 2008, which was passed in October and laid out the proposals for auto-enrolment and a new system of Personal Accounts. As far back as 2006 the government made clear its intention to force every employer in the UK to provide a pension plan by 2012. The proposed system of Personal Accounts represents the minimum employers will have to offer - they pay 3%, while employees pay in 4% and 1% comes from tax relief. Employers already offering a pension scheme equivalent or superior to Personal Accounts need not enter the government's system, although employees must be auto-enrolled in the existing alternative.
Auto-enrolment has been widely welcomed across the industry as a necessary step in engaging an otherwise apathetic workforce in retirement saving.
"The passing of the Pensions Act 2008 last October, bringing with it the introduction of auto-enrolment and Personal Accounts, will make great strides in increasing the number of people saving for their retirement through a pension," says Richard Wilson, senior policy adviser at the NAPF.
However, while auto-enrolment might be broadly supported, Personal Accounts are not without their detractors. Concern about the adequacy of the 8% contribution rate is widespread, while complexity in the regulations and the lack of a coherent communications programme rankles with employers and financial service providers.
Maggie Craig, director at the Association of British Insurers (ABI), says: "There is a lack of any sensible communication campaign from government which says that savings are a good thing and we should be involved in pensions; 2012 is only just over two years away and if you are trying to change cultural attitudes, two and a bit years is not an awful lot of time."
Further, Carberry at the CBI says existing complexity in the legislation will undermine government efforts to encourage saving, and he calls for changes to be made.
The Personal Accounts Delivery Authority, the body responsible for overseeing the system, is in consultation with the pensions industry on the scheme's future design, and says it is continuing to research the most appropriate approach.
Although the government continues to face accusations of complexity in retirement saving, in April 2006 it imposed sweeping tax changes to the pensions system designed to promote simplicity. From 6 April 2006, known as A-Day, the number of tax regimes was reduced from eight to one. In spite of numerous set-backs and hiccups, pensions simplification received a warm reception from the industry as more barriers to retirement saving were removed.
However, just three years after A-Day, chancellor Alistair Darling announced in his 2009 Budget that tax relief on pensions for those earning more than £150,000 a year would be slashed from 40% to 20%. Speaking at the time, Darling argued that it was "difficult to justify how a quarter of all the money the country spends on pensions tax relief goes, as now, to the top 1.5% of pension savers".
The government's new tax rules will not come into force until 2011, but to prevent high earners ploughing money into their pensions before then, anti-forestalling measures have been put forward in the Finance Bill 2008. These include reducing tax relief for high earners on ‘irregular contributions' over and above the special annual allowance, with government defining ‘irregular' as payments made less frequently than quarterly or monthly.
Unfortunately for the government, this decision has caused outrage across the industry from employers through to service providers, lawyers, associated bodies and opposition parties. The main contention is that by penalising the top earners, the government runs the risk of disenfranchising the very people who provide pensions for the general workforce. If the pensions decision-makers see their own entitlements eroded, there may be little incentive to offer retirement plans to everyone else.
"The changes to pensions tax relief in April's budget are completely at odds with incentives to save," says the NAPF's Wilson. "The changes will lead to extra complexity, undermine the EET [exempt, exempt, taxed] principle of pension taxation and lead to a risk that high-earning decision makers will simply disengage from the pensions system altogether."
The ABI's Craig describes the announcement as the thin end of the wedge, adding: "The whole point of having pension simplification was that it was supposed to provide a framework that we could trust to last us for the next 20 years or so, yet three years down the line the government is making it complicated again."
In spite of the clear opposition to the changes, government has made few concessions. In the Finance Bill's latest reading in parliament, the special annual allowance was increased from £20,000 to £30,000 but the lion's share of opposition amendments was withdrawn.
Law Debenture's Ashworth says: "I fear that the Budget changes have been a serious blow to the credibility of occupational pensions as well as the reliance which can be placed on government policy previously declared as settled for the long term. I am not conscious that there has been much action which has been very helpful [but] I would still like repentance from the Budget tax changes; it is not too late."
Alongside pressure to rethink its stance on tax relief for higher earners, the government is also tackling requests to make pension money more accessible to savers. Originally touted by Labour peer Baroness Hollis, the debate centres on unlocking savings and allowing scheme members to take a lump sum from their pension before age 50 to help fund more immediate needs.
Steve Webb, Liberal Democrat shadow work and pensions secretary, says there are a predicted 6,000 homes set for repossession in the UK this year, yet the average mortgage arrears is just £5,000. If employees were able to access the necessary funds from their pension pots today, many repossessions could be avoided.
"Many people [facing repossession] will have a pension fund from which they will take a lump sum tax free and under normal circumstances they would spend that on a holiday or home extension and so on. Why should we say to those people that you can't touch that money at age 40 when you are being repossessed, but when you are 55 you can spend it on a world cruise," Webb says.
Although Webb describes the debate as peripheral, he notes there is cross-party support and the proposals also have backing from industry bodies such as the ABI and CBI.
Occupational pensions in the UK have experienced sweeping change in the past five years and adjustments to the system have met with mixed reactions and enjoyed various degrees of success.
As reform continues government needs to work in tandem with industry and employers to ensure that pensions not only stay on the agenda but that they are seen as an appropriate and valuable savings vehicle. Achieving such a goal, particularly during testing economic times, may appear a monumental challenge but with the future financial security of millions resting on today's decisions, it's an objective the government must be willing to meet.