Defined Ambition – the Beginning of the End for Final Salary Pensions?
Final salary or defined benefit pension schemes are headed for the tip. These outdated pension schemes have brought some companies to their knees and others so saddled with debt that it has choked off competitiveness. The government has been working on a way forward out of the mess.
On 7th November the Department for Work and Pensions (DWP) released a paper entitled “Reshaping workplace pensions for future generations”.
The consultation paper formally introduced the concept of “defined ambition”: a system of pension savings which promises to share risks including inflation, investment and longevity between employer and employee.
The paper quotes the unsurprising yet worrying statement that “traditional final salary defined benefit schemes are in terminal decline” according to the Minister of State for Pensions, Steve Webb MP. This is demonstrated by the fact that since 2007, the percentage of open schemes has more than halved, from 36% to 14%, leaving just 841 schemes open today.
So how could Defined Ambition actually look in practice and how would it compare to existing Defined Benefit schemes?
Defined Benefit Vs Defined Salary Pension Schemes
Defined Benefit (Final Salary) – you are promised a certain amount of pension. However, your employer will not be able to predict with any accuracy how much this will cost them to provide.
Defined Ambition – your employer could promise you a minimum size of pension pot at their selected retirement age; you would still not know how much retirement income it would buy, but at least you would know the minimum that would be in your pot.
There can be no doubt that one of the primary aims of the proposals are to improve the likelihood that schemes will be able to meet their obligations through reducing the cost to employers. However, the upshot of this is that if employers are making cost savings, then ultimately they must be passed on in some form to the individual members.
What is it that employees would likely lose?
Protection – Defined Benefit members were traditionally sheltered from falling annuity rates but not under Defined Ambition.
Inflation proofing and spouses pensions – Employers may “continue to offer schemes that include index-linked benefits and survivor rights” this will no longer be “a statutory requirement” from as early as 6th April 2014.
An annual pension of £10,000 adds up to £250,000 over 25 years without inflation increases whereas it would add up to £351,000 if it rose in line with the current rate of inflation, at 2.7% and so the loss of indexation could seriously reduce the level of benefits payable to the member.
To compound the problem further, employers would also be given the opportunity to move the age at which a worker is allowed to retire on a full pension.
Whilst this is still at the proposal stage, any changes could come into effect from as early as April 2014 leaving very little time for members to get to grips with how this will affect their retirement.
For British expats with final salary schemes who haven’t taken benefits yet, they have the option of transferring their pensions overseas to a QROPS. With annuity rates at all time lows, we are seeing high transfer values, i.e. high lump sum pension pots from final salary schemes. Once offshore, they are outside of the UK tax net which means as long as the British expat stays offshore, they avoid UK taxes on their pension and the entire pension can be passed on to their spouse upon death with no tax taken by the UK government. They could also choose inflation linked gilts if they want protection from rising inflation. This would take care of the two bullet points above.
You can contact us for a free pension transfer analysis and at least find out what your options are to protect yourself from future changes to taxes and pension rule changes.