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Pension tension

The Victorians might have thought that discussing money was sordid, but here in the 21st century the question of what we’re going to live on when we hit old age is regularly discussed in the very best places.

Money is always in the news one way or another. Yesterday the BBC reported that while HSBC did pretty well in a tough climate, last year it paid out £2.8bn to cover the cost of past wrongdoing. It has paid fines of $1.9bn for money laundering, and made further provision for $2.3bn compensation for mis-selling financial products in the UK. It’s to be hoped that those with pension products are adequately compensated.

In October 2012, the pensions auto-enrolment process started for the largest employers. And although that’s only just under-way, the Government still has concerns that much of the population is still not making adequate provision for retirement. This will put an increasing financial burden on those of working age.

Under automatic enrolment, the minimum level of contributions will be 8% of gross earnings. The bands currently are between £5,564 and £42,475. By the time the programme is fully up and running in 2018, contributions will made in the following proportions: 4% from the individual employee, 3% from the employer and 1% in tax relief from the Government.

For many people saving the minimum amount will not be enough to give them the level of income they would like to achieve in retirement. One way of encouraging people to go beyond the statutory minimum, where it is appropriate for them to do so, is by using automatic escalation. As with automatic enrolment, an individual no longer has to take an active role once they have signed up and decisions to increase saving happen automatically when they get a pay rise.

In an effort to revitalise workplace pensions, the Department for Work and Pensions has published a strategy paper setting out in some detail its ideas, including a new kind of pension arrangement called "defined ambition".

As well as the creation of Defined Ambition pensions, the DWP wants to achieve greater scale in pension funds, more transparency on charges, and find other ways to help people recognise a good pension scheme.

Defined Ambition has been put forward as a way of bridging the perceived gap between the two main pension saving models in the UK. These are “Defined Benefit” and “Defined Contribution”. In a Defined Benefit pension, investment risk rests with the employer. With Defined Contribution the individual takes responsibility for his own savings level and risk profile.

With a Defined Ambition pension, risks are shared, offering greater certainty to savers about the final value of their pension pot than in Defined Contribution, and these is less cost volatility for employers than in Defined Benefit. While examples of these types of pensions already exist, for example, career average or cash balance schemes, the Government wants to see how it can encourage and incentivise the industry to develop other, more innovative products and bring more of them to market.

A number of potential new models for “Defined Ambition” pensions are outlined in the Government’s paper. Here are some examples.

Where the employer promises a defined level of benefit, and when the member leaves the scheme by retiring or leaving the employment, the benefit is converted to a cash lump sum of an equivalent value - either to purchase a retirement income, or transfer to a Defined Contribution scheme.

A guarantee which ensures a saver gets back at least what he puts in could encourage more people to remain in a pension and save for their old age. One way of doing this would be to have a money-back guarantee funded by a levy on members’ funds. While an employer might opt to pay the levy for an individual, it is likely the payment would be made by the member, relative to their funds. The cost could be kept down if this were a mutualised fund guarantee, that is, provided on a not-for-profit basis by the private sector, or a government-sponsored but industry-funded body, similar to the Pension Protection Fund.

The Government will monitor charges regularly across the pensions industry and the Minister reserves the power to cap charges if such action becomes necessary.

The idea of a “star rating” system for pension schemes within the industry is being explored as part of this process. It is important that employers recognise and choose quality schemes and that employees value that provision. This could include charges, good governance and transparency.

The Government is keen to work with the pensions industry to look at whether a pensions market with a smaller number of larger scale, multi-employer pension schemes might offer both employers and employees value for money.

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