When you are young, the world seems a reasonably simple place. When I started in pensions in the early 1990s, most trustees and members at least thought they knew where they stood. The Trustees had a “well funded” scheme largely invested in equities, valued every 3 years by the same Scheme Actuary who had valued it since the days of the abacus, using the same actuarial basis – an interest rate of 9%, salary escalation of 7% and fixed 5% pension increases.
Some employers were on prolonged contribution holidays. Members accrued 1/60th of salary for each year of service. What could possibly go wrong?
Fast forward 20 years.
Through Maxwell, historically low interest rates, the coming and going of the Minimum Funding Requirement, OPRA to the Pensions Regulator, the Financial Assistance Scheme, the Pension Protection Fund, Tax “Simplification”, Trustees’ Knowledge and Understanding, Liability Driven Investment, the rise and fall and rise again of the buy-out market, successive rises in the State Pension Age … and suddenly the world is extremely complicated.
Employers have headed for the exit gates. Mass scheme closures and cessation of defined benefit accrual. Schemes once in surplus are now taking down companies. Big companies.
Members face uncertain futures. What exactly will those DC pots buy? Will they be getting their full DB promise?
Then along come the Government with talk of extreme deckchair rearrangement:
- In the budget George Osborne introduced the concept of taking defined contribution benefits as cash taxed at marginal rates of income (as opposed to the previous 55% tax charge levied on amounts in-excess of the initial 25% tax free lump sum).
- Then Steve Webb mentions that he’d like to see changes to the tax relief on pension contributions – away from the current system based on marginal rates, to a flat 30% tax relief.
- Now the Pensions Minister has floated the idea of buying back into the State Scheme previously contracted-out benefits (GMPs).
These three changes represent:
- The biggest potential (I say potential as some of them aren’t even out for consultation as yet) changes to the UK pensions system since the War. And I’m not talking about the Iraq War.
- A material challenge for both defined contribution (think life-styling?) and defined benefit (think DB to DC transfers) management
- A recognition that the current pensions system isn’t working. People aren’t saving enough.
- Perhaps the moves of a Minister who knows an election is on the horizon.
They are designed to encourage pensions saving. To make pensions easier to understand. The rationale is that if you make things simpler to understand, more money will flow into the system, hence relieving the long-term health care burden on the State.
But here is the thing – Pensions saving is by its very nature long-term. If the public don’t know the terms of the deal, as those terms keep getting changed, isn’t there a massive danger that people switch-off and decide to invest in something simpler? With the proposed changes, pensions are becoming more akin to other savings vehicles. How long before tax relief is abolished altogether?
As the consultation responses flow in, one thing is certain. It is going to be an extremely interesting year ahead. The Minister has posed some extremely challenging questions. The industry has been, I think it is fair to say, taken by surprise by some of these proposals. It is going to be fascinating to work through their full implications…