New Pensions? Defined Ambition Provision
The DWP has recently published a consultation paper, entitled "Reshaping Workplace Pensions for Future Generations", setting out its proposals for new, "defined ambition" pensions. Such schemes, suggested by the government to be a "third option" between defined benefit (DB) and defined contribution (DC) schemes, are really one or the other category of scheme amended to be more flexible and simpler and cheaper for employers to run. These will to some extent share the risks more equally between employer and employee, and the consultation paper has set out a number of proposals:
Defined Benefit:
Amongst the proposals for a simplified DB structure are:
- the removal of the statutory requirement to provide increases to pensions in payment, or survivor pensions.
- providing a core benefit, with discretionary benefits or increases as and when the scheme funding position allowed. In such cases, the legislation would ensure that funding, employer debt and pension protection fund requirements would only apply to the core benefit as specified in the scheme rules.
- when a member leaves service, his benefits which will have been built up on a DB basis would be automatically converted to DC benefits and the cash value transferred to a nominated DC fund.
Further, it is proposed that employers may be allowed to alter the scheme pension age to reflect increased longevity and to link more closely to changes to the State Pension age. To protect members, employers would not be able to adjust the pension age for those within 10 years of retirement.
The paper makes it clear that it will only be possible to make changes to future accrual in existing schemes, so that existing benefits will be unaffected.
Defined Contribution:
Whereas the employer bears the risk of providing the promised benefits in a DB scheme, the member bears the investment risks in a DC scheme. The proposals in the consultation paper in respect of DC provision are aimed at providing members protection by way of some form of benefits guarantee.
The proposals presented include:
- a money back guarantee, where the member's total fund will be at least equal to the total contributions paid into the scheme, and which would be applied at retirement or on the member leaving the scheme.
- investment return guarantees, where part of a member's accumulated fund would be guaranteed when the member reaches a particular age (and possibly offering a minimum level of investment return).
- retirement income insurance, where an insurer would pay out if the member's fund at retirement is exhausted.
- a pension income builder, where members effectively buy deferred annuities with part of their contributions, giving a guaranteed level of income from retirement, with the remainder of the contributions invested in collective risk-sharing funds to try to increase the retirement income above the guaranteed base pension.
A further possibility discussed is a collective DC scheme. As with normal DC schemes, the employer and members both contribute a fixed amount, but the assets are held collectively and invested in a wider range of investments. It is possible to target a certain level of pension income (although that level is not guaranteed); holding the assets collectively could allow investment in riskier, higher-return investments to try to increase the overall investment return; equally this enables the investment risk to be shared.
Changes to the legislation are proposed to include a new definition of "defined ambition schemes" - this would be a scheme that would provide some form of guarantee of members' benefits, but not complete certainty of the level of income or when it would be paid. The definition of "defined benefit scheme" would be amended to state that it is a scheme where there is complete certainty of the level of benefit paid in retirement.
The consultation closes 19 December.
This article is for general guidance only. It provides useful information in a concise form. Action should not be taken without obtaining specific legal advice.