A new pension scheme is in the pipeline
Pensions minister Steve Webb recently revealed his idea for a third type of pension scheme - 'defined ambition'. But why does he think it's needed, and how might it work?
As things stand, final salary ('defined benefit') schemes - where the employer shoulders all the risk in providing a guaranteed pension for life - are in rapid decline, as rising life expectancy has made them too expensive.
Shell, the last FTSE 100 company to offer final salary pensions, announced its scheme will close to new employees in 2013. Instead, employers increasingly provide 'defined contribution' pension schemes, where both the company and the employee contribute to a pension pot, which is then invested in the stockmarket. But members have all the responsibility for building up their pension pot and for converting it into a retirement income.
As a result, there is much concern about these pensions being seriously underfunded – not enough people are paying in, and those who do contribute don't pay in enough to cover their retirement costs.
Webb proposes something in between, where employer and employee share the risks. There are several ways this might work. One is a 'cash balance' scheme, where the company guarantees each member a fixed pension pot but the responsibility for turning this into a retirement income lies with the employee.
Tom McPhail, head of pensions research at Hargreaves Lansdown, feels defined ambition plans are not necessarily the best way to improve pension planning. "There is no appetite from companies to underwrite more pension risk," he says.
He believes the government should concentrate on what can be done to improve defined contribution schemes. Auto-enrolment into workplace pension schemes will start later this year, meaning employees will have to opt out if they don't want to contribute - rather than opting in to join the company scheme, as happens at present.
"Let's get that in place and then focus on the painful process of ratcheting up contributions," says McPhail.
A market-weighted index of the 100 biggest companies by market capitalisation listed on the London Stock Exchange. It is often referred to as “The Footsie”. The index began on 3 January 1984 with a base level of 1000; the highest value reached to date is 6950.6, on 30 December 1999. The index is “weighted” by how the movements of each of the 100 constituents affect the index, so larger companies make more of a difference to the index than smaller ones. To ensure it is a true and accurate representation of the most highly capitalised companies in the UK, just like football’s Premier League, every three months the FTSE 100 “relegates” the bottom three companies in the 100 whose market capitalisation has fallen and “promotes” to the index the three companies whose market capitalisation has grown sufficiently to warrant inclusion. Around 80% of the companies listed on the London Stock Exchange are included in the FTSE 100.
In exchange for any lump sum – usually your pension fund – an annuity is “bought” from an insurance company and provides an income for life. When you die, the income stops. Annuity rates fluctuate daily and depend on your sex (although from 21 December 2012 insurers will no longer be able to use gender as a factor when calculating annuities), age, health and a number of other factors, so you have to pick the right one and, once bought, its terms cannot be altered, so seek financial advice.