Government pension proposal could be bad for workers
The Flexible Defined Benefit scheme will be dependent on how well a company pension scheme is funded – if the scheme doesn’t have enough money in it at any given time, the government is proposing that companies increase the scheme pension age and not pay inflation-linked increases to those already drawing their pension.
This means that, just as workers are about to reach the age at which they can begin taking their company pension, they could discover they have to work longer before they can access the cash.
Moreover, the proposed new pension scheme means that, in lean years, when the scheme has been underperforming, those already in receipt of their final salary pension will not see their pension payments rise in line with inflation.
Laith Khalaf, head of corporate research at Hargreaves Lansdown, said: "Under this new proposal workers could save diligently throughout their lifetime, only for the rug to be pulled out from under them at the last minute.
"The government is trying to manage the decline of final salary pensions, but Flexible Defined Benefit schemes will be complicated, costly and will create huge uncertainty for pension savers about what pension income they can expect."
In recent years, many private sector companies have closed their final salary pension schemes as the increased life expectancy of those in receipt of their pension (plus poor investment performance) led them to become to expensive. But the final salary pension is alive and well in the public sector.
The government proposals apply to benefits built up in the future, rather than those built up to date, but they will worry pension savers, who will wonder how they will be able to maintain their standard of living if the value of their pension income is eroded by inflation.
To illustrate the value that inflation-linking can add to a pension pot, Hargreaves Lansdown says a £10,000 annual pension adds up to £250,000 over 25 years without inflation increases. This rises to £320,000 with inflation increases of 2% a year; or £351,000 with inflation increases of 2.7% (the current level of inflation as measured by the CPI); or £416,000 with inflation increases of 4%.
The government believes the new-style schemes will be cheaper for employers to run and help wean them off the more expensive final salary model.
But Khalaf said that it was a poor time to be making proposals for radical new pension schemes at a time when the industry is trying to introduce auto-enrolment to workplace pensions.
"Employers are in the middle of implementing auto-enrolment, one of the biggest shifts in workplace pension provision ever embarked upon on the UK," he said. "Talking to them about Flexible Defined Benefits is about as useful as offering a marshmallow to someone fighting a fire. The DWP should be focussing its energy on making auto-enrolment work rather than carrying on with this wild goose chase."
An increase in the general level of prices that persists over a period of time. The inflation rate is a measure of the average change over a period, usually 12 months. If inflation is up 4%, this means the price of products and services is 4% higher than a year earlier, requiring we spend and extra 4% to buy the same things we bought 12 months ago and that any savings and investments must generate 4% (after any taxes) to keep pace with inflation. Since 2003, the Bank of England has used the consumer prices index (CPI) as its official measure of inflation (see also retail prices index).
Final salary pension
A defined benefit pension scheme is one where the payout is based on contributions made and the length of service of the employee. A typical scheme would offer to pay one-60th (0.0168%) of final salary (the one you’re earning when you finally retire) for each year of contributions to the scheme (even though these years were probably paid at a lower salary). Someone retiring on a final salary of £30,000 who had been a member of the scheme for 25 years would receive a pension of 42% of their final salary (£12,300 a year before tax). Sadly, many companies are winding up their final salary schemes or closing them altogether, meaning pension benefits accrued after a certain date (or those available to new employees) may be on a less generous money purchase basis.
The Consumer Price Index is the official measure of inflation adopted by the government to set its target. When commentators refer to changes in inflation, they’re actually referring to the CPI. In the June 2010 Budget, Chancellor announced the government’s intention to also use the CPI for the price indexation of benefits, tax credits and public sector pensions from April 2011. (See also Retail Prices Index).
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.