A new pension scheme is in the pipeline

25 April 2012

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.

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New proposal

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.

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