Government pension proposal could be bad for workers

7 November 2013

The government has proposed to introduce a new-style final salary pension scheme that could delay people taking their pension and see pension incomes damaged by inflation.

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.

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"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.

Poor timing

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."

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