Firms may get right to reduce final salary payments

21 February 2017
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Struggling companies may be able to reduce pension benefits for employees, according to a new government green paper on the future of defined benefit pensions.

Defined benefit pensions – including final salary schemes – pay a guaranteed income once you retire that is based on your length of service and earnings. This is unlike defined contribution schemes where the size of your pot is dependent on contributions and investment performance.

However, defined benefit pensions are expensive and the costs can be a massive drain on employers’ finances and many schemes are facing significant deficits. At the start of the year the UK’s schemes were facing a collective shortfall of £197 billion.

 

Pensioners could lose out on up to £20,000

In order to tackle these challenges, the green paper suggested giving stressed employers the ability to water down benefits for members. This might include adjusting the rate at which payments increase over time. Instead of linking payments to the Retail Prices Index (RPI) rate of inflation, firms may be allowed to switch to the Consumer Prices Index (CPI). As this is lower, it could save employers a lot of money – however over the length of a typical retirement this seemingly innocuous change could cost pensioners as much as £20,000 in lost income.

Sir Steve Webb, former pensions minister and now director of policy at Royal London, said that in some cases some firms may even be able to scrap inflation linking altogether. “The most worrying proposal is to allow certain schemes to ‘suspend’ annual pension increases if money is tight. With rising inflation, annual indexation is an important part of protecting the living standards of the retired population.”

In particular he expressed concern that employers would be able to take advantage of such a rule change. He adds: “There is a significant risk that relaxing standards on inflation protection with the best of intentions for exceptional cases could be exploited and lead to millions of retired people being at risk of cuts in their real living standards.”

Tom McPhail, head of retirement policy at Hargreaves Lansdown agrees: “Of particular interest will be the possibility of allowing struggling employers latitude to reduce the burden on the company of continuing to support their pension scheme. Defining a set of rules to achieve this whilst also minimising the risk of employers gaming the system will be challenging.”

The green paper seeks to strike a balance between the often conflicting needs of employees - in terms of both their pension rights and ongoing employment - with those of the employer, shareholders and the economy as a whole.

 

Affected parties, including scheme members, scheme trustees, and employers are being invited to respond to the discussion paper by sending an email to defined benefit@dwp.gsi.gov.uk or a letter to DB Consultation, Private Pensions, 1st Floor, Caxton House, 6-12 Tothill Street, London, SW1H 9NA. The consultation will run until 14 May 2017.

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