Considering defined contribution pension pros and cons

November 24, 2009

damian-stancombe1-Damian Stancombe is head of Corporate Defined Contribution Pensions at Punter Southall Group. The opinions expressed are his own.-

Three things to keep in mind for defined contribution pensions:

Higher earners

Pension plans help build financial security in retirement, and in the face of a looming pensioner crisis the government continues its efforts to increase the number of savers. There is one exception: if you earn more than 150,000 pounds all bets are off.

In April 2010, we will see these high earners lose their tax-free allowance and suffer further through the introduction of a 50 percent income tax rate. A year later, an effective charge of up to 30 percent on all pension contributions will bring an immediate cost for a benefit realised later in life.

This substantial change to pension tax relief may dramatically affect the suitability of pension saving when compared with other investments and disengage the decision maker in the company from pension provision.

Employers would be well advised to ensure pension scheme members are aware of these changes, along with the thorough “anti-forestalling” rules already in place. They may also wish to review traditional pension provision as an effective reward strategy for key employees.

Concerns of employers about priorities

Punter Southall has completed a series of successful seminars across the UK, focused on these issues and addressed employers concerns for the provision of defined contribution pensions.

Around 250 finance directors, HR managers and pension managers representing employers attended the seminars, and the majority were surveyed on their views on the top concerns for DC pensions going into 2010.

Top of the list was the selection of the DC pension provider and design of a pension scheme (based on the closure of existing “defined benefit” final salary schemes), closely followed by the upcoming challenges created by the shift to Personal Accounts planned for 2012, along with concerns about the choice of a “default” investment fund (which scheme members who don’t pick another option are automatically placed into).

Sadly, issues such as member engagement, at-retirement education (i.e. advice for scheme members about to retire on how to get the most from their pension pot), and scheme governance scored poorly and audience interaction revealed that these areas were not considered a priority – this is despite the Pensions Regulator only last week stressing his concerns about these areas not being fully considered by employers.

These responses from the attendees closely reflect our experience in dealing directly with UK employers.

For most employers, getting the new scheme design right and selecting the most suitable provider means the challenge of balancing the need to create something of value to members along with the cost of providing it. Many large corporates are also reconsidering Trust based schemes in the light of auto-enrolment planned for 2012 and the ability to refund employee contributions within the first two years.

It is not surprising that investment is a concern given recent turmoil in markets and the swings in volatility of between 40 percent and 50 percent (in both directions) in value that many default funds have suffered. Worryingly many employers are not taking action to remedy this problem and still need further guidance on how to achieve a more consistent performance in the future.

But the issue of Employer Duties in 2012, and accompanying Personal Accounts is one that worries many employers as they are uncertain how it will impact their business.

Challenges posed by “auto-enrolment”

One particular area of concern that Punter Southall has relates to auto-enrolment (where new joiners are automatically enrolled into a pension scheme). We whole heartedly support the view that the sooner it happens, the better to encourage participation in UK contract-based DC schemes en masse.

However, the National Association for Pension Funds has echoed the views of many by telling the Department of Work and Pensions that the proposed reforms need an “injection of common sense” and has made several recommendations to improve the auto-enrolment process.

Our desire is that we look at the bands of people who are enrolled automatically and ask that this is reviewed. Auto-enrolment may be a necessary evil to force retirement saving for the disenfranchised masses but it is important to ensure that the masses are identified correctly.

The bands we suggest are those that under 30 years old are not automatically enrolled, as student debt and lifestyle apart means pensions are not really affordable. They are also all going to be working a lot later in life, probably retiring at 70 or older, so why force saving so early? Whilst Pension Credit is being washed out of the system I would also suggest that those over 55 years old are also exempt, along with greater consideration given to those at the lower end of the pay scale.

This leaves the real core market to aim at. Take-up rates will therefore be higher and more importantly, we believe it will be deemed a success.

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