Many companies are paying pension costs which are avoidable. By avoiding paying excess costs they could pay higher contributions to workplace pensions. This blogs calls for higher pension contributions and lower pension costs
It is quite common for employers to be paying more for the maintenance of their legacy pension schemes than in funding the workplace pension pots of current staff. This is leading to inequalities, not least between generations and genders. The cost of managing the legacy – typically for older male workers, is restricting payments into workplace pensions, for younger staff of all genders.
Some of this corporate pension cost is avoidable- any opportunity to reduce the excess costs of pensions needs to be taken.
Workplace DC pensions are chronically under-funded
Compliance with the auto-enrolment minimum contribution regulations is generally considered insufficient to match the pension expectations of those in defined benefit schemes. Take this example from the Government on how “John’s” DC workplace pension might be funded.
That example simply won’t replace sufficient income to help savers stop working. While we can make savings more efficient, it’s increasing contributions that do most to drive good pensions. On AE minima, employer and tax subsidies contribute as much to the pot as the member does.
Many employers choose to pay more than the minima , especially where members to agree to swap salary for pension contributions (where extra contributions can be cost neutral). Some employers will match higher contributions from staff – targeting helping the pension enthusiasts. Some employers choose to pay much higher contributions – whatever their employees do. Where employers go above and beyond members have got good reason to be grateful – and many employers would do more if they could.
Employers are aware that further pension contributions are urgently needed and they know that making them is an extremely tax-efficient form of rewarding staff. But pension costs don’t start and end with obligations to staff in the new workplace pensions. Most medium to large employers have to consider pension costs holistically.
There is scope to redress this inequality through consolidation.
Of course the major legacy demand on a company’s Profit and Loss is from the trustees of defined benefit schemes. These schemes aren’t self-sufficient and require deficit contributions to be paid as a priority over dividends and investment in corporate R and D. These contributions are unavoidable as they are driven by the guidance of the Pensions Regulator and to default on them carries existential risks.
For DB schemes which are well enough funded , the employer will often wish to remove the scheme from its balance sheet by buying out the benefits with an insurance company. The Department of Work and Pension’s (DWP) White Paper on the sustainability of DB pension schemes commented that, even when schemes are well-funded, the cost of insurance provision means that it is unlikely that many will be able to buyout the benefits in full. It said that new consolidation vehicles could therefore offer a more affordable option than insured buy-out
For unlike deficit contributions much of these “excess” costs are avoidable and should be avoided. Companies do not need to run their own pension schemes and can make significant savings in fixed costs, by sharing these with other employers. This can be achieved through transferring the management of the pension schemes to a master trust – or where funds allow, a Superfund.
Two of the main advantages of consolidating into a larger pension scheme are better governance, and the greater opportunities which come with scale, including access to more efficient investment strategies.
While Superfunds and insurance buy-outs allow an employer to take a pension liability off the balance sheet, that may not be affordable or desirable,
When a pension scheme transfers into a Master Trust, the link to the sponsoring employer is not broken and the benefit of the employer’s support (covenant) is not lost. So, there is no need for the employer to find a cash injection to compensate for that. The master trust is a simple way for employers to increase the efficiency of DB payments and these can be substantial. Too many employers are unaware of the scale of the savings can be made.
In a recent online poll, Stoneport – a master trust that is used by employers to outsource DB management – found employer’s understanding of the costs of their DB plans varied,
I suspect that a high proportion of these running costs are “excessive” as they need not be incurred. Were such costs to be avoided , there could be a budget for an increase in workplace pensions and finance directors will of course have competing claims on any cash flows.
Of course there are competing arguments for keeping an occupational scheme as an exclusive arrangement. These center around control and are often influenced by trustees reluctance to give up responsibilities that they have owned and exercised over time. In some instances there are reasons why schemes cannot hand over management, typically where their funding and administration needs rectification.
But for many employers, the reasons for the continuation of an exclusive defined benefit or defined contribution are unclear. In such cases, it may be in the corporate interest to challenge trustees as to what their trust is adding by way of value for money.
Reward and Finance Directors should consider pensions holistically and aim to redress their unequal spends on their DB and DC savers. If they can do so without reducing DB benefits, they should press to wind their DB plans up and transfer assets and liabilities to a consolidator.