For many years we have been led to believe that the only good DB scheme has a bulk annuity inside it and it’s on the way to being bought out. I was in hospital for the shockwaves of Pension IHT changes to hit private sector DC pension schemes offering pots rather than pensions that now looked a tax problem for the wealthy.
In January of this year, one of the first blogs I read was from Hymans Robertson, it claimed DB as a means for rich people with inheritance tax problems to switch from a DC to a DB orientated pension approach. It contained this section, set in a discussion in the then new concept of taxing inheritances on the unspent pot of a DC “pension scheme”.
Here is the bit that made a lot of sense.
Unintended upsides for DB pensions
Under the new regime, DB spouse and dependant pensions will not be subject to IHT. So, DB pensions become a more attractive vehicle for passing on wealth to the next generation, compared with DC retirement income.
People with DB pensions can spend confidently, without the fear of running out of money. They can pass on their wealth tax efficiently, through spouse or dependant pensions and DB schemes could externally insure lump sum death benefits, to keep them out of the scope of IHT.
These changes are less likely to affect members of DB schemes that are open to accrual. A saver with the option of contributing more towards a DB pension could still take advantage of IHT rules to plan tax-efficient wealth transfer.
The changes may end up creating an unexpected opportunity for saving structures with a DB element. For example, an employer could offer a hybrid scheme with a DC pot that can partly be used to buy a DB pension at retirement. A member could choose the amount of pension to buy and whether to include a spouse or dependant pension, so they can strike a balance between guaranteed income, flexibility, protection and efficient wealth transfer.
At the time , I was working on a capital backed defined pension scheme run on a commercial basis. The idea was that properly invested , such a scheme could offer 10-15% retirement income than an annuity – an employee benefit beyond retirement that could enable staff who were sticking around to build more pension and go do something more productive – like enjoy later life! Or put another way, ensure that they didn’t clutter the workplace.
At the time, the idea that retirement lifetime income would become a default for DC schemes by 2027 was not in the air. But that’s what the Pension Schemes Bill is promising.
For Hymans Robertson , the concept of a commercial DB plan was not a consideration, instead they argued that there might be a use here for surpluses, another area of change for the Pension Schemes Act to enable. At the time the idea was reliant on a change of perspective from TPR
Can we really bring DB back?
So far, the IHT changes appear to be positive news for a DB renaissance. However, with DB comes risk that the sponsor has to absorb – there is no doubt that DB schemes carry more risk to the sponsor than alternative DC arrangements.
Even though the government has given DB a perhaps unintended boost through the new IHT regime, without sponsor appetite, DB is unlikely to make a comeback. To improve sponsor appetite, the government needs to make surplus sharing between employers and members more attractive and easier, so a DB scheme can become an asset for a sponsor. We think DB schemes should be about reward as well as risk.
The Pensions Regulator (TPR) should set an enhanced objective of improving pensions for workers. A change in TPR’s mandate would give employers and the pensions industry freedom to innovate and provide new saving designs (such as hybrid DB-DC arrangements). These would give DB schemes a longer-term investment and open the door to investing in more productive assets, securing higher pensions and reducing the cost of sponsoring DB schemes. For more on this, see our paper A Pensions Plan for the new Government.
Carried out carefully and with a long-term view, these changes could move the dial on the risks associated with DB and help improve sponsor appetite.
Sadly the meetings I have had with DWP since the Pension Schemes Bill do not encourage the idea of defined benefit as a means of paying a retirement income for life. There is a coughing and a promise that it might be possible to allow capital backed DB pension schemes or DB schemes working off there surpluses to back DB plans.
However this would require “secondary legislation” mentioned with the sorrowful look that the DWP reserve for discussions of superfunds or anything that might link commercialism with defined benefit pensions.
It seems that the commercialism of pensions is exclusively the property of the insurance companies offering bulk purchase annuities. It was explained to me that the DWP had no intention of gong where the insurers were in charge.
It appears that the Treasury do not want DB schemes to reopen and put pressure on the hard-pressed PPF. Nor do they want the highly successful insurance industry to have competition from the pension industry while it is eating its way through it.
Yesterday I was at the Prado in Madrid which houses Goya’s Saturn solution to threats from his own sons.…now is this to be applied to pensions!!
Your title is a bit misleading!
Employers do not need any new legislation to re-open DB Pension Schemes for their current employees. It is only once the pension assets have left the collective employer controlled pot that the problem arises, either through buy-in out buy-out or through contributions paid into DC arrangements.
Describing DB pension scheme assets as an employer controlled pot may be surprising to some but the DB pension schemes have always held the assets to meet the employer’s deferred remuneration promise to its current and future as well as past employees. The employer has the freedom, subject to restrictions highlighted by the Virgin Media case not to change the deferred remuneration promise granted during past service, to change its deferred remuneration promise for its current and future employees. The change of employment terms is a matter for consultation and negotiation, but would a promise, guaranteed by both the employer and the PPF, of a pension of x% of salary not be more attractive to employees than a y% contribution paid into a DC fund over which neither the employee or the employer has any control over investment performance or the loss to administration costs and profit to the scheme sponsor.
The pension scheme assets also appear on the employer’s Balance Sheet.
I am with you here Pension Oldie and was not trying to suggest that re-opening DB schemes is not only right but should be applauded. The problem is not with employer sponsored schemes but with schemes commercially sponsored with capital – the superfund legislation is very difficult to operate and it looks like final legislation is some way off. Consequently we are not seeing commercial DB funds opening up and those that try , finding they have some discouragement. There may be a third factor holding back the Government’s lack of enthusiasm , apart from worries about stressing the PPF and annoying the ABI – that is the prospect of CDC at some point. I hope we do get CDC but I am disappointed that it may be at the cost of other forms of collective solution to the very obvious DC problems we have at present.
Big-Short 2 – the sequel.
Never have so many been put in debt by so few.
We will I’m sure (and in just a few years time) look back on this period and see it for the greatest slight of hand in the history of financial economics, and delivering the last nail in the coffin in what in Sir John Kay identified as the “biggest avoidable policy disaster in British politics”. And truly, it is.
The problem is not that the ABI is powerful (it is, and it is only doing its job to promote the profits of its members – the large insurers), but rather its that the DWP (full of well intended civil servants) lacked meaningful ministerial direction for the first 25 years of this century that is the problem (17 office holders since 2000, noting also the down-grading of the role by Teressa May in 2016 – what timing!). Civil servants, by nature, fear failure more than they’d rejoice in opportunity, and the insurers cleverly created a whole lexicon around that fear, promising to eliminate the bogeyman of “risk” and doing so by banishing those wild horses of Investment and Opportunity.
But hope, perhaps at last we have a Minister who fully grasps the issues? It’s also becoming clearer that the TPR gets it too – i.e. who’s looking out for what’s in all of this for the members – those working people who’s accumulated toil and contributions created the £1trn of DB schemes.
Its truly bizarre – indeed it feels like we’re re-enacting a UK version of the Big Short – as £50bn p.a. of members’ pension savings, accumulated over 40 years, is gleefully handed over bag-fulls to a small handful of mega-insurers, increasingly foreign owned and protected (we do hope) under the blazing Bermuda sun, while mysteriously (under our noses) stripping the UK economy of its growth capital.
The informed understand that each tranche of £50bn (of accumulated members’ interest) is expected to deliver c£10bn (low risk) profit to insurers over the life of the ‘contract’, and it seems without a jot of a concern for improving the lot of the poor members!?
And to be clear, all but a morsel of that capital at play essentially comes from the ceding schemes – e.g. L&G’s half year accounts the other week show clearly the paucity (c1%) of ‘capital’ that the insurers actually bring to the table (to be fair to L&G at least we can see that as one of the few insurers that still publishes accounts as Plcs).
While we scurry around looking to others – be it Australia, or now Canada – for a guiding way forward, remember the UK entered the 2000s rightly admired as having one of the best systems in the world! It was a 12 million member mass “mutualisation” arrangement, and it was as close as any nation got to a wide stakeholder community – underpinned by employers, the 12 million members pensions saving were invested in the economy, and it was they who shared in the profits and gains through their secure pensions.
Employer’s and members created these schemes – surely we must find a better way, one where we can allow the members to continue to share in the expected upsides (and downsides) – that’s the concept of mutualisation. Each £10bn profit being shovelled to insurers would provide an awful lot of inflation protection and much needed pension uplifts for those that actually created the value in the first place.
From the mood music on Pension Schemes Bill 2025, I think members can expect more from their Pension Minister and regulators, and I hope they can find the will to make it happen, and before its too late…
Thank you – whoever you may be!