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.