Can defined contribution pension plans ever offer the benefits of more expensive final salary schemes? Nick Martindale investigates
When Royal Dutch Shell announced in January that it was to close its defined benefit (DB) scheme to new members, it became the last FTSE 100 firm to do so.
It’s been a long and lingering decline over the past 20 years for DB plans, but changes to accounting rules and the impact of the recession have seen employers seek refuge in defined contribution (DC) schemes. “These are both cheaper than DB arrangements and, crucially, costs are consistent and predictable,” says Tim Middleton, technical consultant at the Pensions Management Institute.
Paul Macro, UK head of defined contribution at Mercer, says the introduction of auto-enrolment from this October onwards will only add to the trend for firms to move over to DC. “Organisations are not going to want to auto-enrol people, who may not be that interested in pensions, into a high-cost DB scheme,” he says.
But there are decisions to make in how organisations structure such DC plans. Companies of a more paternalistic nature might favour a trust-based occupational scheme, says Mr Middleton, although these can be expensive to run and require the input of skilled trustees.
Auto-enrolment will only add to the trend for firms to move over to DC
An increasingly common option is the use of contract-based schemes, where the employer contributes to a series of individual contracts between members and an insurance company or investment manager, but has no legal responsibility for the management of such plans.
“The two positions have come much closer together in the last few years and will continue to do so because the Pensions Regulator has recognised that contract-based schemes do not have enough governance,” says Mr Macro. Organisations are now only likely to go down the trust route if they are moving over from a defined benefit set-up, where they already have the required structures in place, he adds.
Within the contract set-up, though, there are a number of options employers might want to consider, says Alex Davies, managing director, corporate and pensions, at Hargreaves Lansdown Asset Management. These include group personal pensions or group stakeholder plans, while the introduction of the National Employment Savings Trust (NEST) or one of its rivals could also be an option, albeit relatively untested.
Some employers are looking at corporate wraps, enabling staff to invest pension contributions in a range of products, including self-invested personal pensions, stocks and shares, ISAs and cash ISAs, as well as conventional savings accounts, says Mr Davies.
“The good thing about this is that it serves all types of employees, whatever stage of life they are at,” he says. “For instance, lots of young people want to save, but they don’t want to lock all their money away in a pension. Higher earners, on the other hand, often find that the reduced pension allowance of £50,000 is not enough.”
With the shift to DC moving the risk for funding an adequate pension to employees, responsible employers are likely to take more of an interest in educating staff about taking responsibility to save for their own retirement, particularly with an estimated seven million extra people likely to join DC schemes under auto-enrolment.
“There remains a stubborn resistance to paying fees for advice, even when the longer-term consequences of an uninformed decision can prove far more expensive,” says Mr Middleton. “The longer term solution must surely involve the provision of pensions-related information and advice via the workplace. This might be offered as a form of employee benefit, possibly as part of a flexible benefits package.”
Alex Thurley Ratcliff, strategic consultant at SHILLING Communication, says companies need to deliver personalised communications to employees in language they will understand. “Focus on messages like ‘What would 1 per cent more cost and what would it give you?’” he says. “People can’t cope with the ‘big scary gap’ but they can grasp the idea of affording 1 per cent more.”
With all but the very smallest organisations required to offer a workplace pension scheme by 2016, any employer who fails to accompany such plans with effective communication, which will help employees understand the value they are getting, is wasting money.
“If you have a budget of 10 per cent of salary for pensions, you might actually be better using 9 per cent as contributions and 1 per cent of salary promoting it,” says Mr Macro. “Companies will get more out of that approach than they would out of putting 10 per cent into the pension and just leaving it at that.”