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Traditional Final Salary Pensions in Terminal Decline

The UK Pensions Minister has acknowledged that “traditional final salary defined benefit schemes…..are in terminal decline”. This statement forms the backdrop to a consultation issued by the Department of Work and Pensions in November 2013 putting forward proposals for reshaping workplace pensions in the future.

MORE FLEXIBLITY FOR EMPLOYERS TO CHANGE THE RULES OF THEIR EXISTING FINAL SALARY SCHEMES

As companies face escalating liabilities in relation to maintaining their final salary pension schemes, the UK has seen record closure rates. According to the consultation, in 1995 there were over 5 million people enrolled in final salary pension schemes, but by 20I2 this had reduced to 1.6 million. Employers have made it clear that without having options to reduce cost volatility, the case for maintaining final salary schemes will continue to weaken.

In order to assist employers with their existing final salary schemes, the government has set out several proposals to give additional flexibility in relation to future accruals within existing final salary schemes. Measures proposed include the ability to:

    • Remove requirements for pension income payments to increase with inflation

li>Change the pension age to cap costs from increased longevity

  • Allow employers to convert a final salary scheme pension into a cash value for transfer to a defined contribution scheme when an employee leaves their employment before retirement. This would only apply to future benefits accrued after the implementation.

 

The government has confirmed that these proposals would not apply to deferred pension members or past accrued benefits of active members of a final salary scheme. However, the amendments will result in employees sharing more of the risk associated with providing a final salary pension in the future.

DEFINED AMBITION PENSIONS

The government is consulting on a framework to enable the development of new forms of workplace pensions termed “defined ambition pensions” (“DA”). The goal of DA pensions would be to provide greater certainty about retirement income for employees coupled with more risk sharing (including in relation to inflation, investment and longevity) between employers and employees. In essence, they would sit somewhere between final salary pensions and defined contribution/money purchase plans by offering some level of guarantee.

Draft legislation on these measures is expected in 2014.