Defined benefit schemes face £3bn VAT hit

A return to the original rate will lead to higher inflation and therefore higher payouts on inflation-linked benefits for those who have retired or are soon to do so.

As the economy enters what is widely expected to be a long and deep recession lasting into the next decade, the Chancellor’s brainwave of stimulating consumer spending by reducing VAT to 15% in his pre-Budget report will cause more pain for companies, not less, pensions consultant Watson Wyatt has suggested. This is because the expected return to a normal rate of tax in 2010 will cause inflation to rise and push up company contributions accordingly.

According to its calculations based on a pensioner currently receiving £10,000 a year from a defined benefit scheme who will live for another 20 years – and using HM Treasury forecasts to 2013 on inflation, and an expected stabilisation of inflation at 2.75% thereafter – companies will end up paying £144 more per person than they are now by 2015.

The pensions consultant put the value of company pension liabilities that are, or will soon be, in payment at just under £300bn – though it added there were no official estimates on this – and said, due to the VAT change, liabilities could increase by around £3bn by 2028.

“The earlier VAT reduction will not produce offsetting savings for employers because inflation would anyway be forecast to be below zero at the relevant time,” says John Ball, head of defined benefit consulting at Watson Wyatt. “The costs add up for schemes with thousands of pensioners. In the case of public sector pensions, it will be the taxpayer who foots the bill.”

Watson Wyatt’s Ball added that unfunded public sector schemes’ annual costs would also increase by £3bn as a result of the VAT change impact.