Consulting » Time running out for DB schemes as pension fatigue sets in

THE GOVERNMENT’S latest pension reforms may result in only the UK’s biggest companies maintaining their defined benefit pension schemes, while prompting executives and high earners to opt out due to potential tax liabilities.

Chancellor George Osborne announced in his Autumn Statement that the maximum tax-free amount that employees can save each year in a company pension scheme is to be reduced to £40,000 from £50,000 in April 2014 – down from £255,000 in the previous parliament. The cap on tax-free lifetime pension savings will also be cut to £1.25m.

The government says the measure is aimed at targeting the wealthy, but critics say it could hit middle-income workers or long servers in final salary schemes. The Institute of Directors has called the move the “latest in a long line of tax grabs”.

Poisoned chalice

Pensions experts say the changes will not affect the majority of those employees still fortunate enough to have defined benefit (DB) company pension schemes as they are unlikely to reach that threshold. However, more executives, managers and other high earners will be hit by the government’s plans and, as a result, finance directors may need to work with HR departments to develop a series of more immediate reward and benefits packages as top staff pull out of company pension schemes altogether.

Keith Webster, partner in the pensions team at law firm Osborne Clarke, says companies may find the salary and pensions increases they have given some staff as a reward may be seen as a poisoned chalice if the remuneration package takes employees over the reduced £40,000 tax-free threshold.

“There is a risk that employees may end up with a significant tax bill as a result of their salaries and pension contributions increasing. It would be a bitter pill to swallow to think that an increased remuneration package could leave you worse off,” he says.

Alan Higham, chairman of Annuity direct, a retirement income specialist, suggests highly paid employees may opt out of the company pension scheme, given the reduction in the amount of tax-free savings.

“Managers and executives could steer clear of DB pension schemes as part of their remuneration package and opt for cash bonuses, share options and other short-term rewards instead. DB schemes have been attacked over the past decade, and there is a feeling that this latest announcement is one of the final nails in the coffin,” he says.

Experts believe more and more companies will now be forced to close their DB schemes to new members, and that many will transfer some employees to a defined contribution (DC) pension scheme instead. As a result, FDs may have to consider what impact these changes can have on the workforce and how they should structure reward and remuneration schemes in future.

“Large companies with PLC balance sheets and significant asset bases have the only schemes that are likely to remain open,” says Mike Carpenter, director at independent financial advisor Carpenter Rees. “This is especially true where private companies need to offer comparable benefits to the public sector. FDs will need to review their schemes to see what the value is to their workforce and recruitment programme. They must put themselves in a position with a greater degree of certainty about the future – and effectively communicate any changes to their workforces.”

Even worse, the raft of legislative change has created a burden on company pension schemes that is beginning to grind down UK business. The continual changes to UK pensions are making companies consider whether they should outsource their schemes altogether.

“There are over 1,000 sets of statutory regulations regarding company pension schemes in the UK, including around 15 Acts of Parliament,” says Rosalind Connor, partner in the pensions group at law firm Taylor Wessing. “It is little wonder, especially given the time and cost of running them, that companies want to close down their own schemes and just outsource pensions provision to an external specialist.”

Higham agrees companies are unhappy about the regularity of pensions reform. He believes FDs are angry that the raft of changes they have had to incorporate over the past decade has effectively resulted in many companies having to provide three separate schemes – a DB scheme for older, long-term employees now closed to new members; a defined contribution scheme for recent joiners; and a pay increase for those employees who have decided to opt out of the pension scheme altogether.

“Companies are having to operate a number of different pension and benefits schemes due to changing regulations. This adds to a company’s expense, so it is unsurprising that UK business is critical of the latest round of changes,” he says.

There are other strategic considerations that may prompt companies to abandon DB schemes. For example, says Connor, if a company wants to restructure its international operations, it needs to assess what the pension liabilities may be in each of its territories – and if the costs are too high due to shortfalls within the schemes, the company may need to abandon the project. “It now appears that the pensions tail is wagging the corporate dog,” she says. ?