SINCE the election a startling contradiction in government policy has simply grown more and more glaring. On the one hand government – in common with states elsewhere in the world – is keen to limit the burden on the state by shifting responsibility for pensions onto the individual. On the other, the last 40 years or so have seen a seemingly endless assault on defined benefit pension schemes, arguably the most successful mechanism for ensuring that people do not have to rely on the state for an income in their old age.
As Charles Cowling, a director at JLT Employment Benefits notes, the Treasury’s White Paper on the pension tax changes expected in the chancellor’s March 2016 Budget are likely to make pensions even less attractive to higher rate taxpayers than they are at present. This could come about through a further reduction in the amount of pensions savings by the higher paid that will attract tax relief, as well as in other measures, such as lowering the overall size of the allowable pensions pot.
Cowling points out that if the government further disincentivises board-level directors and senior executives from continuing with company pensions, the overall incentive for any management of any organisation to retain defined benefit schemes is weakened. This in turn will add to the momentum with which DB schemes are already being shut down or closed to further accrual, he says.
But the changes could go still further. There is even the possibility that the government will contemplate a complete transformation of the way pensions are taxed. Instead of providing tax relief on pension savings and taxing benefits once they are paid, the government is thought to be contemplating flipping this around, so that there is no tax relief on contributions, but benefits are then provided tax free, as they are in the ISA regime.
“This would be a massive transformation and it is hard to see how it could be anything other than a disincentive for companies to continue with any form of pension that is superior to the bare, statutory minimum, defined contribution (DC) scheme,” Cowling says. He points out that by way of contrast, there is a huge incentive for the Treasury to go down this road since it would provide a significant short-term boost to government finances.
The consequences long term though, would be severe as government would lose out on taxes it currently raises from pension income.
“The nature of the democratic process is that politicians naturally favour short-term gains even when they come with long-term adverse consequences, since the storm tends to break long after they have left office,” Cowling says.
“It is hard to overstate the negative effect this continual tweaking and rethinking of the pensions regime is likely to have on future pensions savings. When people save for a pension they are thinking 20 and 30 years ahead, but the pension regime for the last four decades has been in constant flux. It is very difficult for anyone to be confident that when they save today, the rationale for their savings will not be undercut by future changes to the system by government,” he adds.
The great shutdown
Already, even before we see the impact of the March 2016 Budget on pensions, DB schemes across the UK are being closed at an ever-increasing rate. Research carried out by JLT Employee Benefits points to a decline of 13% in ongoing DB provision among FTSE 100 companies, in the 12 months to 30 June 2015. This calculation takes into effect the impact of changes in factors such as mortality assumptions and market conditions.
“Only 55 FTSE 100 companies are still providing more than a handful of current employees with DB benefits, if we ignore companies with ongoing DB service costs of less than 1% of total payroll,” Cowling says. “Of these 55, less than a quarter are providing benefits that equate to ongoing DB service costs of more than 5% of total payroll.”
Overall, the total deficit of FTSE 100 pension schemes has worsened by a further £19m through the year to 30 June 2015, and now stands at £78bn. Total pension liabilities, meanwhile, have increased by £37bn, to £614bn.
The scale of the disincentive to companies to keep DB schemes open and running can be seen from the size of the contributions those FTSE 100 companies still running DB schemes are having to pay into the scheme to reduce deficits, with all 55 companies reporting significant deficit funding, Cowling says.
“There is evidence that pension buyouts and spending on derisking DB schemes through mechanisms such as mortality swaps, are on the rise,” he says. “The end of contracting out means that companies with significant DB schemes will suddenly be paying National Insurance contributions again. Sadly, things do not look bright for long-term retirement savings in the UK.”