It's time to switch to career average pensions
Guest blogger Bob Bullivant explains why career average pension schemes are a fairer proposition.
There are many unpleasant risks surrounding retirement. You may not have much money, you may live for a long time, inflation will eat up the money you do save, while there is also the possible need for care.
The birth of the pension scheme
It's precisely because of these that pension schemes came about. During the twentieth century it was fashionable for employers to ensure that their staff were well looked after in retirement through the provision of pension schemes, which paid a proportion of salary at retirement. Funds were set up, and for a large part of the twentieth century these schemes worked well and in the early nineties most funds were in surplus.
At this point, the Revenue decided that if a fund was in surplus it should not enjoy corporation tax relief on the contributions made, and employers eagerly accepted the concept of the contribution holiday. The issue here was an erroneous assumption that investment returns would continue to rise!
This was made worse by the infamous tax raid on pension funds in 1997. When combined with declining investment returns, people living longer and a new generation of Finance Directors demanding to see better value and the end of the open-ended liability which pensions bring, the writing was on the wall.
Put simply all of the risk of providing a pension was falling on employers and they were not prepared to accept those risks.
A knee jerk reaction
The reaction was knee jerk and did not require a lot of thought. Employers simply closed schemes and move to money purchase, which meant that all of the associated risks of pension – investment risk and longevity – were passed to the members. From the perspective of the Finance Director, the annual contributions are defined.
This is a rather typical reaction to a major issue – violent reaction in the opposite direction without a lot of proper consideration. The result is that more and more people are now faced with the prospect of a poor income in retirement as they grapple with something they really do not properly understand. I was intrigued by a response to my last blog that educating people about pensions is key – I think this is a very good point, but a first requirement would be a dismantling of the complexity around pensions, something the so called pension simplification of 2006 simply failed to achieve.
A sensible compromise
There is also a midpoint, which to my knowledge few employers have adopted – namely the career average scheme. The big problem with final salary schemes is that any increases in salary in the few years prior to retirement are very expensive. In contrast, the career average scheme averages pay over the whole of the length of service, and in the process reduces the cost impact of later increases.
It favours the lower paid at the expense of the high flier who presumably has more ability to top up contributions.
I cannot help but wonder if there will be a move to equilibrium, where the risks are shared between employer and employee rather than the past and current system of heaping all risk on one party. Along with higher contributions and a later retirement age, I firmly believe that career average schemes may offer the answer.
Bob Bullivant is chief executive of Annuity Direct
What do you think? Would a career average scheme offer a healthy middle ground? Let us know your views below.