BLOG: The DB pension elephant in the room
However, with the outcome of the government’s consultation on incentivising saving in the UK expected before the 2016 Budget in March, there’s scope for plenty more change ahead. And now the festive period is out of the way, there’s no shortage of discussion about how best to tackle some of the big issues.
For me, the subject getting a lot of air time is tax relief. In particular, tax relief on the way in (typically via a pension) versus tax-free on the on the way out’ (typically via an ISA). But not something that would keep too many people up at night. The benefits, however, of each do need to be properly, and simply, explained before any changes to the current regime are put to bed. Once we do that, how we tax or ‘top-up’ contributions becomes more of an issue for the technical boffins.
A bigger issue though is the apparent imbalance in the tax relief claimed by defined contribution (DC) schemes and defined benefit (DB) schemes – the so-called ’final salary’ schemes.
The opportunity to save into a DB scheme doesn’t exist for many today outside the public sector and it is even reducing year on year there too. Yet of the £20bn currently spent on tax relief for occupational pension schemes each year, over £15bn goes to those in DB schemes. Much of the reason for this is because DB schemes tend to have more generous contributions from the employer.
The reduction of the lifetime allowance (LTA) to £1m from £1.25m from next April further highlights the imbalance. Because of the way the LTA is calculated in a DB scheme (£salary x20), members can be taking up to £50,000 a year before the LTA restriction kicks in. However in a DC scheme, with annuity rates as they are, a member can only achieve an inflation proofed income of around £30,000 from their £1m maximum.
Added to this is the difference in the level of contributions. Payment levels into DC schemes are much lower than their DB counterparts, especially when you look at contributions to NEST. Many people still think of pensions as being two-thirds of their final salary even where they are in a DC scheme. So there is some work the industry needs to do to address this misconception, as the reality is, that for the majority of people, DC pensions are going to be small and certainly considerably smaller than the final salary schemes many of their parents may have enjoyed.
While initiatives like auto-enrolment have a noble purpose, they are undoubtedly just the beginning. Any new incentive to save into pensions must encourage DC pension savings beyond the auto-enrolment default level of eight per cent. That is half of what’s required.
Those who are already in, or have access to, a DB scheme don’t need to be encouraged to save. It’s time we levelled the playing field, get more people saving into DC schemes, maximising their employers contribution and take meaningful action to help prevent the first generation of people to retire poorer than their parents being just around the corner.
Mike Kellard is chief executive officer of AXA Wealth