The Pension Schemes Bill which is currently making its way through Parliament implements various strands of the Government’s workplace pensions revolution. In this article we consider some of the important changes the Bill will introduce.
Background to the Bill
The Government published its strategy document Reinvigorating Workplace Pensions in November 2012, shortly after the largest UK employers became subject to automatic enrolment.
Given the historic decline in the provision of defined benefit (DB) schemes, many eligible jobholders who are admitted to a pension scheme through automatic enrolment will find themselves accruing defined contribution (DC) benefits, whether in trust-based schemes or in contract-based personal pensions.
In DB schemes, the benefits payable on retirement are fixed by the scheme rules and employers are responsible for ensuring the cost of those benefits are met. This is now proving too volatile and onerous a burden for many employers who, as a result, have been closing their DB schemes in recent years.
In DC schemes, the employer usually pays a fixed percentage of its employees’ salary into the scheme and whatever income the member gets from the scheme in future depends on the level of contributions, the investment return and annuity rates at retirement (although changes announced by the Government and taking effect in April 2015 will give members more choice over how to access DC benefits).
In the strategy document, the Government recognised that many people who are automatically enrolled into a DC scheme will be uncomfortable with the fact that their future outcome is so uncertain and that they bear all of the risk instead of the employer. As a result, the Government has been exploring the option of a third way between DB and DC; one which gives members more certainty of outcome than in DC schemes but without the cost and volatility for employers associated with DB schemes.
Detail of the Bill: Defined ambition
Following a consultation in 2013 – Reshaping Workplace Pensions For Future Generations – the Government published its Pension Schemes Bill 2014 (the “Bill”) in June 2014. Under current legislation, pension schemes are split between those that are money purchase schemes and those which are not. A money purchase scheme is one which provides money purchase benefits (the Pensions Act 2011 amended the definition of money purchase benefits to mean benefits which cannot give rise to a funding deficit).
The Bill will split private sector schemes into DB, DC and “shared risk” (or “defined ambition”) schemes. Which category a scheme falls into will depend, broadly speaking, on the level of “pensions promise” which it provides to members. The concept of a pensions promise is not something which has been defined in UK legislation before now.
DB schemes will be those which pay members a retirement income for life from a fixed pension age and which include a full pensions promise in relation to the level of that income. DC schemes will be those which provide no pensions promise at all during the accrual phase as to the level of benefits payable on retirement (DC schemes will include those providing money purchase benefits as described above).
Shared risk schemes will be a half-way house between DB and DC; a way of implementing the Government’s desire to offer schemes which are less of a burden to employers than DB schemes but which offer more certainty to members than DC schemes. A scheme will be shared risk if there is a pensions promise in relation to some of the benefits which members receive on retirement. Examples include schemes where a promise is made about the size of the member’s individual pension pot at retirement and schemes which provide money purchase benefits but with a guaranteed investment return.
If a scheme provides a mix of benefits in such a way that it does not fall neatly into one of the three categories, each benefit will be treated as being provided by a separate scheme.
The Government’s intention is not to create a separate legislative regime for each category of scheme. Instead, requirements such as those relating to communications and governance will be tailored depending on which category a scheme falls into.
Detail of the Bill: Collective benefits
The Government is also keen to facilitate the establishment of schemes which provide collective benefits, whether via DC or shared risk arrangements. Collective benefit schemes feature in other jurisdictions but are not currently possible under UK tax and pensions legislation. The Bill therefore provides a broad framework enabling schemes to provide collective benefits.
An example of a DC scheme which provides collective benefits is one which pools all of the member and employer contributions received into one large pot, with benefits on retirement then being paid out of that pot (i.e. members do not have individual accounts as with traditional DC schemes). In theory, pooling contributions allows for economies of scale, a broader range of investment options and the smoothing of investment returns, with the outcome for members hopefully being more stable and certain than if they had their own individual accounts within the scheme. At the same time, employer contributions will be fixed, which means that if funding levels drop (for example due to poor investment performance) the targeted level of benefits will be reduced and the employer bears no additional funding risk.
Much of the detail around the funding and investment requirements for schemes providing collective benefits will be set out in regulations.
The Bill also contains changes relating to the new flexibilities around DC benefits which the Government is proposing to introduce from April 2015, the majority of which are covered in a separate Taxation of Pensions Bill (see here for further details). These provisions include:
- the framework for the guidance guarantee whereby individuals with DC arrangements will be offered free and unbiased guidance about the range of options available to them at retirement;
- new requirements in respect of individuals who seek to transfer out of an existing DB scheme in the private sector to take advantage of the new flexibilities, for example, to take independent financial advice; and
- a power to prevent people transferring benefits out of unfunded public sector pension schemes into DC schemes in order to take advantage of the flexibilities (as the Government is concerned about the cost to the Exchequer if there is a surge in transfer requests).
The Bill may provide opportunities for employers to develop schemes which are more attractive to their staff than traditional DC schemes but less costly for the employer than DB schemes; this may give them a competitive advantage in staff recruitment and retention. However, whether there is any appetite for this amongst employers, given how far the market has already swung from DB to DC, remains to be seen.