PENSIONS FIT FOR PURPOSE
The crisis in the UK pension system often leads to calls for employers to do more. This is because companies have in the past played a major part in retirement provision because it suited them to do so. But times have changed and so has the role that companies play in providing pensions. By Lee Jagger, partner and head of corporate pension advisory, KPMG.
Pensions come from three main sources – the State, employer sponsored plans and voluntary individual arrangements. Each of these components has its problems and together they are not delivering decent pensions to the majority.
The State pension system is incomprehensible to most people and not designed to provide more than a very basic safety net. Companies have been through a succession of changes to their defined benefit pension plans in the last decade in order to reduce risk and exposure to volatile costs. They have replaced them with defined contribution plans where all of the risks rest with employees.
The trend will not reverse and indeed seems to be gathering pace as market developments have focussed attention on the real prospect of buying out pensions with insurance companies and achieving a full discharge of the risks. And yet all the evidence suggests that individuals are ignoring the problem and failing to rise to the challenge of saving more themselves. This is little surprise given our weak savings culture and the overwhelmingly negative press that surrounds anything to do with pensions and it is unlikely to change quickly with the gloomy economic outlook and the credit crunch having further undermined confidence in financial institutions.
But let’s not forget that retirement income also comes from a variety of other sources including personal savings and investments, property and inheritance. Increasingly retirement income will also include non-retirement income as people decide that they can’t afford to retire and therefore carry on working albeit in different activities.
There has been a grudging acceptance of the decline in both State and occupational pensions. Indeed surveys point to particularly the younger generations not wanting to rely on the State or their employer to take care of their needs in retirement. There is an acceptance that they need to take responsibility … which they will do as soon as they have paid for today’s essential luxuries and paid down some of their debt mountain!
Against this backdrop companies generally wish to continue to play a role in pension provision but in a different way to how they have done in the past. Generally that role is to provide the mechanism to save for retirement rather than provide any certainty over the level of retirement income. The level of company commitment will vary according to the circumstances of each company. In particular, it will depend on the business benefits that can be achieved through for example improved employee engagement, reduced turnover and the company’s reputation and brand. Where these issues are important the savings arrangements are characterised by choice, flexibility and value and might include some of the following key ingredients:
- Incentives to save, for example through matching contributions made by the employee.
- Flexibility in how much to save and integration with employer share save arrangements
- A commitment to regular, clear communication. The message is that individuals should take personal responsibility for their retirement savings, but that they will be supported through a flexible arrangement delivered cost effectively, including the benefits of the employer’s purchasing power. Individuals will also have access to planning tools to help them make and review their decisions on how much to save and how to invest.
- Maximum tax efficiency of pension and other benefits including the use of salary sacrifice.
- Ancillary benefits to cover health and risk events.
- Integration with HR and business processes to accommodate flexible and variable working patterns and ensure that pension, health and risk issues are carefully managed through the key employment lifecycle stages.
- Appropriate investment choices which are continually reviewed to keep up to date with market developments. For example this might include making available dynamic funds where the asset mix varies automatically over time, diversified growth funds which include alternative asset classes to reduce volatility without losing upside potential, and pre retirement funds which hold a mixture of corporate and government bonds to mimic how insurers price annuities.
Such arrangements provide a competitive proposition and the means to achieve a decent level of retirement income. But the responsibility is shared – individuals need to take responsibility to make active choices about how much to save, in pensions or elsewhere, in order to meet their needs in retirement.