The introduction of the single-tier pension may simplify things in the long term but presents massive implementation and communication complexity in the short term. John Lappin investigates
The simplification of the state pension system and reduction in means-testing is something that pension professionals see as a hugely worthwhile goal. While it looks as though there will be many casualties along the way, particularly amongst those contracted in, it should make the decision about whether to save for retirement much easier to understand,which can surely only make auto-enrolment more straightforward.
But as Towers Watson consultant David Robbins points out, for many people the state pension will be lower and simpler when in all likelihood most people would prefer higher and more complicated.
He adds: “It does rely on people believing politicians won’t mess about with it, which is a pretty heroic assumption. It is not just only higher earners who lose out. Anyone contracted-in with a reasonably full career will be worse off. The Sun in its editorial put it quite well. The state will only pay for your bread and butter. It you want jam on top you will have to save.”
Yet even the road to this simpler world is proving rather complicated. With contracting out into DC already abolished, defined benefit schemes face stiff challenges, not least given the shorter timetable for the enactment of a statutory override law. Corporate advisers also report that members of the public are also unsettled about contracting in and contracting out, and whether past decisions now make sense with hindsight.
It may not be a direct concern for those creating new workplaces schemes or making sure existing schemes comply with auto-enrolment, but it certainly represents a new communication challenge.
The legislation governing the state pension tier is not finalised yet, though we know much of the overall shape.
Although the pension landscape is likely to be overwhelmingly defined contribution by the time the single-tier pension comes in in 2016, many of the questions are focused defined benefit schemes. With the ending of contracting out, DB schemes and members will face a higher National Insurance bill and many believe that could be the end of them.
The threat to these schemes is one of the live issues raised in front of the DWP select committee. But the pension minister’s view may be instructive.
“While they could use the opportunity of the end of contracting out to get rid of that type of pension scheme altogether, and some may choose to do so, frankly, the ‘nail in the coffin’ analogy – this coffin has got enough nails in it already, so if they are still going now, this will have some effect, but I don’t see it being seismic,” he told the committee.
Barnett Waddingham consultant Malcolm McLean points out that after the committee, the bill must go through both Houses of Parliament, so employers must be careful about just how much they communicate at this stage.
But he says those with defined benefit schemes do need to start considering what they will do about the planned national insurance rise because the bill could be substantial.
He says: “The new state pension when it comes in will bring to an end the second state pension, which brings to an end contracting out. That will mean an increase in NI for both employers and employees. For employees I suspect they will have to accept that as a consequence. I would be surprised if any employees will bail them out, because they themselves are going to have to pay an increased amount too.”
McLean points out that the Government recognises the strains this could cause and is consulting on a statutory override on the requirement to consult trustees about a reduction in benefits to reflect the loss of the rebate, though he says many employers would still want to consult the employees anyway.
While the debate continues, McLean says: “Many employers will look at the cost of running these schemes. We hope it doesn’t precipitate the closing of the remainin final salary schemes. They can put the extra cost on to the employees though I don’t think many will do that. They will accept the increase, close the scheme down or fiddle around with accrual rates. For employers with DB schemes it is time to start thinking very hard about this increase of NI and which of the options they should go for.”
PTL managing director Richard Butcher says: “The result of contracting out for most employers is they have been able to make their schemes more generous than they actually are. A scheme of 1/60s contracted out was broadly equivalent to 1/80s contracted in. Communication is going to be key. There are few employers who will voluntarily provide DB. The thrust is towards ‘let’s drop it now because we don’t want to shoulder the extra cost of NI and the other cost of running DB scheme’.”
These private sector schemes cover a little over a million employees. Robbins says: “The maximum number in terms of employer NI costs is a little bit under £1,200. The maximum for employees is about £480. From an employer’s point of view your DB pension is already costing more than you thought when you set up. In some cases, you might have very few very important people left and it might not be worth changing. In other cases, they may say they can’t afford to do this. The only concession from the Government is that you can make certain changes without trustee consent, but they haven’t removed the need to go through a consultation process with employees. If you are going to do that anyway you might as well do that for a big change as a small change and change it for long standing workers and well as younger workers.
However, whatever the fairness from a public policy point of view for those who have been contracted out and are contracted back in, Robbins says they could be paying £480 extra but accruing around £200 a year for each year past state retirement. That should help employers in their discussions about changing schemes.
Butcher points out that one anomalous group of employers may be those which have taken over public sector contracts and could face contractual obligations where they have been issues certificates of broad compatibility issued by the Government Actuary’s Department.
“Employers who took on local authority contracts who transferred people using a passport are being told they can’t downgrade the value of the benefits.”
He says that when firms win local authority contracts the profit margins can be around 3 or 4 per cent of turnover. He adds: “They could be harming their margin. Those employers may have to lump it, but they are not very happy about it.”
Pensions Management Institute technical consultant Tim Middleton says the biggest affected area will, of course, be public sector schemes, but here there is a difference between funded and unfunded schemes.
“With the big statutory principle civil service and NHS schemes, as far as public finance, I would question the implications because if it is a big unfunded pension scheme it is really just directing public money in a different direction. It is cost neutral. Where it will make a significant difference is funded public schemes, local government and some private schemes, where it will be more expensive because they will be paying full rate national insurance.” Middleton says the minister may be considering other changes that might fit with his own ambitions for defined ambition schemes.
“As defined benefit schemes won’t be providing an alternative to state benefits, they won’t have to provide indexed benefits. People may offer simplified DB without compulsory indexation so he may have that at the back of his mind.”
But that is a question for the future. “A lot of schemes will have to reconcile their contracted out benefits. They will have to start working out how they are going to reconcile their Guaranteed Minimum Pensions and there are all sorts of complications. There is a new phase to TPR data quality initiative looking at schemes to sort out common data, and conditional data.”
He adds: “As well as that, there is also the possibility the DWP will have another go at achieving GMP equalisation. That could be quite an interesting mess.”
The impact on defined contribution will not be on the scale of the challenge facing defined benefit. But that doesn’t mean there won’t be a lot to do if schemes want to be provide rounded pensions communications.
Hargreaves Lansdown head of pension research Tom McPhail says the changes could be quite significant for advisers but particularly providers.
He says: “For pension communication purposes, scheme booklets and guidance, there is a whole load of rewriting to be done. Communicating the pension landscape, calculators will have to reflect the changed world orders. MAS and TPAS will have to update their data set. For providers and pension advisers there is going to be quite a lot of work to do.”
Buck Consultants head of DC and wealth Philip Smith is unsure how much of communication work, DC employers will take on and what responsibility they have. He says: “The answer may be not that much. You have so many imponderables with DC anyway. You have now another one. How big is my state pension going to be? Yes, it is going to fade away over time, but the length of that tail will depend what the transitional arrangements are or if there is a hard line in the sand where the Government says tough. But it will be hard to walk away from past S2P promises.”
He adds: “Employers have been trying to integrate the state pension into their own pension statements, and even that has proved challenging because the integrated piece from DWP doesn’t work very well. It could be in future they continue to try and integrate what the personal state pension is going to be. But that depends on the DWP providing the data in the format that someone can deal with.”
McPhail says there will be a lot of individual raking through the embers in terms of entitlements and contracting out and in decisions.
He says: “As far as DC is concerned as we go through 2017, the DWP calculates everyone’s foundation amount in terms of what your state entitlement is as at 2017. We will have to look at the implications. What the state pension looks like and what accrual you might put in on top of that. There will be revisionist analysis of decisions around contracting in and contracting out, for example where a provider contracted them in. We will have to rake through the embers of those fires and see if there is anything interesting there.”
Smith adds that he has met many employees who were adamant that they would stay contracted out despite prevailing wisdom and the fact it did not make sense that they should contract in. He notes it looks they may well be proved correct.
But while these issues might suggest that individuals will pay more attention to individual circumstances Smith does not think that either employers, nor many individuals will pay advice around the issue.
McPhail says it certainly adds a layer of complication around the pre-retirement process. “There was a trend towards employers providing pre retirement seminars, guidance, information. This now all has to be factored into it. If you dealing at a generic level, it is difficult. If you are giving dedicated individual advice at the point of retirement, it is going to get quite complicated. But hopefully that will wash through the system.”
Butcher adds: “Any generic communication on this is going to be 17 volumes thick and that is going to deter people. Some employers will provide specific individual advice. A lot of them will be unwilling to pay for it.”