Government considers new type of pensionCheaper than final salary - but still low risk

11 April 2012

Many employers have switched from defined benefit (DB) to defined contribution (DC) pension schemes

The Pensions Minister, Steve Webb, has outlined a number of alternatives to the current ways that people save for their retirement, as fewer and fewer companies offer the 'gold-plated' pension saving schemes of the past. 

Mr Webb has called for a compromise between old-style final salary pensions (defined benefit) and the more common money purchase (defined contribution) model, where risk has been effectively transferred from employer to employees.

Cash balance pension scheme

The first of Mr Webb's suggested alternatives is a 'cash balance' scheme, where employers guarantee a pension pot but not the annuity income that this will secure. This is currently used by the supermarket chain Morrisons. 

Removing investment risk, this still leaves employees exposed to fluctuations in annuity rates. In recent years these have fallen dramatically. To generate pension income of around £6,000 it is now necessary to have saved at least £100,000.

The Minister's other suggestion is a system of flexible pension start dates, which depend on life expectancy. Employees could be faced with working for longer before they qualify for a pension.

Employers should share more pension risk

Commenting on his proposal Steve Webb said: 'There must be somewhere in the middle, between the old traditional final salary schemes – where absolutely every risk was on the firm – and a pure defined contribution scheme where... you put the money in but you have absolutely no idea what pension you're going to get at the end.' 

'I think firms would like to offer employees some sort of certainty, but without the costs and burden that they currently face.'

The death of final salary pensions

Defined benefit (DB) schemes were once commonplace in industry but many have now been closed to new members. They are still prevalent in the public sector, however. 

Most employers now offer defined contribution (DC) pension schemes to their workforce. Individuals accumulate a pension 'pot' through their working years and use this to buy an annuity when they come to retire. 

In contrast to defined benefit schemes, the outcome with money purchase schemes is hard to predict. The value of your 'pot' will vary depending on its investment performance, and the income your annuity generates depends on prevailing rates at the time.

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