More final salary pension schemes close Risk-sharing schemes now dominate private sector
29 June 2012
A new report reveals the continuing decline of private sector defined benefit (DB) schemes. Two thirds of active members of occupational pension schemes are now in defined contribution (DC) schemes.
Money purchase or defined contribution scheme numbers will receive a further boost with the introduction of auto-enrolment in October 2012 as many DB schemes are already closed to new members.
Defined benefit schemes decline
The Pension Policy Institute (PPI) reports that active membership of a defined benefit (DB) pension scheme in the private sector has fallen from a high of 8m members in 1967 to 1.6m in 2011. Almost 70% of DB schemes in the private sector are now closed to new members, meaning that new employees have to join a defined contribution pension scheme instead.
Around 20% of private sector defined benefit schemes are also closed to future accruals. Existing members can no longer build up further benefits but those accumulated from earlier service continue to be held in the scheme and will be paid out on retirement.
The decline of defined benefit pension schemes in the private sector is in marked contrast to the public sector, where they are still widely offered. The National Association of Pension Funds estimates that 5.4m people belong to a public sector defined benefit pension scheme.
Rise of defined contribution
Defined contribution (DC) pension schemes are identified by the PPI as the most commonly offered option in the private sector. Two thirds of active members are now saving in a DC scheme. The report anticipates a further rise in DC numbers with the start of auto-enrolment in October 2012, observing that 'most new pension savers will be automatically enrolled into a DC pension'.
The switch from defined benefit to defined contribution has been driven by a number of factors, including increased life expectancy and poor investment returns. The PPI notes that the overall cost of funding DB schemes has risen from 11% of salary in the 1950s to 25% today. Defined contribution schemes are a cheaper option for employers and effectively transfer risk to employees, whose retirement income is far less certain.
Rather than receiving a pension based on their final salary and the number of years they have been a scheme member, their contributions are invested and grow in an individual fund, or pension pot. At retirement, further uncertainty is added by the need to buy an annuity. Annuity rates fluctuate over time and have fallen to a current average of 6%.
The decline of defined benefit schemes brings new challenges for individual pension scheme members. Which? pension expert Ian Robinson said: 'Defined contribution schemes are here to stay and members need to be aware of how they work and what they will deliver.
'It is still possible to build up a healthy retirement income but this needs more active supervision than old defined benefit schemes. Building up a good pension pot is essential for those currently contributing, while shopping around for the best annuity deal is important when you come to retire.'
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Annuities explained - options and choices examined