Britain’s pensions system is both inequitable and unsustainable. In effect, younger workers on defined contribution (DC) pensions are paying an inter-generational subsidy to older workers on defined benefit (DB) schemes. The gap between the “haves” and “have nots” is only widening. Fortunately there is a solution.
A glance at the lopsided division of benefits illustrates the need for change. Currently, 70% of private sector workers have DC pensions and receive around £4.5 billion in employer contributions each year. Yet the remaining 30% enrolled on DB schemes collectively receive nine times that figure – some £42 billion. In other words, employers’ are having to pay such a disproportionate amount to meeting the obligations of DB schemes that they are not meeting the needs of the majority.
My research shows that if a 45 year old on a DC scheme wanted to retire at 68 with the same sized pension as his peers with defined benefits, he would have to be putting away 40% of his salary. No wonder younger workers are not saving enough for retirement. Currently the average worker only puts 2.9% in his pension, with another 6.1% contributed by employers.
One solution would be for employers to increase DC payments. But, that is rarely an option for many in this fragile economy environment, particularly if the DB scheme is already restricting the ability of the company to pay more into DC plans.
Alternatively defined contribution schemes,could target higher returns by taking more risk within a system that protects savers by holding back profits in good times. But even that would take generations to bring about a more equal distribution.
Instead, I believe we must rebalance the existing pot. This is not as radical a move as you might think. With a series of small adjustments we could remove cost, thus making a massive difference to young people – a generation already burdened by higher student debt, restricted access to the housing ladder and has to wait longer for retirement.
My plan would be to tweak payments for retirees on DB schemes. Their pensions would rise as normal in line with inflation for five years, but in the sixth year after the change, they would not receive any increase. Members of DBs scheme yet to retire would face the same freeze six years after starting to draw their pension.
This would allow pensioners time to plan and make little overall difference to DB members. However, the savings it would generate that could be redirected towards DC schemes would be a game-changer for the younger generation.
My calculations show the measure could reduce DB liabilities in the UK by a one off amount of £45 billion. If schemes were then mandated to disinvest an equal amount from their assets and pay it into a centralised fund, 17.2 million private sector employees would receive an immediate £2,600 boost to their pension savings – just under 10 per cent of the average DC pot .
Just imagine how many young people with no pension arrangements at all would wake up and pay attention. The wider boost in getting people engaged in thinking about pensions, and taking responsibility, would be huge.
Those in defined benefit plans might say a promise is a promise, but we must all realise that by maintaining DB schemes in their current form we are condemning subsequent generations to financial hardship in old age.
To read the full report please download the PDF (PDF 916.60 KB).
This article represents the views of the author only, and does not necessarily represent the views or professional advice of KPMG in the UK.