Defining pensions – as easy as A, B, C?

Pensions

Julie Hutchison

4th June 2014 at 2:28pm

Pensions have been in the news again, as proposals were announced in today’s Queen’s Speech which mean a new form of pension is being considered for introduction in the UK – “defined ambition” pensions.

But what are they? And how are they different from the types of pension we have in the UK at the moment?

This video from the Pensions Minister explains more:

What type of ‘pension promise’ do you have?

A “defined ambition” pension is a halfway house between two common forms of pension in the UK.

There’s a simple way to understand the 3 different forms of pension – it’s as simple as DA, DB and DC :

  • DB – Defined Benefit – full promise of a guaranteed income – there are fewer of these in the UK now than in the past. These pensions involve paying an income linked to your years of service and former salary.
  • DC – Defined Contribution – the new flexible rules coming in April 2015 will mean you can generally take what you want when you want, after you reach the minimum pension age.  There’s no promise of a certain income since that would limit what you can take and when – you’re in control.

Upside and downside of DA

Commentators have pointed to a range of positives and negatives with DA pensions.  Here are some of the potential benefits :

The idea is that returns are ‘smoother’ and less affected by stock market ups and downs, which some people may prefer.It’s obviously very early days in looking at DA pensions. We’ll know more when the Private Pensions Bill is published, and we look at the details of the proposed DA model. Watch for future blogs on this topic.

It’s possible that returns could be better, but there is no guarantee of that.

With the pooling of investments into very large funds, there may be economies of scale when it comes to fund management charges.

And some downsides :

  • It’s not clear how DA would work in the UK. Employers are mid-way through the introduction of auto-enrolment, where many employees will automatically join a pension scheme. This upheaval to move to a new system could risk undermining auto-enrolment and the goal of getting more people saving.
  • DA aims to smooth pay-outs to people retiring through a constant stream of new contributions from younger members, i.e. there is inter-generational cross-subsidy. To guarantee new contributions, will it require a higher level of compulsory saving?
  • DA retirement benefits are geared towards more certain incomes (although not guaranteed, and there are examples of these being reduced). This is inconsistent with recent announcements in the Budget, where people have much greater freedom in how they take retirement benefits. Many people will not want to lock into a regular income in the way of an annuity or defined benefit pension.
  • Similar to With Profits, the underlying structure of a DA can be complex and not transparent to the member, which runs contrary to the move towards greater transparency in the UK.

What does it mean for you?

It’s obviously very early days in looking at DA pensions. We’ll know more when the Private Pensions Bill is published, and we look at the details of the proposed DA model. Watch for future blogs on this topic.

Meantime, here’s a link to a BBC article with more information on DA pensions.

And for the 4 million+ people in the UK who are self-employed, DA pensions are unlikely to be relevant given their usual workplace focus – if you’re self-employed, you’re in pole position to control your own pension arrangements.  If you’ve recently changed job and moved to freelancing, this blog has some pointers for what to keep in mind.

What do you think – do you prefer DA, DB or DC? Post your comments below, we’d love to hear from you.

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This blog and any responses to comments are not financial advice.  A defined contribution pension is an investment.  Its value can go up and down and it may be worth less than you paid in.  We recommend you speak to an expert to get guidance on your own situation.