Pensions Minister Steve Webb may have come up with a third way through the current occupational pension crisis. While the threat of stock market crashes mean that defined contribution schemes have lost savers’ confidence, defined benefits schemes are unsustainable for an aging population.
Defined contribution schemes are those where employers contribute a certain percentage of their workers’ wages to the scheme. Sometimes employees contribute too. The fortunes of the fund depend on its performance. So if the fund performs well, the saver can look forward to a comfortable retirement. But if the fund does not perform well, the saver may not even get their original contributions back. The danger of underperformance has proved to be a significant disincentive to workers who feel they have other financial priorities.
Defined benefit schemes on the other hand, operate so that the scheme promises a certain income to its members. Those who run the scheme are bound to pay the defined level of income. Twenty or thirty years ago, when people were not expected to live more than a decade after they retired the projected pensions were achievable. But with retirees now expected to live for a couple of decades, sustaining the agreed pay outs is impossible. Employers who sponsored such schemes have found themselves having to transfer significant assets into them to make up deficits.
How does Steve Webb’s plan meet in the middle of these two types of schemes? Webb seeks to share the risk between employers and employees. So a defined ambition scheme could give an estimate of how much pension would be paid out. But the figure is an estimate rather than a promise, and the employee may have to delay their retirement date to achieve that level of income, depending on how the fund had performed.
Another idea is that the scheme could give employees a range of values in which the pension may pay out. So the scheme is bound to pay out the lower level, but may achieve the higher amount, depending on the fund’s performance.
Whichever way they are structured, Webb must set out the schemes’ advantages clearly to savers so that they can plan their retirement.