The effect of the phasing out of contracting out for defined benefit schemes is dividing opinion amongst pension experts.
Towers Watson says the move will lead to more employers closing these schemes to existing members, as it will be more expensive to offer schemes on existing terms.
But JLT Benefit Solutions points out that the move, which is being taken to facilitate the payment of a universal flat rate pension of around £140 a week, could mean a boost for employers because rebates did not offer fair value in any event.
The Budget Red Book confirms that: “Moving to single tier provision would end contracting out for defined benefit pension schemes… the Government will investigate the potential impact on employees and schemes in both the private and public sectors”, although it does not no propose a date for the abolition of contracting out for DB.
The DWP has estimated that the number of employees building up new rights to contracted-out defined benefit pensions in the private sector fell from around five million to around two million during the 20 years to 2008/09. The option to contract out into a defined contribution pension was anyway being removed from April 2012.
There are around five million public sector employees in contracted-out schemes.
Osborne says the change will probably come in when the £140 a week universal pension comes in, but from 2012 contracting-out rebate rates will be reduced. Employees will only get a 1.4 per cent rebate, instead of the current 1.6 per cent and employers will get a 3.4 per cent rebate, instead of the current 3.7 per cent.
The Budget documents show reductions in these rebates will save over £600m a year each year from 2012 to 2016. By getting rid of the entire rebate, the saving would be more than an extra 6bn a year extra.
John Ball head of UK pensions at Towers Watson says: “Having declined so rapidly, what is left of private sector benefit pension provision was never going to stand in the way of the Government’s ambitions for the State Pension. If the Government waits a few years to bring this in, there may be less than one million active members in private sector defined benefit schemes who will be affected. Unfortunately, it is again employers who provided good pensions who will face disruption as the Government tries to fix the system for everyone else.”
Duncan Howorth, chief executive of JLT Benefit Solutions, says: “The decision to implement, albeit over several years, a ’Universal’ state pension of £140pw is good news in terms of prospective workplace pension reforms. This development goes a long way to mitigate means testing risk – the risk of individuals being no better off by saving in a private pension. Moreover, moving to a single tier State provision would also end contracting out for defined benefit pension schemes.
Whilst this would necessitate a massive overhaul for schemes still open to some members, this short term burden could be more than offset by the long term benefits and the change could mean a triple boost for employers.
“The existing rebate for contracted out DB schemes does not represent fair value for the benefits that schemes are required to provide.By contracting back in and reducing benefits accordingly, employers will be sharing pension risk with the state, and reduced benefits means it is less likely employees will be hit with an annual allowance tax charge from April 2011 and, therefore, there will be fewer people drawing on the “Scheme Pays” facility to cover the charge.”
Tom McPhail, head of pensions research at Hargreaves Lansdown says: “Unfortunately this reform of the state pension will be delivered at the cost of the final salary sector. This will be particularly keenly felt by public sector workers. The proposal to end contracting out will mean higher National Insurance rates for all final salary scheme members; currently they pay 1.6 per cent less, though this is due to fall to 1.4 per cent in 2012. Under auto enrolment employers are already facing a substantial increase to their pensions bill; this is likely to finish off any lingering support they may have for final salary pensions.”
Dr Ros Altmann, director general of Saga says: “The rules for contracting-out are the most complex part of our whole pension system, which is itself the most complex system in the world. ;By sweeping this away, future pensions will be far simpler. Also, of course, workers and employers will all then pay the same rate of National Insurance, regardless of what kind of pension arrangements they have, which is far fairer.”