The report from the Office of National Statistics earlier this year showing a further fall in the overall level of pension saving in defined contributions schemes made for depressing reading. It may be that the widening out of pension saving through the process of auto enrolment will eventually reverse this worrying trend, but it leaves me feeling uneasy about the overall direction of pensions in the UK in the early decades of the 21st century.
Half a century ago, in the late 1960s and early 1970s, we had a thriving private and public sector defined benefit culture in the UK. Admittedly it only extended to that half of the workforce working for the very largest employers (including the largest of all employers, the Government), but for a very long time we had a real and widely-held culture of paternalism and business pragmatism on the part of such employers.
From an individual’s point of view this strong employer covenant meant, in effect, that those covered by defined benefit pension schemes were paid every month or week with two forms of income: ready money that they could spend on daily living and deferred pension money that they could not access until they reached a relatively old age.
Such people were building up substantial pension wealth while their neighbours who were not in defined benefit pension schemes were not. This is something that was not apparent to many people at the time and is only now becoming widely known because of recent pension reforms, giving people wider access to and rights over their accrued defined benefit pensions – the so-called pension freedoms.
For decades, two families in neighbouring houses could well have thought that their lot in life was much the same. But if one family had a parent or parents accruing pension wealth through a defined benefit pension scheme and the other did not then their lifetime financial realities were likely quite different.
Pension wealth, though, is invisible while people are of working age. These neighbours may well have had similar cars on the driveway over the years, spent similar amounts on household luxuries and holidays, and felt their lives were the same.
But in reality they were not. A defined benefit pension scheme promising
pension benefits based on a sixtieth of near-final earnings for each year of employment would have required funding at the level of something like 23 to 25 per cent of earnings every year. While some employees were lucky enough to be in schemes that required no contributions from the employee – non-contributory schemes were commonplace in the banking and insurance professions – most employees would have been required to pay 5 or 6 per cent of their earnings towards the cost of the pension benefits. That level of contribution though would still have left the employer making the lion’s share of the annual contribution required.
For people who have been members of defined contribution pension schemes for all of, or many decades of, their working lives, the invisible pension wealth accrued can have been quite substantial. It is not at all uncommon for such people to find that the pension wealth they have accrued over the course of their working lives is worth more than the houses they have spent most of their lives paying for through their mortgage.
Their invisible wealth may in practice mean they have accrued lifetime assets of double the value of those of their neighbours. Something nobody in the 1960s and 1970s would ever have thought credible.
Today, this quite shocking reality is beginning to become widely understood, but is doing so at a time when the commitment of employers to their employees’ pensions is diminishing.
While it is understandable that employers have closed down defined benefit schemes because of the risks they entail for businesses, the switch to defined contribution schemes has been made with a corresponding reduction in the amount employers seem prepared to contribute to such schemes.
Many see this as a failure of the schemes themselves, but I do not go along with the demonisation of defined contribution schemes.