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Is Your Pension Thin and Weak, or Strong and Well-Defined?
By Lain Morse and Simon Bain
October 4, 2004
All but the largest companies are likely to discourage new employees from joining a company pension scheme, to save on the extra costs, according to a study published this week.
Small to medium-sized companies, the biggest source of employment in Scotland, are engaging in "window-dressing" by setting up a company pension scheme whilst trying to keep membership as small as possible, according to the study by the Pensions Institute at Cass Business School in London.
It says tactics have included setting contribution levels too high for young workers, limiting information, and holding briefings outside office hours.
The study adds to concerns over how defined contribution (DC) schemes are already the poor relation of defined benefit (DB), or final salary, schemes because of lower contribution rates by employers, creating a two-tier workforce. Although companies are saving money on pension provision, few are passing it back to staff in the form of salary or other benefits.
There are some noteworthy examples of employers trying to compensate staff in DC schemes for the loss of DB benefits. Marks & Spencer doubles-up employee DC contributions, so a 6% employee contribution is matched by a 12% employer contribution. This matches the ratio of contribution into the average DB scheme.
Meanwhile, the Financial Services Authority has made slightly higher pay increases to newer staff in its DC scheme against those on final salary pensions.
However, these remain exceptions to the rule. Charles Cotton, at the Chartered Institute of Personnel Development, warns: "In 20 years' time when staff from the same company but in different schemes retire at the same time from the same jobs at the same salaries, there will be trouble as they compare their pensions."
Cotton says that where staff are offered membership of a new DC scheme, "in nearly all cases, the level of employer contributions into the new DC scheme is far lower than the same into its predecessor".
John Lawson, pensions technical manager at Standard Life, confirms: "Funding rates into private sector DB schemes sit between 15% to 25% of wage costs, the public sector in the 20% to 25% range.
Funding to DC schemes is typically far, far lower. Some newly established DC schemes have contribution rates of as little as 1% to 2%, those replacing DB schemes probably average less than 10%." The TUC believes the average for all DC schemes is closer to 6%.
Few employers compensate new staff accordingly. Suppose two employees of the same age are each earning £24,000, one joined in time to be a member of a DB pension scheme now closed to new members, the other joined too late and became a member of a new DC scheme.
Employer contributions into the first average 20% of salary, into the second just 6% - an annual cash difference of £2360.
Tom Powdrill, senior policy officer at the Trade Unions Congress, says: "This is simply not fair. Employers can argue that the two types of scheme are not directly comparable and so they are justified in paying in less into DC ones, but the truth is that a personal pension or similar offers no guarantees at all." While DB schemes are supposed to pay a minimum pension based on a sum which multiplies a fraction of final salary (usually fortieths or sixtieths) by years of service in the scheme, DC plans move all the investment risk to the employee.
A combination of low funding rates and investment risk will almost certainly have disastrous consequences for many employees who are currently in DC schemes. Arthur Ziegelman, senior partner at pension consultants Watson Wyatt in Edinburgh, says: "Take-up on DC schemes has not been as good as hoped for, and the likely outcome is that future generations of employees will retire with inadequate pensions."
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