Osbourne Tinkering Too Much?

Five out of six of Britain’s “final salary” pension schemes do not have enough money to pay the pensions promised to workers, according to the latest official analysis of the £1.3 trillion sector. The difficulties faced by these schemes are worsening thanks to an array of factors – many of them related to tax and other legislative changes introduced in recent years.

If – as previously thought likely – George Osborne cuts pension tax relief for higher earners in his March 16 Budget, those schemes which remain open for employees to build up further benefits will “shut overnight”, according to Britain’s foremost pensions body, the Pensions and Lifetime Savings Association.

Mr Osborne is this weekend reported to have pulled back from such action, following angry protests by MPs. But experts say the damage is done: a pension system famously referred to as “the social security miracle of the Western world” is set to sink.

Final salary pensions pay a retirement income linked to workers’ wages. For decades they were the norm, and Britain’s comparatively high level of pension saving is due almost entirely to the billions still locked away in these schemes.

But they are moving inexorably into the red, increasingly unlikely to be able to pay the retirement incomes promised to members. As it stands, of the total 5,945 schemes more than 4,900 are in deficit. If these pension schemes were required to fund their collective pension promises today, most would fail.

A dwindling number of schemes still allow workers to build up benefits.  In 2010 roughly half of schemes were “open” to further saving.

Today the proportion is nearer one in five, according to the Pensions and Lifetime Savings Association (PLSA – previously known as the National Association of Pension Funds). These schemes would shut at once were higher-rate tax relief to be scrapped, the PLSA said.

Helen Forrest Hall, a final salary specialist at the organization, told Telegraph Money: “It would be virtually impossible to allow new benefits to accrue if tax relief were cut, because would be less going into the scheme – but the same promises would still be required to be met.”

In a PLSA poll of its members it emerged that 86pc of pension schemes said they would stop taking new contributions if the Chancellor changed pension tax relief. Even if these schemes were to close, their problems would not be wholly solved.

“The assumption is that if you stop allowing employees to build further benefits you would be protected,” Ms Forrest Hall said. “In fact other problems would emerge. Pension schemes could face cashflow issues, for example.”

These could arise because most “open” schemes pay current pensioners with some of the contributions from those still in work. If the contributions dried up, the scheme might have to sell assets – shares and other investments – to raise cash.

This could come at inopportune times in the market. Pensions lawyer Martin Jenkins of solicitors Irwin Mitchell LLP is more apocalyptic. “In the past, final salary pensions were without doubt a good thing for all employees from the factory floor to the boardroom. The problem companies faced was how to finance the benefits.

“Now, if tax relief is reduced, the burden switches the other way. Employees will struggle to see whether it is even worth saving into the scheme.”

‘Uncertainty is killing off the best workplace pensions’

Mr Jenkins points out that many final salary pension schemes are far larger than the businesses whose employees they were set up to serve. “In some cases even the shortfalls within the pension funds are larger than the sponsoring employers,” he said. “Even without a loss of higher-rate tax relief, too much is happening too fast. It’s like cars changing lanes at breakneck speed.”

The National Insurance hit

Final salary pension schemes are foundering mainly because pensioners are living longer than expected, and because in recent year’s investment returns have been low.

But the schemes face a raft of other pressures, including fallout from tax changes already introduced. From April 6, for example, pension schemes will lose a tax break worth roughly 3pc.

This is going because “contracting out” – whereby a worker’s company pension scheme took on the responsibility to provide the equivalent to the second state pension – is being abolished. Irwin Mitchell calculates that for every employee earning £40,000, the change will cost an extra £1,162 per year.

Other tax changes have added hugely to schemes’ workload. In July 2015 George Osborne took aim at top earners, limiting the extent to which they could save each year on a sliding scale. The basic annual limit for most taxpayers’ pension contributions is £40,000.

For 45pc taxpayers the annual maximum that can be saved into a pension falls to £10,000 once their income reaches £210,000. In practice, preventing employees from breaching this becomes complex and costly for the schemes.

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