Mercer has welcomed the principle behind the introduction of a new single tier State pension of £144 per week but has cautioned companies that the change may require a redesign of defined benefit (DB) schemes and a review of defined contribution (DC) schemes. Issuing the white paper removes a large amount of uncertainty for companies faced with changes to the UK’s pension system, says the consultancy. However, some employers with DB schemes will need to take steps to minimise the cost of the changes that will arise following the removal of contracting-out.
The new state pension will be introduced from 6 April 2017 and will apply to new pensioners reaching State Pension Age on or after this date. The new benefit will replace the current Basic State Pension and Second State Pension, and should reduce the proportion of pensioners eligible for the means-tested Pension Credit. However, from April 2017 DB schemes will no longer be able to contract-out of the State Second Pension. Historically, companies and their employees who were members of a pension scheme and contracted-out of the State Second Pension, could pay reduced National Insurance (NI) contributions. Now, both members and the contributing employer will see an increase in this cost.
According to Glyn Bradley, Actuary at Mercer, “Our 2012 Melbourne Mercer Global Pensions Index stated that the health of Britain’s pension system could be improved by raising the minimum pension for low-income pensioners and by increasing the coverage for employees in occupational pension schemes. The Government’s proposals, together with auto-enrolment, should achieve this.”
“From the perspective of individuals, when Winston Churchill debated the amount of the original Old Age Pension over a hundred years ago, he said, 'It is not much, unless you have not got it.' Knowing that someone who has paid, or been credited with, 35 years of National Insurance contributions will have a minimum of £7,500 a year to retire on – which should be free from means-testing - should make it easier to plan for additional saving over a working life.
Mr Bradley added, “However, it is very uncertain by how much life expectancy will increase over the next few decades, so the longer-term trade-off may well be that retirement ages rise further. In addition, the changes will bring challenges and impose costs on contracted-out defined benefit schemes. The main National Insurance rates will rise by 3.4% for these employers and by 1.4% for their employees. And this, at a time when companies are struggling with increased liabilities and low levels of cash-flow.”
According to Mercer, companies that have incorporated aspects of the state system with their own schemes will also need to keep a close eye on the developing legislation. Changes in state benefits can result in unforeseen problems for private sector schemes. Companies with DB schemes open to future accrual should revisit scheme design as a result of these increased costs to ensure that they continue to target appropriate benefit levels at a cost that the company can afford.
Mercer highlighted that in cases where a DC arrangement has contracted-in to the current State Second Pension, any changes will not impact directly on scheme design. However, the consultancy believes that companies should review their schemes to check that, when added to the new State Pension, it is still expected to deliver the intended broad level of benefit at retirement. DC schemes may also need to consider if the changes to the State Pension Age will affect the 'target retirement date' used in retirement illustrations provided to members.
The Pensions Minister also announced that the number of qualifying years required to receive full State pension entitlement will increase to 35 years from the current requirement of 30 years. This remains lower than the 44 years for men and 39 years for women required prior to 2010. The paper sets out details of the formula approach which will be used to increase the State Pension Age in future.
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