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Changes in final salary rules
By Rachel Lacey
If you're fortunate enough to have a final salary pension, you may want to think twice before switching jobs should new rules slash the rate at which deferred pensions grow.
At the moment, around two million private sector employees with final salary schemes see their accrued benefits increase in line with the retail price index (RPI), subject to a maximum of 5% a year, when they switch jobs. This ensures their funds aren't eroded by inflation.
But, in order to reduce the costs of these expensive schemes for employers, the Government now wants to halve this benefit and reduce the cap to 2.5%. While this will save employers between £250 million and £400 million a year, according to Government calculations, Standard Life reckons it will cost the average retiree £7,000 in lost income.
With RPI currently at 3.9%, it's easy to see that a 2.5% cap will give savers' funds insufficient protection against the ravages of inflation. In fact, benefits will instantly drop by 1.4% a year.
"Reducing the pre-retirement revaluation rate for these benefits to a maximum of 2.5% will see deferred benefits slashed in real terms, particularly if inflation continues at current levels or higher," said Andy Tully, marketing technical manager at Standard Life. "If someone left their company in their mid-40s, and inflation was 4%, by 65 their benefits will have reduced by 25% in today's money terms." He added: "Inflation would have to fall substantially for people not to lose out."
Younger workers and women to be hit hardest
The move will hit workers that leave work or change jobs after 5 April next year when the legislation is expected to come into force. Experts say younger workers with plenty of time before they retire and women who take time out to raise a family will be the biggest victims.
Unsurprisingly, the move has not been welcomed by the trade unions, with the TUC suggesting that the Government is exploiting the public's lack of pensions knowledge to sneak through punitive legislation. General secretary Brendan Barber said: "Someone somewhere has made a cynical calculation that widespread ignorance of how pensions work will protect the Government against what could be an angry backlash."
Other critics point out that it seems unfair to apply the changes to private sector pensions only and leave the deferred benefits of public sector schemes untouched. Ian Smith, a director at Central Financial Planning in Worcestershire, said this issue is likely to become a growing concern among workers in the private sector. "People are going to start realising how much of their tax bills are going toward subsidising pensions for public sector workers that they cannot afford for themselves."
In spite of these concerns, Tom McPhail, head of pensions research at Hargreaves Lansdown, described the move as a "proportionate measure", given the combined effects of falling investments and increasing longevity on final salary schemes. "Member protection regulations are all well and good, but you do get to the point where they become self-defeating," he said.
But while reducing the inflation-proofing cap will save employers money, McPhail doesn't think it will be enough to make a real difference. "It's going to do little to stem the tide of final salary scheme closures," he said.
The Association of Consulting Actuaries says that despite the financial position of many final salary schemes improving, more closures are on the cards. It estimates that around 80% of all final salary schemes are now closed to new entrants.
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