Pensions
The true value of a company pension
Gareth Stears, pensions technical consultant at Aries Insight , argues for higher employer contributions
O ccasionally you hear complaints that public sector workers are still in lucrative defined benefit (DB) pension schemes whilst those of us in the private sector have to slum it with inferior defined contribution (DC) funds. The essential difference is that with DB, the benefit is defined (e.g. you’re promised 1/60th of your salary for each year of employment) whilst with DC, the contribution is defined (you’re given 5% of your salary as a contribution to your fund). At a glance, 1/20th of your salary upfront might appear more generous than 1/60th later. But that 5% is a one-off while the 1.67% is paid every year, potentially for decades. How much is a future DB promise worth as a one-off contribution today? The Universities Superannuation Scheme has an employer contribution of 21.1% (for a 1/75th accrual), though that rate is hotly debated. According to research from the Office for National Statistics (ONS), in 2019, 85% of employees in (pre-funded) DB schemes received employer contributions of at least 12%, with 29% receiving over 20%. For the sake of argument, let’s call the average employer DB contribution 15%. In comparison, 80% of employees in occupational DC schemes receive employer contributions of less than 8%. The comparison between employer contributions in the public sector (where DB schemes are common) and private sector (where most provision is DC) shows the divide (see Table 1). Are private sector employees compensated with higher salaries? Separate research (also covering 2019) by the
Table 2
Role A Role B £30,000 £31,000 DB pension 5% DC
ONS found that mean private sector and public sector earnings were almost equal. Furthermore, their earlier research from 2016 compared employees of similar occupation and experience for a more analogous assessment. It did find that private sector pay was higher, but by just 1% – not enough to compensate for the variance in pension contribution. Some seem to want the public sector to end this injustice by closing its DB schemes. I don’t expect the public sector unions would meekly accept this without compensation in other ways. (In 2011, they were promised the last reforms had settled the matter for 25 years!) This is levelling
Salary
Pension
Employee contribution Take home pay
10% 5%
£27,000 £29,450
15–20% 31.8 +20% 34.1
2.2 2.8
private sector employers that kept their DB schemes open). The private sector would be forced to respond, either with increased salaries or (hopefully) with higher pension contributions. This could improve contribution rates without the need for legislation, or it might ‘sugar the pill’ if and when auto- enrolment contribution rates eventually go up. The current 3% minimum employer contribution looks miserly in comparison to what some employers offer. In the very least, it should give people pause for thought about their own contribution rates if their employers offer too little. The issue of under-provision for retirement is often put down to the closure of DB schemes to be replaced with DC. But if more employers started (or resumed) contributing 15% into people’s DC funds, that would go a long way towards addressing the issue. There are other flaws with DC of course: employees taking all the risk, tough decumulation decisions; but cold, hard cash makes up for many sins. This isn’t about bashing employers. They might fairly argue that they never planned to contribute 15–20% of salary, and DB just became too expensive retrospectively. With better information though, the value employees give pensions compared to salary may shift into pension’s favour. Employers have always been better placed than individuals to provide for retirement. If their contributions were a more treasured part of the employment package, they might increase enough to make a dent in our crisis of under-provision for retirement. n
...3% minimum employer contribution looks miserly...
down, when we should be levelling up. The solution is to broadcast the true value of DB pensions. Scheme actuaries could report this figure to The Pensions Regulator for an average to be produced. The Government Actuary’s Department might produce a proxy figure. For supply and demand to work, customers need information. In the employment market, the ‘customers’ are candidates looking for jobs, and the information they need includes the value of pensions. Say you’re deciding between two job offers (see Table 2). You can see how role B might appear like a better deal. If you value role A’s employer contribution at 15% though, the value of that package is around 6% higher. Role B would have to offer circa £32,850 to achieve parity. This knowledge gap could have a dampening effect on private sector employee benefit packages. If people better understood the value of DB pensions, the best and brightest might flock to the public sector (and to those paternalistic
Table 1 – Employer contribution rate
Public sector
Private sector
0%
0.9 1.3 1.1 50.6 2.5 34.4 29.7 8.7 31.8 2.2 34.1 2.8
0–4%
4–10% 10–15% 15–20%
+20%
41
| Professional in Payroll, Pensions and Reward |
Issue 60 | May 2020
Made with FlippingBook - Online magazine maker