'Mega pension' plans anticipated

Radical plans for new "mega" pension schemes with the clout to boost people's chances of getting a better value retirement income are expected to be unveiled in the Queen's Speech tomorrow.

The Dutch-style pooled pensions are not without risk, experts have warned
The Dutch-style pooled pensions are not without risk, experts have warned

The anticipated shake-up would allow workers to pool their money into Dutch-style "collective pensions", shared with thousands of other members, although financial experts cautioned that this type of scheme can also carry drawbacks.

A consultation into collective pensions is already under way and the changes are expected to be introduced as early as 2016.

Pensions Minister Steve Webb has described collective schemes as "some of the best in the world" and recently highlighted claims that they could result in people getting a 30% bigger pension.

While the precise detail of exactly how any such scheme would operate over here is yet to be revealed, in general, collective defined contribution (CDC) schemes are seen as a middle ground between two types of pension scheme which already exist - defined contribution (DC) schemes and defined benefit (DB) schemes.

DB schemes, such as final salary pensions, offer people a guaranteed level of income when they retire, but they are increasingly scarce as employers have found them very expensive to run as people live for longer.

DC schemes have increasingly replaced DB schemes, but they push the burden of risk back onto the employee in terms of the eventual size of pension income they end up with from their individual savings pot.

CDC schemes usually work by employers and workers contributing into one giant pool of assets. The economies of scale involved in managing one huge fund instead of lots of smaller pots can help to boost the eventual size of someone's pension because less money is eaten up by fees.

The pension that is paid out of this type of pot when someone retires is often a proportion of their average salary, with some inflation uplift built in.

But unlike DB schemes, this "target pension" may be adjusted downwards if assumptions about investments do not pan out as expected.

Tony Clare, pensions advisory partner at Deloitte, warned: "Dutch-style pensions offer benefits but it's also important to consider their drawbacks.

"For example, 55 out of 415 Dutch funds actually reduced pensions in payment in 2013 alone.

"Many Dutch pensioners have experienced falling pensions and standards of living as a consequence."

Some experts have also raised concerns that having schemes where people's cash is pooled together instead of held in individual pots could prevent them from taking advantage of new rules which will make it easier for people to use their pension pots like a cashpoint when they reach the age of 55.

But Government sources have disputed these claims, saying that while the Government has been looking to take inspiration from pension schemes in other countries, it has also been considering the lessons learned from their experience.

The new pension flexibility, which was announced in the Budget and is due to come into force next April, will mean that people will have greater freedom to cash in their DC pension pots rather than feeling forced to use them to buy a fixed income for life called an annuity.

The reforms come as the rollout of a scheme to automatically place people into workplace pensions continues. Around 3.3 million workers had been automatically enrolled into pensions by the end of April, according to the latest figures from the Pensions Regulator.

Independent pensions expert Ros Altmann also suggested that another possible downside to having one giant scheme is that older members could end up with a bigger slice of the benefits from it than younger members.

She said this is because pension payments from such schemes rely on actuaries' forecasts about future returns and the life expectancy of members.

If these forecasts turn out to be wrong and scheme benefits are belatedly reduced, older scheme members will have had more than their fair share of the scheme's assets, leaving younger members with a smaller pension than their contributions could have generated on their own.

She also raised concerns that lower earners in the scheme could also end up subsidising wealthier members, as people on lower wages tend to have a shorter lifespan.

Dr Altmann said the Government would be "absolutely right" to legislate to allow CDC schemes, but added: "it is important not to over-hype the potential benefits of such pension arrangements".

Tom McPhail, head of pensions research at financial services firm Hargreaves Lansdown also pointed out that in the Netherlands, the labour market is more "heavily unionised" and employers are more accustomed to working with each other.

Mr Webb told The Sunday Telegraph that the key advantage of such schemes was "pooling risk" of investments performing less well than expected across large numbers of people of different ages, "just like car insurance or the NHS".

"It gives people greater certainty and probably better value," he said.

"There are some quite strong claims made for how much better it is. People say, you will get a 30% bigger pension.

"You might, you might not, but clearly it is pretty unambiguous that you will get a more certain outcome and potentially a better one."