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Despite increasing slightly over the past few years, contributions
to defined contribution (DC) pension schemes in the UK still fall
short of supporting decent pensions for the majority of people,
warns Tony Pugh, UK head of defined contribution pension services
at human resources consultancy Mercer. His view was based on a
study conducted by Mercer covering 600 DC plans in 18 main industry
sectors, with combined assets of more than £7 billion ($14.3
billion).
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According to Mercer, overall contribution rates to DC schemes are
up from an average of 9.5 percent of salary in 2002 to an average
of 10.4 percent at present. Employers contribute an average of 6.8
percent and employee rates are an average of 3.6 percent. “At the
current rate, most employees will get more pension through state
benefits than their occupational plan, which may come as a surprise
to many,” said Pugh. ”The problem is more acute the higher an
individual’s pay, and the older they are on joining the
plan.”
Of note was that in its 2006 Work & Savings Survey, Mercer
found that 52 percent of individuals believe they will get a
pension of more than 50 percent of their pay on retirement.
However, Mercer’s projections show that at current contribution
rates, the average employee with 30 years’ service is more likely
to get just 20 percent to 30 percent of pay from their company
scheme.
“One way of addressing the inadequacies of the current system is if
employers implement more imaginative approaches to their defined
contribution pension arrangements,” said Pugh. One approach, he
explained, is to use salary sacrifice, an approach that increases
the value of member contributions by about 30 percent.
Salary sacrifice schemes allow employers to pay pension
contributions on behalf of the employee in return for a reduction
in salary. The increase in the value of member contributions
results from lower personal income tax and national insurance
payments. Despite the benefits, only 13 percent of UK employers
offer salary sacrifice schemes, said Pugh.
“Encouraging employees to do more for themselves is essential and,
clearly, good communication and education are vital,” he continued.
“Techniques such as automatic scheme entry requiring member
contributions and encouraging members to divert part of their
future salary increases into the plan can have a significant impact
on adequacy.”
Employers could also give members approaching retirement better
support to shop around for annuities, added Pugh. He stressed that
despite the legal requirement that members can purchase their
pension annuity from any provider, in 22 percent of schemes members
still automatically purchase annuities from their scheme’s own
provider. Doing this results in the risk of not getting the best
deal, as, according to Mercer, annuity rates can vary in the market
by up to 25 percent on any one day.
Another observation from the survey was that, while over 50 percent
of employers provide members with access to financial advice at
retirement, almost one-half of them do not pay towards the cost of
this advice.
Overwhelming choice
Investment choice is another area in need of careful consideration.
“Members are blinded by the plethora of investment choices
available. Providers and plan sponsors need to recognise that the
level of knowledge in this area varies widely between members and,
as a result, so does the inclination to become involved in
investment decisions,” said Pugh.
“Offering a simple core [default] plan to the majority of employees
and allowing those looking for more choice to opt for another
arrangement can be a powerful aid in helping to remove confusion
caused by the wide array of choices. Such a core/satellite approach
is also helpful for scheme trustees as they can then concentrate
their efforts on the needs of the many without complicating the
plan because of the demands of the few.”
