The Department of Work and Pensions (DWP) has recently proposed a new breed of pension, which will be known as ‘Defined Ambition’. It is intended to provide a greater amount of certainty for people whose pension income is ultimately influenced by investment performance, as opposed to being a set amount based on their salary.
Currently, pensions can be separated into two main types – Defined Benefits and Defined Contributions. To summarise:
- Defined Benefits pension – income received when you retire is typically based on your salary and length of service in the scheme. For example, a Final Salary pension scheme is commonly based on a percentage of the member’s salary before retirement, multiplied by the number of years they were in the scheme. This provides a known income for the member in retirement, which has become an increasingly valuable benefit in recent years, due to falling annuity rates and volatile stock markets.
The increased costs and unknown liability that this type of scheme has created for employers has led to a number of schemes being closed to new entrants in recent years.
- Defined Contribution pension – this involves you (and/or your employer) paying monthly contributions. These are invested in funds which are designed to grow over the years until you retire, at which time they are converted to produce an income.
Most new pensions, including those used for Workplace Pensions and Personal Pensions, are Defined Contribution type.
The key drawback of the Defined Contribution type pension is that the income that someone will receive at retirement is dependent on investment returns and also on annuity rates that apply at the time, both of these can and do change significantly and can lead to someone receiving a much greater or much smaller income from their pension than they had anticipated when they retire.
This uncertainty, together with historically low annuity rates, have made pensions a less attractive option for many investors, leading to the DWP’s current rethink.
The Pensions Minister, Steve Webb, has for some time been looking at how to make pensions more attractive without placing the burden of providing full guarantees on employers. A decision has been reached and put out for consultation to introduce the Defined Ambition pension. The description set out in the consultation paper is that “A Defined Ambition (pension) scheme would be a scheme under which members are given some form of guarantee in respect of their pension, but not complete certainty of the level of income that they will receive from it in retirement, or when it would be paid.”
The exact detail of what form these guarantees will take is yet to be confirmed, though the consultation period finished in December 2013 and the DWP aims to consult on draft legislation in the next few weeks,
If you would like to discuss your ambition for retirement plans and how the legislation could affect you, please get in touch with us at Platinum.