More pension changes and how they could affect you

Paul Lewis / 04 June 2014

Less than three months after the Budget promised us more freedom to do what we like with our pension savings, the Government has come up with two more ideas which will make big changes in the pension we pay into at work - and could restrict those freedoms for many employees.

At the moment pensions at work are one of two sorts. One promises a pension related to your earnings - either to your final salary at retirement or to your average pay over the time in the scheme. These are called 'defined benefit' (DB) schemes because the benefit you get at the end is guaranteed.

The other sort of scheme simply saves up the pension contributions paid by you and your employer into a pension pot which you can convert into a pension when you retire. There is no guarantee about what it will be worth. These are called 'defined contribution' or DC schemes as it is what you pay in which is fixed, not what you get out.

Under the plans announced in the Budget people will be free to take out the whole of a DC fund at age 55 or older and spend it as they want.

Find out more about the different types of pension...

Defined ambition schemes

But now the Government wants to introduce two alternative kinds of pension plan. First, instead of a defined benefit scheme, the employer could offer something similar, but without any guarantees, perhaps saying it hoped to pay a pension which was a proportion of your pay, and hoped to raise it each year with inflation. But if investment conditions were bad, or longevity increased more than expected, it wouldn't be able to do all of that.

There would be aspirations, but no guarantees. The government calls this a 'defined ambition' scheme, because what the employer hopes for would be defined, but not guaranteed.

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Collective defined contribution schemes

The second new type of pension would save your money up into a pension pot. But instead of you having the right to convert it into a pension yourself, that would all be done by the scheme you paid into. 

To work well, such a scheme would have to be very big, and take in employees from a wide variety of employers. By using its size it could have very low charges - and by paying out the pension as well it could produce bigger benefits than you could get yourself. At least that's the theory.

Because these schemes pool the contributions and the pensions of hundreds of thousands of people they are called Collective Defined Contribution schemes - or inevitably CDCs.

These new choices are for employers - it will be up to them to decide what pension to offer. The employee will have to accept that choice - or opt out altogether.

Such collective schemes already exist in the Netherlands and in Denmark and are generally seen as some of the best pensions in the world, offering pensioners perhaps 30% better for the same contributions as people get in the UK.

On the other hand, there are reports in the press that some pension experts in Holland think the UK system is better and want to adopt something similar.

Find out more about collective pension schemes...

More flexibility

These two new ideas - which share some common principles - give pension providers more flexibility about the kind of scheme they were allowed to offer.

The drawback for the individual is that both Defined Ambition and Collective Defined Contribution schemes would not allow individuals the freedom to take their money and run. Or if they did they would have to pay a hefty exit penalty.

The Government has already said that people in public sector defined benefit schemes cannot take their money out and it is expected to change the law so that private sector defined benefit schemes can ban such transfers too, or impose penalties.

Although the Government hopes to get the new legal framework in place by April 2015 it will be a lot longer before any actual DA or CDC scheme is offered. 

And by then the new freedom to take out our pension fund and spend it will have become part of everyday expectations. So any new plans which would restrict that freedom may prove hard to sell.

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The opinions expressed are those of the author and are not held by Saga unless specifically stated.

The material is for general information only and does not constitute investment, tax, legal, medical or other form of advice. You should not rely on this information to make (or refrain from making) any decisions. Always obtain independent, professional advice for your own particular situation.