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Transitioning from defined benefit to defined contribution is a path to be taken by many—and plenty don’t know where to start. Anderson, head of consumer relations at the Pensions Trust, says lessons can be learned from managing defined benefit portfolios—and these could, and should, be passed to new members.
“If an employer has a trust-based DB pension scheme, setting up the mechanics of a DC arrangement might be quite straightforward, as long as the trustee uses its powers appropriately and the employer meets all government requirements. You could cease DB accrual and open up a DC arrangement either within the trust you have already or set up something completely separate. It’s less easy for employers in multi-employer DB schemes. Closing to future DB accrual might lead to a large bill under Debt on Employer regulations. Recognizing that DB pensions were becoming unsustainable for some employers, the Social Housing Pension Scheme, designed exclusively for 550 employers, amended its approach. In 2007 they introduced additional options as the final salary 1/60 was getting expensive. They brought in lower-rate accrual and in 2010 introduced DC.
People join final salary pensions because they just sign up and retire with up to two thirds of their salary. Benefits are formula-based, so they could be forgiven for paying less attention to pension matters. For those with only DC options it’s very different. That’s why employers and trustees have to ask: What do we want for our members? What do they need? First, we have to get them to join. With auto-enrollment coming to the UK, people have to take steps to leave. The trouble is that members are typically getting lower contributions from employers—although our housing associations are some of the more generous—so we have to engage with them on how much they should be putting away and help them understand the link with that amount and benefits at retirement.
DC funds have made huge investments into the systems that underpin administration. You could arguably administer a DB scheme just using paper as members’ benefits are calculated according to a formula. If the employer pays contributions late or early, it doesn’t affect the benefits. With DC, the size of your fund depends on how much you pay in, when it is invested, and in what. If an employer doesn’t pay the contribution on time and the member misses investment returns, the company is on the hook to make up the difference. There is a requirement for scale in the DC market to share the cost of this investment.
We have to think about investment outcomes. Unlike in DB, DC members choose the assets in which their funds are invested. Some are quite engaged with this—many are not—but it’s important not to offer a bewildering array of choices. Many trustees would be happy for members not to make asset allocation decisions and are pleased to create a strong default option. We surveyed members in one of our employers who chose the default option—the overwhelming majority said they weren’t comfortable making investment decisions and were happy to leave it to the trustee. The employer bears any additional cost in DB; in DC, it’s the member who takes a hit to their pension. This is why we changed from a traditional lifestyle fund—which often takes a very static approach—to a target-date approach. Members select their expected retirement date and we invest according to that window. In the early years we might invest in more aggressive return-seeking asset classes. We have an investment manager making asset allocation decisions for each of our target-date funds and this can include more alternative and dynamic options than a typical lifestyle investment approach. Members should be given ample help in getting the best annuity. If your provider doesn’t have an annuity service that gets the best for the member based on their fund and their lifestyle, then your members are probably missing out on the full benefit of any excellent investment approach and good contribution history. That would be a shame.”