Government's attempt to save salary-linked pensions could eat into other retirement schemes

A Government attempt to save salary-linked pensions could see private sector workers’ retirement funds eaten away by inflation and the loss of payments to the spouses of deceased policyholders, it was reported last night.

About two million workers are still on final-salary schemes but their retirement income might no longer be legally required to rise with inflation under new proposals. The scheme would not affect pension rights already accrued by staff.

Payments to survivors – widows and widowers – might also be lost and the change could cut the value of a pension by nearly a third over 15 years in retirement, the Daily Telegraph reported.

However, Pensions Minister Steve Webb insisted the changes were designed to encourage firms to offer salary-linked pensions by making them cheaper to provide.

“Final-salary pensions have been in long-term decline and if we do not act they could disappear altogether,” he told the Telegraph.

“Over time, we hope employers will see they can pay salary-related pensions without all the risk, so we could see a renaissance in this space, but these things take time.”

Mr Webb said in a Government consultation paper that the “time is ripe for innovation”, adding that “these are exciting possibilities”. The consultation will close on December 19 and the Government aims to consult on draft legislation in the new year.

Laith Khalaf, head of corporate research at Hargreaves Lansdown, said the proposals could result in some workers having the “rug pulled from under them”.

He said: “Inflation-linking is an important part of final salary pensions, and workers probably don't understand the full value of it.”

Mr Khalaf said that while a £10,000 annual pension adds up to £250,000 over 25 years without inflation increases, it would add up to £320,000 with inflation increases of 2% a year, assuming the Bank of England hits its inflation target, or £351,000 with increases of the current rate of CPI inflation of 2.7%.

The Government has been investigating the scope for creating a new category of pensions called defined ambition (DA) schemes, which would widen choice by encouraging the growth of a “middle ground” between two very different types of pension which currently dominate the market.

Under the current system, people tend to belong either to a defined benefit (DB) scheme, where the employer bears the investment risks of a worker's pension, or a defined contribution (DC) pension, where the employee bears the risk burden.

“Gold-plated“ DB schemes such as final-salary schemes are in long-term decline and have become increasingly expensive to run as people live longer. The percentage of DB schemes that are still open has more than halved since 2007 - from 36% to 14%.

DC schemes are the type of pension people are most likely to be placed in as the Government's reforms to place people into workplace pensions automatically are rolled out.

The Government has recently moved to tackle concerns that some of these schemes have ”rip-off“ charges and it is considering imposing a charge cap.

Up to nine million people will be newly saving into a pension or saving more over the next five years under auto-enrolment.

Under DA schemes, pension saving risks would be more evenly split between firms and employees.

A range of suggestions has been put forward in a consultation paper to tackle the ”market gap“ between the two types of pension, which aim to give employees more certainty about their retirement outcome as well as removing some regulatory burdens for employers.