Shortly after coming in to office, Rachel Reeves announced her plan for a major pension reform. The detail has not been completely disclosed to date. More will come to light following consultations, in the lead up to the expected Pension Schemes Bill in 2025. In the meantime, in this article we’ll discuss the details that have been announced so far.
Defined Benefit and Defined Contribution pensions
Defined benefit and defined contribution are two types of pension schemes in the UK. The main difference between them is how the amount you are paid in retirement is calculated.
A defined benefit pension determines the amount you are paid in retirement based on your final salary or career average salary, and how long you have been a member of the scheme. A specific, pre-determined annual income is guaranteed each year for the rest of your life, from the scheme retirement date (usually 65), rather than having a flexible pot value. It generally increases each year to keep pace with inflation, but the amount of escalation is up to the scheme. Defined benefit pensions are more common in public sector employment.
A defined contribution pension scheme is more common in private sector employment. Retirement income from a defined contribution pension is based on the value of your pension pot at the point of retirement. With defined contribution pensions there is no guaranteed level of income. Instead, the value of all pension contributions and how the investment has grown over time are determinants.
What has Rachel Reeves announced to date?
The Chancellor of the Exchequer has announced a plan to boost the UK’s economy through the “biggest pension reforms in decades”. Reeves is looking to “unlock around £80 billion of investment” in the UK, through the creation of pension “mega funds”. Reeves has based her pension reform on the Canadian and Australian pension schemes.
Local Government Pension Schemes (LGPS)
There are currently 86 council defined benefit pension schemes, managing assets of £354 billion for over 6.5 million members. Each of these schemes has associated fees including administration, governance and management costs. The government intend to consolidate these LGPSs .This may be accomplished by merging schemes to make a smaller quantity of funds, each managing a higher value of assets. The intention is that costs would be less and the potential for higher returns is greater. With greater investment potential, these funds will have access to investment opportunities they didn’t before.
Private sector workplace schemes
Reeves is also looking to encourage private sector workplace pension schemes to consolidate in the same way as the LGPS. There are currently around 60 multi-employer workplace pension schemes. The government is looking to consult with these schemes to determine the viability of bringing about pension reform here. Reeves hopes to set a minimum size for multi-employer defined contribution pension schemes to make the schemes more efficient to administer. Higher value investment funds also have the potential for higher returns.
Why is pension reform needed?
The UK pensions market is one of the largest in the world. It is thought that the LGPS and defined contribution pension markets could manage around £1.3 trillion worth of assets by 2030. The concern, however, is that this market is very fragmented, with many smaller schemes. A government spokesperson has stated that the pension reform will not obligate or require schemes to invest in UK businesses and infrastructure. However, by curating reform based on the Canada model, UK infrastructure projects, growth companies and private assets will receive a boost, as will the UK economy. Many pension analysts have acknowledged that investments in larger projects could prove positive for returns. They have highlighted, though, that the smaller projects currently invested in by the schemes should not be forgotten about.
Will the proposed reform impact my pension pot?
If your pension is in a defined benefit scheme, the amount you receive is not linked to the value of your pension pot. Consolidation of schemes and where investments are made will therefore have no impact on retirement funds received. This is not the case with defined contribution schemes. As with any investment, there is the chance its value may go down as well as up. However, the government’s intention is to reduce the associated costs and increase investment opportunities, yielding higher returns.
Many elements of this reform are still under consultation. The details will be finalised over the coming months, with legislation forming the Pension Schemes Bill next year. If you have any questions about how your pension may be impacted, don’t hesitate to contact our team.