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• Employers that operate both defined benefit (DB) and defined contribution (DC) pensions may find there is a perception of unfairness in the differing benefits received by staff.
• For DB schemes, employers can restrict the amount of an employee’s salary increase that counts as pensionable, or increase member contributions over a staged period.
• For DC pensions, employees can use salary sacrifice contributions, which will help the employer make a bigger contribution to the DC scheme.
Employers should take steps to allay feelings of unfairness between staff in different pension schemes, says Tynan Barton
When an employer has a number of legacy pension schemes in operation, it may need to address the issue of fairness between staff who are on similar reward packages, but are in different types of pension schemes, such as a defined contribution (DC) or defined benefit (DB) plan.
A starting point is to try to bring the cost of the DB arrangement under control, rather than increasing the value of the DC scheme. Maureen Duckworth, pensions technical manager at Scottish Life, says one way of doing this is to stop or restrict future accrual under the DB scheme.
“If [employers] stop future accrual, they could move everybody out of the DB scheme into a DC arrangement,” she says. “They would still have the cost of providing the benefits people have already got, but they would have stopped adding to their commitment to buy those benefits. They could also restrict how much of an employee’s salary increase will count towards pension benefits.”
For example, if an employee gets a salary increase of 5%, only 2% of that would actually count towards their pensionable salary. Over time, this reduces the amount of salary on which the employer will provide defined benefits, thus reducing its costs.
Although more and more DB schemes are closed to new members, the cost of funding these schemes is still rising. One way to mitigate this is to gradually increase members’ contributions, perhaps over a three- or five-year period. The rise could be in increments, perhaps starting at 2%, then going up to 4%, and then 6%, depending on the contribution level needed to keep the scheme open.
Salary sacrifice and DC schemes
Salary sacrifice can also help the employer make a bigger contribution to a DC scheme, while helping to reduce cost. An employee will sacrifice part of their salary in exchange for an employer pension contribution. The employer will save national insurance (NI) and, in most cases, will use the saving to increase contributions into the pension scheme or to meet the financial commitment of keeping the scheme running.
An important consideration when addressing the issue of fairness is that the DB scheme will, typically, be contracted out of the state second pension (S2P) scheme, whereas the DC plan will be contracted in. This means that, for a fair comparison, DC scheme members should look at the sum of the accruing state second pension.
There is also a difference in NI contributions, because if the DB scheme is contracted out, the employee pays a lower contribution. But if the DC scheme is contracted in, they will pay higher NI. Clive Grimley, partner at Barnett Waddingham, says: “You have got to look at this fairness point, both from your pay packet and from the accruing benefits point of view. Education is needed.”
Good communication is vital
Andy Cheseldine, principal at Lane Clark and Peacock, says communication is vital to redress the perception that one employee may be receiving a better benefits package than a colleague. “If [employers] offer people a total reward statement that sets out the different benefits they get, it is possible that if two people receive a package worth £30,000, one might get a pension worth £6,000 and one might get a pension worth £2,000,” he says.
“But what are the other bits of the package? Maybe one gets medical cover and the other does not. Try to pull the whole thing together to say it’s fair because of these other benefits.”
Grimley agrees, saying that a combined statement for people who may have been moved from a DB to a DC scheme, showing the benefits from both arrangements, will help to put a value on the benefit.
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