Defined contribution: Funding DC schemes
In defined contribution schemes members carry the risk of guaranteeing their own benefits in retirement
Since the sponsoring company does not guarantee the benefits of DC schemes the risk is with members. Ensuring members make the right choice is a central responsibility for DC trustees, so they need to understand the options very well themselves.
It is increasingly common for trustees to be responsible for running a mixture of pension schemes. A common situation is a closed defined benefit (DB) scheme, which is still investing, combined with a more recently established defined contribution (DC) arrangement open to new employees.
However, the role of the trustees is very different for each type of scheme.
Some DC schemes will have separate governance boards discrete from DB trustee boards. DC trustees assess the success of the scheme based on the level of take-up and contributions paid across the workforce as well as ensuring members’ funds are performing appropriately. Consequently, DC trustees must understand funding principles for DC schemes, including the principles relating to investment choices and performance measurement. This implies monitoring the performance of the various professional advisers working for the scheme – the accountants, investment managers, lawyers, custodians and consultants.
New contribution requirements
The Government’s auto-enrolment initiative means everyone over a certain age and earning over a certain salary level will pay into a pension. It requires a minimum contribution of 8% of qualifying earnings (although this will be phased in between 2012 and 2017). The employer must pay a minimum of 3%, the employee 4%, with a further 1% paid by the government. Some in the pensions industry have warned employers may ‘level down’ to the minimum legal requirement, since 7% to 8% is currently the average employer contribution and 3.5% to 4% the average employee contribution in a DC scheme.
Further, the pensions industry believes that even now current contribution rates are insufficient to generate pensions of two thirds of salary – the level the public and pensions industry has come to consider a reasonable target. As a rough rule of thumb, an individual needs to invest contributions equal to half of his or her age to reach this level.