There are 2 vehicles
- (1) a DC arrangement (which could be trust or contract); plus
- (2) a Supplementary Trust
The employer decides what level of benefit to target ("the aspirational benefit"). For example, suppose the employer currently provides a 1/60th final salary scheme but wants to change because of concerns over cost and risk. 1/60ths could be retained as the "aspirational benefit" but it is not guaranteed, but instead becomes a DC target level.
At any point in time, a target DC balance (TDC) can be calculated for any member equal to the cost of the "accrued" aspirational benefit. The purpose of the trust is to provide funds to "top-up" the members DC balance, ideally to TDC so in total they provide the aspirational benefit.
The employer commits to pay each year a fixed percentage of profits into the Trust.
A first pass at a suitable rate (x%) would be current smoothed pre tax profit times x%
= (required contribution for aspirational benefits less joint DC percentage contribution rate) times pensionable salary across whole membership.
The calculated x% would then probably be reduced so that only if strong profit growth is achieved would the aspirational benefit be paid.
Every year the trust is valued and the covered percentage calculated as:
100 times trust asset value ÷ (total TDC for all members less total DC balances)
Maximum 100%
For members who leave, die or retire during the year, a payment is made from the trust to their DC account equal to
Covered percentage times (TDC at exit less DC account at exit)
So what is the point of all this?
- - Affordability - the Company exposure is DC plus a percentage of profits so it only makes the extra contributions when it has profits available to do so
- - Contribution levels - basic DC plus profit share
- - Suitability - will work for any employer, but best suited to medium/large Companies
- - Investment - DC investment choice is entirely up to member. Supplementary Trust should be in bonds for stability
Why is this better than pure DC?
- - it shares risk. In years when market is low and/or annuities costly the individual payouts are higher because (TDC less DC balance) is higher
- - it retains the advantages of DC (e.g. investment choice) but the trust provides an element of smoothing
- - provided the percentage of profits chosen is reasonable, members can expect to get close to the "aspirational benefit"
- - from Company perspective cost is stable and DB accounting is not required. Further the intention is to provide a good level of target benefits without guaranteeing them.
To be attractive the trust would need the same tax reliefs as a pension trust. This would require a change in the law to permit a collective DC arrangement to be set up, that is a DC trust in which there are no individual accounts. It would also be necessary to permit transfers to be made from the Supplementary Trust to the DC vehicle.
Keywords: vehicles
