New definition of 'money purchase' will discourage innovation in pension schemes, expert warns

The Pensions Act 2011 (57-page / 365 KB), which received royal assent last week, restricts the definition of "money purchase benefits" so that stricter protections apply where an attempt is made to guarantee pension benefits beyond the assets invested in the scheme.

However pensions law expert Matthew de Ferrars of Pinsent Masons, the law firm behind Out-Law.com, said that the revised definition stemmed from "an unduly cautious interpretation of European law".

He said that the change would make it more difficult for employers to introduce more innovative schemes, intended to share the investment risk between employers and employees, without taking on board the stricter requirements applicable to defined benefit schemes.

A defined benefit scheme is a scheme that promises a set level of pension once an employee reaches retirement age no matter what happens to the stock market or the value of the pension investment. A money purchase scheme is a type of defined contribution scheme, in which the final value depends on the performance of the scheme member's individual contributions. This means that the scheme member bears the risk of any fall in value of the pension investment.

Defined benefit schemes are subject to stricter requirements than defined contribution schemes, which are intended to ensure there is no difference between the pensions promised to members and the pension fund available. They must undergo regular valuations and make contributions to the Pension Protection Fund (PPF), which pays compensation to scheme members if their employers go insolvent and can no longer meet their pension commitments.

Pensions law expert de Ferrars said the change would prevent employers finding a "third way" between expensive defined benefit schemes and more risky defined contribution schemes.

"It is a real shame that the Government now intends to set in stone a world where only two forms of pension scheme are possible. This stems from an unduly cautious interpretation of what European law requires," he said.

"Fortunately, the new narrower definition should not impose additional restrictions on self-invested personal pension schemes (SIPPs) or small self-administered pension schemes (SSASs). These specialist schemes often provide pensions directly from scheme assets rather than securing them with an insurer under an annuity contract. These schemes are exempt from most of the legislation otherwise applicable to defined benefit schemes."

The Act does however contain a wide provision allowing the Government to exempt certain schemes and forms of benefit from the new definition, de Ferrars said. It is expected to consult on regulations setting out those exemptions in due course.

Amongst other changes, the Act makes some amendments to the new workplace pension reforms which will require employers to start auto-enrolling qualifying workers into a pension scheme which meets minimum requirements from 2012. Employers will be required to automatically enrol 'eligible jobholders' aged between 22 and the state pension age who are earning more than £7,475 a year.

The Act also raises the retirement age for women to match that of men in 2018 before the age rises to 66 for both sexes in 2020.