Final salary pensions 'tilted': Study urges shift into personal schemes

MOST employees in traditional 'final salary' pension schemes could be better off in a defined contribution scheme such as a personal pension, a new book from the Institute for Fiscal Studies suggests.

The book says that final salary schemes - which pay pensions based on earnings immediately before retirement - are tilted in favour of long-serving employees and the higher-paid, typically managers.

'At the most basic level, a majority of plan participants, via their contributions, subsidise a few,' the authors write. 'This privileged minority will exhibit longer tenures and higher salary profiles. They will be better off and male.'

Low-paid women come off particularly badly in a final salary scheme, because they are unlikely to work for their employer for very long.

These problems exist even without the 'deliberate manipulation' of final salary schemes perceived by some critics, with managers awarding themselves large pay rises shortly before retirement in order to qualify for bigger pensions.

The book challenges the common assumption that personal pension plans are more risky than occupational or state pension provision. Frequent legislative changes make the level of state provision extremely uncertain. Members of company pension schemes face the risk of losing their jobs, and have no way of knowing how much their final salary might be.

Millions of workers have taken out personal pension plans since 1988. But life insurance companies have been criticised for over-selling them, particularly to members of occupational pension schemes.

The main advantage employees see in final salary, or defined benefit, schemes is the contribution made by the employer. The IFS analysis argues that the refusal of most employers to pay contributions into their employees' personal pensions represents 'a significant restriction of individual choice'.

The IFS finding on the inferiority of final salary pension schemes is based on an analysis of 3,500 people in or approaching retirement in 1988/9. Assuming the level of employer contribution, the authors found that about 60 per cent of employees would have been better off in a defined contribution scheme, where a set amount is paid in each month or year.

Pensions Policy in the UK: an economic analysis, by Andrew Dilnot, Richard Disney, Paul Johnson and Edward Whitehouse, is published today by the Institute for Fiscal Studies.