LONDON - A Labour victory in Thursday's general elections might signal a greater emphasis on group pension arrangements.
But U.K. pension experts fear that regardless of which party wins election, pension fund tax benefits might be cut, potentially sounding the death knell for defined benefit plans.
While Tony Blair's Labour Party has maintained a hefty lead in opinion polls over the ruling Conservative Party, British observers are loath to call a winner ahead of the May 1 elections.
Nevertheless, both leading parties have given voters something to think about in terms of the future of pension policy in Britain.
Stakeholder pensions aired
Labour Party officials have focused on extending pension coverage to the half of the working population not now covered by pension plans.
They propose creation of "stakeholder pensions" - a type of industrywide scheme based on partnerships between employers and financial institutions.
These schemes could be sponsored by employer organizations, trade unions or even local chambers of commerce. They would offer economies of scale, with more efficient asset allocations and lower fees than individual pension schemes.
In addition, they would provide greater disclosure to participants on the value of their retirement savings, what level of pension could be anticipated, and the effect of making additional contributions.
The problem with Labour's proposals, some experts contend, is they are noticeably short on detail, and provide little evidence to prove that employers would embrace such schemes or workers would put aside enough money for their retirement.
"You have to look for evidence that Labour has found the key," said Chris Lewin, head of group pensions at Guinness PLC, Edinburgh.
In fact, 80% of employers are wary of Australian-type industrywide schemes, fearing loss of control and greater influence by trade unions, according to a recent survey by the London-based consulting firm Alexander Clay, a unit of the Aon Group.
While Labour Party leaders attempt to bridge the gap for non-covered workers, especially lower-paid ones, reigning Conservative Party officials would rewrite the rules altogether.
In a surprise move last month, Prime Minister John Major proposed scrapping the existing pay-as-you-go state pension system for new workers and replacing it with advance-funded individual pension accounts. While shifting more risk onto individuals' shoulders, the state would guarantee workers receive at least the same benefits as under the existing basic state pension.
Workers older than 20 would receive a rebate of a portion of their national insurance contributions. These rebates would be channeled to government-approved pension providers.
Experts praised the far-sightedness of the proposal, but said it has a number of serious problems.
For one thing, one generation would have to pay twice, paying for their own pensions as well as for current retirees and workers already in the existing state system. That would result in higher taxes over the next 40 years.
But a new study from the Adam Smith Institute, London, said transition costs would be covered by higher investment returns and boosts to economic growth.
Reversal of tax treatment
A more serious threat is that the proposal would be financed partially by reversing the tax treatment of state pensions. Instead of receiving tax deductions on employer and employee pension contributions and paying taxes on benefits, the Tories would cause contributions to be taxable and benefits to be tax-free.
Employers would have to explain why two workers nominally earning the same gross salary received different levels of pay on an after-tax basis, said Richard Malone, director of Croydon-based Sedgwick Noble Lowndes Ltd.'s retirement practice.
What's more, such tax treatment would discourage additional voluntary savings. Mr. Malone questioned why younger workers voluntarily would tie up savings for 35 or 40 years when they could receive the same tax treatment from Personal Equity Plans or Tax Exempt Special Savings Accounts, where their money would be locked in for five years.
Nor would workers feel assured future governments would stick to a promise of not taxing benefits.
Also, the employer contribution would be taxed as a contribution-in-kind, said Sheila Longley, a spokeswoman for the National Association of Pension Funds, London. She termed the taxation change "a very dangerous move."
Paul Greenwood, a research actuary in William M. Mercer Ltd.'s Chichester office, said if the reversed tax structure were applied to employer-provided schemes, it would render defined benefit schemes unworkable.
Once money is taxed, it would be hard to allocate it to other workers; final-pay plans rely on being able to shift unallocated free reserves, he said.
"In the long term, we think the Tories' proposal means the end of final salary defined benefit schemes," Mr. Greenwood said.
Threat of cutting tax benefits
Whichever party is elected, experts worry some of the tax privileges accorded to pension plans will be pared, as governments struggle to generate new revenue without upping income-tax rates.
In particular, a further cutback in the tax credit on dividends would harm pension funds and charities. In 1993, the government reduced the Advance Corporation Tax credit to 20% from 25%, effectively reducing investment income on U.K. equities by 6.25%.
Elimination of ACT would have severe implications for U.K. tax-exempt investors. Gross yield on U.K. equities would plunge to 2.96% from the current 3.7%, Alastair Ross Goobey, chief executive of Hermes Pensions Management, London, recently wrote to the Financial Times.
Because British pension assets are valued on the basis of future income streams, repeal of ACT would cause many pension funds to become marginally funded or underfunded, he said.
"Any government wanting to do that would have to suspend MFR," the U.K.'s newly adopted minimum funding requirement, Mercer's Mr. Greenwood said. Because the funding rules stemmed from the Maxwell scandal, it's unlikely any government - Conservative or Labour - would eliminate ACT, he said.
Observers also are worried that Labour Party officials are contemplating other changes to tax treatment for pension funds. In particular, they fear the party would reduce the tax rate used for deducting pension contributions to the basic rate of 23% from 40%, on the assumption that the higher marginal rate benefits higher-paid employees.
That, in turn, would force a reduction on taxes paid on benefits, Mr. Malone said. "Otherwise, we would be beginning (down) the path of double taxation."
But a Labour Party spokesman said no such changes have been proposed.
Defined benefit plans at risk
Any reductions in tax benefits might drive more employers away from defined benefit plans, experts said. While 86% of employers surveyed in October by Alexander Clay operated final-pay plans, 40% had adopted money purchase schemes. Only 40% of employers had ruled out dropping defined benefit plans.
"The survey shows that any change to tax reliefs is likely to cause major changes to current private pension provision," said Donald Duval, Alexander Clay's director of research, in a release.
While some observers point to the differences between the two leading parties, a paper from the London-based Association of Consulting Actuaries notes the two have shown growing flexibility on the issue of increased funding of state pensions, suggesting a consensus might be reached.
"A stable consensus would mean good news for employers and individuals savings for retirement," said Hunter Devine, the association's chairman.