REBA inside track: A week in politics could last a long time in benefits policy
Whatever your views on the delivery and timing of Chancellor of the Exchequer Kwasi Kwarteng’s mini-budget on 23 September, its content and financial markets’ reaction to it reinforces themes that are already a key focus for reward and benefits.
Some of the detail was not a surprise: the reversal of planned increases to national insurance rates and a cancelled rise in corporation tax were both part of Prime Minister Liz Truss’s leadership bid. Others, such as the removal of the top rate of tax – now reversed – were far from expected.
Kwarteng’s stated ambition with the mini-budget is to spark growth from business and in the economy. In response, Paul Johnson, director of the Institute of Fiscal Studies said: “A growth strategy needs to encompass education, skills, competition, tax reform — not just cuts — infrastructure, R&D and much more. Cutting tax rates is easy. Much of the rest is not.”
From that analysis, reward, benefits and HR themes, such as fairness in the workplace, continuous learning, and rethinking benefits strategies to support new skills and talent needs, align neatly with Kwarteng’s headline goal of growth, and with Truss’s interpretation of how to achieve it.
But, in the short term, you could be forgiven for wondering just how effective some of the Chancellor’s decisions might be at achieving his vision. Here are just some of the reward and benefits related themes from the mini-budget:
Financial wellbeing and fairness
Kwarteng’s proposed package of tax cuts drew ire from financial markets because it risks increasing government borrowing to plug the gaps from lower tax revenue. And the unfairness of tax breaks that disproportionately favoured the wealthy over low-paid workers during a cost-of-living crisis hit a distinctly raw nerve with the public.
Many employers are already committed to paying the Living Wage to employees, as well as offering other benefits, such as health and wellbeing products, to more people. There is a growing body of evidence that poor financial wellbeing undermines productivity and therefore business growth. So targeting financial support towards lower-paid workers (possibly from the cuts to corporation tax announced in the mini-budget) will become just as important as supporting high-paid employees with tax planning and investment needs as part of a wider financial wellbeing strategy. The reversal in national insurance increases should also help.
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Retirement planning and the cost of living
Recent figures from HMRC show that over-55s were accessing their DC pension pots in record numbers, even before the mini-budget put further potential pressure on Bank of England base rates and inflation. Between April and June this year, there was a 23% increase in withdrawals from defined contribution (DC) pension pots, compared with the same period last year.
With energy bills, inflation and mortgage rates set to continue to squeeze household bills, more employees may look to access their pension savings as a way of keeping themselves afloat.
While taking money out to help weather the cost-of-living crisis may be a necessity in some cases, it could also trigger the Money Purchase Annual Allowance (MPAA), giving employees less opportunity to rebuild their pot for the future.
Kwarteng also announced a reduction in the basic rate of income tax from 20% to 19% from April 2023 (assuming the policy is still in place by then). That will also mean tax relief on pensions falls from 20% to 19% when that comes into effect.
Defined benefit schemes: caught up in market turmoil
No-one expects to see DB pensions on the front page of tabloid newspapers, but the aftermath of the mini-budget relegated celebrities and royalty to the inside pages. Schemes’ Liability Driven Investment (LDI) strategies faltered as bond markets erupted, resulting in a £65bn commitment from the Bank of England to buying long-dated government bonds to protect schemes.
LDI strategies give DB trustees confidence in their ability to pay pensions over the long term, by matching their investments to their future payment needs (liabilities). The strategy typically uses long-dated government bonds and also derivatives, such as interest rate swaps, to achieve this.
The shocks following the mini-budget resulted in such radical changes to bond yields that pension schemes were forced to sell other assets or approach sponsoring employers for emergency contributions to meet margin calls on some derivatives used within their LDI strategies. The effect is analogous to having negative equity on a house, then suddenly being required to find the difference between the current cost of the house and what you paid for it.
But while the days immediately after the mini-budget have been hugely challenging for many trustees, pension funds are ultimately long-term investors. LDI strategies are likely to stay, although schemes may review the extent of their use in their portfolios, or the amount of money that they hold to meet margin calls in future.
And, as is always the case in uncertain markets, there will have been opportunities as well as threats for pension schemes over the last few days and weeks. According to DB scheme funding level trackers, the position of schemes improved during September 2022, moving those aiming for insurance buyout closer to their goal.
Although most DB schemes are closed to new members, older workers may still be depending on DB savings for some or all of their retirement income. The recent high-profile turmoil could be worrying employees with DB funds, so communications from trustees about future stability, once the current crisis is over, will be crucial.
Defined contribution pension scheme charges
At the opposite end of the excitement scale, the government also announced plans to accelerate reforms to the charge cap for default funds in defined contribution (DC) pensions.
Kwarteng proposes to exclude “well-defined performance fees” from within the cap to make it easier for DC schemes to invest in assets such as high-growth privately owned businesses which fall outside the listed assets (equities) and corporate bonds generally favoured by DC pension schemes.
This could offer schemes the ability to diversify their investment portfolios and potentially earn higher returns over time for savers. But there are risks. Scheme trustees will still need to ensure investment decisions are appropriate for the membership and offer value for money, rather than being drawn into supporting government ambitions.
The proposal won’t make much difference in the short term while consultations continue on the changes. Longer term, getting the right balance of risk and return for members, at the right cost and for the right reasons, will be a test of good scheme governance that employers will need to monitor.