There has been much written in the media lately about Final Salary or Defined Benefit Pensions. Whilst they have been a bedrock of pension planning for many larger employers over the years, the majority of them are now struggling to meet their long term liabilities, and as the sponsoring employer is responsible for paying all the costs of the scheme many employers are now in serious trouble whilst the huge costs of the pension drain their profitability.
Even schemes that are well funded are reviewing their position, to limit the future responsibility of the sponsoring employer many schemes are looking at selling their assets and liabilities to insurers. If this happens the final salary pension would be guaranteed but you would lose the option of transferring away and the flexibilities this may bring. An October 2016 report by the Pensions and Lifetime Savings Association even goes so far as to say that out of the 6000 live DB schemes nearly 50 %of them have a 50% or worse chance of not meeting their full pension obligations over the coming 15 years. Whilst the Government sponsored Pension Protection Fund (PPF) is available in the background, clearly this is of a massive concern as the Government’s expectations of them needing to provide support are massively lower than the likelihood of it being needed, and the current situation cannot be sustainable.
Final salary schemes can be complex, but in simple terms, they were designed to provide a pension to employees based on a percentage of their final salary at retirement (or when they leave the employer) and the number of years worked. The pension once in payment is ‘guaranteed’ by the scheme and the sponsoring employer for life, together with whatever level of inflation proofing and death benefits the scheme rules permitted.
So what has gone wrong?
This bit isn’t complex. There are three main issues:
- First of all when these schemes were designed life expectancy was much shorter than today. So the guaranteed pensions are being paid for longer.
- Secondly, the Schemes are required to invest in ‘safe long term assets’. In the main Government Gilts and, due to near zero interest, returns from these have drastically reduced to something like a quarter or less of their historic average.
- Thirdly, in the well-intentioned desire to make schemes safer, successive governments have increased scheme funding costs by tighter measurement of their long term liabilities and the extent to which these must be fully funded today.
These factors have driven up the cost of schemes massively, to the extent that there are very few companies left where new employees can join a Final Salary scheme, many are closing to future accrual, limiting future inflation proofing or being wound up completely. Many employers will even be put out of business by the sheer scale of their pension scheme deficits.
What Can I do?
If you are still in employment with accruing benefits, not much. In the vast majority of situations, it would be wise to continue in the Scheme. If you have left service or are approaching retirement, and work in the private sector, you could consider transferring your pension benefits to your own private pension. Whilst this undoubtedly carries some risk as you lose the guaranteed pension, and this is the important bit, transfer values are at an all-time high. If the transfer value is high enough you may, whilst not guaranteeing you income, be able to secure similar benefits with more flexibility, including full access to the fund if needed from age 55 (57 from 2028), owning the pension fund yourself, more tax efficiencies and being able to pass on the fund to your family on death. Transfer values of 30 to 50 times the starting pension are not uncommon, this could mean a final salary pension of £20,000 per annum might have a transfer value of anything up to £1million.
With the funding concerns likely to increase and interest rates at all-time lows now may well be the time to investigate a pension transfer. You must take specialist advice to make sure the risks are reasonable, (transferring Final Salary Benefits is not right for many and no one should consider transferring without taking advice), and this can only be provided by specialist advisers, such as Joseph Lamb, who hold the specific regulatory permissions and who will investigate all aspects before being able to recommend transferring.