There’s quite a buzz around pensions at the moment – and rightly so, as they provide the backbone of our income in our later years. But currently, pension deficits are hitting the news, and figuring them out can still prove difficult.
Pension deficits concern what are commonly known as “final salary pensions” or Defined Benefit schemes. Final salary or defined benefit (DB) schemes are essentially occupational pension schemes that provide a set level of pension at retirement, the amount of which normally depends on your service and earnings at retirement or in the years immediately preceding when you retire. Because your pensionable salary is used as one part of the formula in order to calculate your pension, a final salary scheme is commonly referred to as a ‘salary related’ scheme. Two common examples of ‘final pensionable salary’ would be your last year’s pensionable earnings or an average of your last 3 years’ pensionable salary.
Recently, there have been high-profile failures of these systems, such as the folding of Monarch Airlines – and the collapse of their pension fund. Initially, it appeared that owners could still walk away with a profit (after new hands tried to turn the airline into a more accessible and “Ryanair-like” product) by offloading debts, and this included dropping the pension fund. Ironically, this was once a major credit to the business. The fund, which is now in the Pension Protection Fund (PPF), had been under speculation of being left short when the business first began to struggle back in 2014, after years of asset-stripping.
Should your employer’s or former employer’s business go into liquidation, your pension may be safeguarded by the Pension Protection Fund (PPF). This was set up in 2005 to cover compensation payments to members of eligible schemes.
The rules laid down within individual pension schemes also help to determine what happens in the event of liquidation, but if you have a final salary (defined benefit) pension, you may be covered by the PPF. The PPF pays compensation to members of eligible defined benefit pension schemes when there is a qualifying insolvency event in relation to the employer and where there are insufficient assets in the pension scheme to cover its liabilities.
Many companies with final salary pensions have huge deficits – companies such as Royal Dutch Shell, which has a pension deficit of £6.7 billion. Companies can be vulnerable to these deficits and so can their pension schemes. They are the legacy of expensive “final salary” pensions that were once popular but have now mostly been phased out and replaced with “defined contribution” schemes in the private sector.
Between them, HSBC, Royal Dutch Shell, National Grid, British American Tobacco and Lloyds Banking Group accounted for 34 per cent of all dividends paid out in Britain in the second quarter of this year. Only one of those companies, British American Tobacco, has a pension deficit of less than £10bn.
There are several reasons why Pension Deficits exist. One is the increase in life-expectancy of recipients. For someone reaching retirement age at 65, the life expectancy for a man is now as high as 86, and for a woman it is 89. Final Salary Schemes promised coverage for life in retirement, but those who are living longer cause a requirement for money to be paid out for longer than was originally planned.
Also, for a scheme to buy ‘an income for life’ for a member, they are required to invest in Gilts or Government Bonds. Low interest rates have negatively affected Gilt yields and therefore the pension schemes’ investment performance.
If you have a “final salary scheme” you can request a cash equivalent transfer value in order to secure your pension pot. Final salary pension transfer values are unlikely ever to be this high again, as they have been artificially boosted by the eagerness of scheme owners to offload their members. Moreover, you won’t have to worry anymore about the fund’s continued solvency.
Another thing to note is that transfer values are closely linked to interest rates – as rates go up, transfer values go down. People with money stashed in savings will welcome the interest rate hike to 0.5 per cent, but the move could have different implications for their pension cash.
The Bank of England’s main motive in raising interest rates was to control inflation, which hit a rate of 3 per cent in September and could go higher.
“The Bank of England’s decision to increase the base rate from 0.25 per cent to 0.5 per cent is expected to drive down defined benefit (DB) pension transfers,” Sir Steve Webb warned recently.
“Anyone considering a transfer may wish to take impartial advice on the pros and cons of a transfer “as a matter of urgency, as transfer values are unlikely to remain at high levels.”
Transferring the Cash Value to a new UK SIPP or Overseas Pension enables expats to protect their pension funds in a new scheme. The crystallised funds are then available for flexible drawdown, including taking a lump sum from the age of 55. Unlike “Final Salary” (DB) schemes, unused funds are also available to beneficiaries.
A review of your financial position would be a sensible option in view of the above.