How Safe are Final Salary Pensions?

UNSHURE

I work for a company that has a good final salary pension scheme. However, from April 2006, I will have to pay double contributions if I wish to remain in the scheme. This will increase my net monthly contributions from around £125 per month to £250 per month.

The alternative is to switch to a cash balance scheme that builds up a money pot and eventually is converted into an annuity. I still favour the final salary scheme. It appears less risky than the other scheme and does not incure 'future annuity price risk'.

My main concern is the safety of the future benefits when I retire. I have heard of final salary schemes in which the employees wound up with nothing at the end of their working lives. If I continue to contribute to this scheme, is it possible that this could happen to me? Or are the new Government safeguards and measures for Final Salary schemes robust enough to ensure that all FS scheme members at least get 90% of their entitlements.

Also, do the Government measures take care of situations such as takeovers and company windups?

NAR

1) I would agree with staying in the final salary scheme;

2) The company seems to have been proactive in sorting out potential shortfall by requesting additional contributions. This should ensure there is less chance of the scheme "going bust."

3) If there is a takeover pension schemes is one of the issues that is dealt with. The current takeover of P&O is an example of this, where Delta World have agreed to continue with the final pension scheme and also to put in large sums over the next 5 years.

thirdparty

The Pension Protection Fund will pay 100% level of compensation for pensioners and 90% level of compensation for the remaining members subject to a cap of £25,000.

Milarky

It seems that the 'final-salary' (defined benefit) pension is becoming steadily undermined by secular (long term) trends - such as people living longer after retirement age. This pushes down the annuity rate and means that proportionately more in total needs to be set aside each year. Also assumptions about future in investment returns may need to be lower - requiring another increase in total savings...

The government doesn't actually back or underwrite the scheme it has set up to address company/pension scheme failures, but at least the intention of the PPF is to act as a 'insurer of last resort' and existing schemes are meant to ward off their deficits by progressively increasing contributions. Thus a scheme should not get into trouble suddenly or unexpectedly as has happened in the past. Look to the strength of your company, also, as their continued profitabilty is what funds the pension contributions.

But you raise an interesting question - if there is a DB scheme which continues in existence but members have the option of paying future contributions into a 'money purchase' (defined contribution) alternative, the latter may be at the mercy of the stock market (and everything else) but at least it would stay in the individual's personal account, so would not effectively reduce in value further if the main scheme was taken under the PPF (and benefits therefrom automatically cut by 10%)

What I'm saying here is that there a something like a 'market value adjuster' (see: 'with profits policies') now hanging over all DB scheme benefits which was not quantified before. And compared to this there is no 'MVA' with self-invested or personal pensions

EdInvestor

There are a lot of inflexibilities about occupational DB schemes, affecting things like early retirement, where nothing can be done without trustees' approval.Increasingly it looks like they are going to be inflexible in the future, or drive a very hard bargain on pension reduction to help you out.

If paying into such a scheme for your main pension it may thus be wise to accumulate other assets (equities in ISAs, property, whatever) which can provide a bridging income from an earlier age, just in case you want to - or have to - retire early. Unfortunately this is not always a voluntary decision

Tim_L

I think the writing is on the wall for final salary schemes, as the fashion following Rentokil will be to sort out the deficits by closing them down - this is a very easy option for CEOs and now the logjam has been broken they will follow one after another. I'll certainly stay in mine, and would pay increased contributions, but I don't hold out much hope it will exist in 5 years time.

What annoys me about this is that there seems to be no contractual obligation attached to the schemes and the companies can do pretty much whatever they like whenever they want without any comeback. So I could well end up paying increased contributions, then have the plug pulled anyway.

UNSHURE

Thanks a lot for your help everyone.

I have undertaken quite a lot of research on this issue. I lean towards the Final Salary Scheme because of the 'defined benefits'. This takes a lot of risk out of the investment.

One of the main worries that I have about 'Money Purchase Schemes' is that they are subject to future annuity prices. If I were at retiring age now, I would only be able to get about £4.5K p/a for eack £100Ksaved (given my circumstances). 4.5% of the money pot built up. Ten years ago, I would have been able to get double this. What will the prices be like in 2020? Can they go much lower?

Conversely, the risk of the Final Salary Scheme seems to be the possibility of the fund disapearing altogether due yo unforseen future circumstance. However, as NAR points out, the company that I work for are being proactive in sorting out the potential shortfall. As well as increasing the employee contributions, they are also going to put a substantial amount of money into the scheme to cover any current shortfalls. In addition to this, it is my hope that the government protection, that is being introduced, should also help to lower risk.

I also like the idea of EdInvestor who suggests an additional investment to provide a bridging income should I need to retire early. I am already investing in low risk ISA's. I think that I will also start a Stakeholder Pension to run at the side of the Final Salary scheme.

caveat_emptor

UNSHURE wrote:

Thanks a lot for your help everyone.

I have undertaken quite a lot of research on this issue. I lean towards the Final Salary Scheme because of the 'defined benefits'. This takes a lot of risk out of the investment.
One of the main worries that I have about 'Money Purchase Schemes' is that they are subject to future annuity prices. If I were at retiring age now, I would only be able to get about £4.5K p/a for eack £100Ksaved (given my circumstances).

As things stand at the moment you won't necessarily have to buy an annuity when you retire. You could buy an income drawdown plan where you have control over how it is invested and how much you draw down each year. Also you retain the capital remaining after each drawdown and this can be left to your dependents on death (less tax of course).

Debt_Free_Chick

Just general comments ...

Employers will be expected to continue to fund existing DB liabilities in full. The PPF only steps in where the employer is insolvent. Employers cannot dump their liabilities on the PPF - those that can pay, must pay. The PPF is there for those that can't pay as they are bust.

Where there is a proposed takeover or any other significant change that might affect the employer's ability to pay, then the Trustees of the scheme are expected to get assurance regarding future funding of the existing liabilities. Included in this, they (the Trustees) are expected to get clearance from the Pensions Regulator i.e. get agreement from the Regulator to any conditions imposed by the Trustees.

As for "contractual" entitlements .... very little in the employment contract is guaranteed for ever and a day. All terms can be varied by the employer, though consent from the employee is generally regarded as advisable. In any event, it's unlikely that your employment contract gives you a right to a pension at all. It probably just states the existence of a pension scheme and refers you to the rules of the scheme - those rules will then state that the terms of the scheme can be changed, but not so that they reduce benefits already built up to date.

All in all, DB pension schemes are less risky than they've been in the past - for the employee, at least.

Regards

Pal

I would go much further than DFC: Final Salary pension schemes are now the safest form of investment you can possibly have.

You only pay a relatively small proportion of the actual cost of the benefits you are receiving. Once you have earned a benefit ithey cannot be reduced without your consent (only future benefits can be changed). Your benefits are guaranteed to increase at least in line with inflation up to certain annual limits. Your benefit can increase in line with your salary which may grow faster than inflation. Your employer is required by law to fully fund the benefits they have promised, and if they go bust and cannot pay, there is the Pension Protection fund to fall back on that would cover the vast majority of most people's benefits.

You get all of the above without being required to take any investment or annuity rate risks.

Name another investment with those types of guarantees!

ReportInvestor

Well put, Pal. You can see why defined benefit pension schemes are heading for extinction outside the taxpayer funded state sector and the boardroom.