Direct Benefit Pensions - who paid?

davechas

For people who are currently retired on final salary/defined benefits pensions: did they as employees have to contribute towards this during their working lives (eg say 3% deduction from their monthly salary) or did they effectively just get this for free with their employers having to finance the pension schemes?

I appreciate this may vary slightly from employer to employer, but in general what applies to most people?

hugheskevi

did they as employees have to contribute towards this during their working lives

Mostly yes.

Looking back at stats for active members in 2000, about 16% of private sector DB members were in non-contributory schemes. Most paid about 5-7% member contributions.

or did they effectively just get this for free

Even the non-contributory schemes are not giving the pension for 'free' - it is part of the overall remuneration package so although it is free to be in, in a competitive market it will have been at the expense of something else (well, that would be the theory, but as the ex post cost proved to be far higher than the ex ante cost that isn't really true in practice).

their employers having to finance the pension schemes?

Even those with high member contributions in the main didn't come close to meeting the full cost of the benefits. Back in the 1980s and early 1990s employers had to put little or nothing into pensions due to the returns achieved, but from the late 1990s onwards the costs escalated significantly.

So it doesn't really matter whether the scheme was non-contributory or the member put in a bit - either way the employer was putting in 25-30% or so (although they didn't know it at the time, and it wasn't for years later until they discovered they needed to put a lot more in).

Farmer-Giles

For a period around the 1990s there was a break in employee contributions and I think for a short spell, a break in employers contributions.
FTSE 10 company.
Fund is now sadly closed to new employees but tends to be around +100% funded.

hyubh

davechas wrote: »

I appreciate this may vary slightly from employer to employer, but in general what applies to most people?

Well... the LGPS (big public sector DB scheme) was 6% for non-manual workers and 5% for manual workers for eighty years, before moving to a banded scale that averages at 6.5% overall. On the other hand, the civil service scheme was traditionally non-contributory for core benefits, and conversely, the rate for police officers was historically 11% and for most has risen a few percentage points still higher latterly.

In the private sector rates could be lower, e.g. Tesco's (still open) DB scheme has an employee rate of 5% I believe. That said, I wouldn't infer from this anything in particular - the fact a police officer can currently be paying 15.05% doesn't mean he or she is actually getting a worse deal than a Tesco employee paying 5%, since you need to look at the benefit structures too.

Also, with respect to the question in your subject-line ('who paid?') - no one fully, which is why final salary schemes are going the way of the dodo!

davechas

Cheers. Would be interesting to know the proportion in non-contributory DB schemes in say the 70s and 80s. I would have thought that the proportion as at 2000 is likely to have already reflected an element of employer "rejigging" to some pension schemes after the problems witnessed in the late 90s (as you already touched upon).

I sort of take the point that in theory even non-contributory schemes are not for "free" as they are potentially at the expense of other areas of remuneration which employers might have been able to offer instead, but equally I imagine it would have been an easy way for employers to reduce their employment costs by stealthily removing pensions benefits for any new employees they took on - eg by shutting entry to DB schemes for new entrants and instead only offering DC schemes (as we have seen in practice in the private sector throughout the early 2000s). In reality is the employer likely to say "ok so we're taking away the DB scheme for you, but in return we'll give you a 5% salary increase compared to your predecessors"? Hardly! Surely would they just shut the DB scheme, and not increase salaries - simply pocketing the savings. The new employees would probably be none the wiser, as most likely they would primarily look at the direct salary when considering accepting a job offer rather than comparing the underlying benefits.

In any case, it sounds as if even the contributory DB schemes were fairly "ringfenced" in the past - in that regardless of what the employee contributes, the employer has to make up the pension fund to ensure the employee a guaranteed level of pension income upon retirement. Comparing this to the contributory DC scheme which is the only option for me, it seems I am entirely at the mercy of two volatile market forces - one being the performance of my pension fund in the stock market, and the second being the annuity rates on offer when I come to retire (which all seem to be headed down and down).

I don't even know how much to save per month towards my pension, not because of a lack of technical knowledge (I'm a qualified chartered accountant) but simply because future annuity rates are such a complete unknown. At the moment I have based my calculations on an annuity rate of 4.5% (which is pretty rubbish compared to historic rates as it is) - but say annuity rates fall even further and are actually 3% by the time I come to retire, that's just wiped 1/3 off the retirement income I have budgeted and saved for my entire life!

hugheskevi

Would be interesting to know the proportion in non-contributory DB schemes in say the 70s and 80s.

The only survey I know of from back then was the GAD Occupational Pension Scheme Survey, but only the post 2000 (and a summary of the 1995 survey) are online. The Pension Commission reports from around 2004 may have some information, but I can't immediately recall any historic contribution series in their reports from memory.

I imagine it would have been an easy way for employers to reduce their employment costs by stealthily removing pensions benefits for any new employees they took on - eg by shutting entry to DB schemes for new entrants and instead only offering DC schemes (as we have seen in practice in the private sector throughout the early 2000s).

Sort of, but it can equally be seen as simply re-aligning pensions to what they were intended to cost (as a % of salary). Back in the 1970s and 1980s the cost of DB pensions to the employer were far less than today - probably about what goes into a DC pension typically. As costs rose, schemes were closed and the employer contribution fell back to the sort of levels typical in the past (although they also had to fund the large shortfalls from the past). Employers had more ways to manage costs (eg discretional indexation) so the guarantee was weaker than the guarantees behind today's DB pensions.

In reality is the employer likely to say "ok so we're taking away the DB scheme for you, but in return we'll give you a 5% salary increase compared to your predecessors"? Hardly!

Quite a few employers did that or similar things, a typical transition from DB to DC would be to close to future members but allow existing employees to accrue, then maybe run exercises to induce switching such as a small salary increase, then maybe a stick (higher contributions, or cap the increase in pensionable earnings) eventually followed by closing the scheme entirely.

The new employees would probably be none the wiser, as most likely they would primarily look at the direct salary when considering accepting a job offer rather than comparing the underlying benefits.

Depends on the employee - lower paid staff tend to under-value pensions. For more senior staff employers often want to be in-line with competitor's pensions to assist recruitment.

In any case, it sounds as if even the contributory DB schemes were fairly "ringfenced" in the past - in that regardless of what the employee contributes, the employer has to make up the pension fund to ensure the employee a guaranteed level of pension income upon retirement.

It should be remembered that although in hindsight DB schemes are very good value, there have been many changes along the way and the past isn't as rosy as many remember.

The employer may be taking all the risk, but if the employer went bust and the pension scheme was underfunded it was members who lost out. It wasn't until 2005 that the Pension Protection Fund was set up, and before then the member could (and did) lose the vast majority of their pension even if they were close to pension age as it was pensioner members who were given priority.

Many years ago there was no preserved pension for those who left the scheme before pension age, and for a while only those with 5+ years of service had to get preserved pension, before it was reduced to the current 2 years.

Statutory revaluation and indexation are fairly recent (in pension terms) requirements. Before then, pension schemes often gave discretional indexation based on how the fund was doing, so there may have been no increases for a few years even in times of high inflation.

In the late 1980s personal pensions were in many cases seen as preferable to DB pensions (leading to pension mis-selling).

In more recent times, the change for RPI to CPI removed a staggering £200 billion from the value of pensions across both public and private sectors. DB pensions are at more risk of policy change than DC.

Personally I'm pleased to have both DB and DC pensions, both have their strenths and weaknesses.

davechas

hugheskevi wrote: »

It should be remembered that although in hindsight DB schemes are very good value, there have been many changes along the way and the past isn't as rosy as many remember.

The employer may be taking all the risk, but if the employer went bust and the pension scheme was underfunded it was members who lost out. It wasn't until 2005 that the Pension Protection Fund was set up, and before then the member could (and did) lose the vast majority of their pension even if they were close to pension age.

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Yeah, that is a fair point. It surprises me how little protection there was in the past if the employer folded.

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davechas

Seems I need to work out how to "quote" properly on this.

atush

you could use the little quote box or just quote the whole post lol.

Anyway, don't think it is a great conspiracy. As the Great cost of DB pensions today has in general been caused due to greater life expectancy. And by greater- I mean that- it has been a huge change.

And that means people used to 'retire' for ten years or less are now retiring for 20-35 years. Due to the increases in medical science and some changing their lifestyle (big change in smoking habits for instance).

So it costs much more than anyone expected. Add in the death in service and spousal pension benefits and what these would cost today on the open market and the question is instead-

Why are there any DB pensions left at all?

kidmugsy

Pensions are part of your pay. "Contributions" towards DB pension are an accounting item, not a reflection of the economic incidence of the pension funding.

Thrugelmir

davechas wrote: »

Would be interesting to know the proportion in non-contributory DB schemes in say the 70s and 80s.

Life expectancy was much shorter back then. A lot of other things have changed in the intervening period as well. So direct comparisons aren't meaningful.