The final salary pension scheme: a relic from an earlier era

I recorded some comments for Newsnight yesterday on the general disaster that is UK pension provision.

New stats show that only around 13% of final salary pension schemes are now accepting new entrants (that’s down from 43% only in 2005). Some schemes have even shut to existing workers – that of Rentokil in 2005 being the most well-known example.

It is easy to see why this is happening. The removal of the dividend tax credit (whereby pension funds could claim back a 10% nominal withholding tax) in 1997 and the end of the great bull market of 1980 to 2000 had a fast and unpleasant impact on the value of pension funds and on their income expectations.

This has been aggressively compounded by the UK government’s rock bottom interest rate policy – which has base rates at their lowest since the late 1600s and gilt yields (the rate funds must use to calculate their liabilities) correspondingly low.

But on top of all this there is one other thing: longevity. The fact that we are all living longer is a wonderful thing in most ways, but if you are a pension fund trustee, it is a total nightmare.

Why? Because you’re paying out money to a whole load of people who retired in the early 80s who you thought would be long dead by now. Instead, they’re popping in between rounds of golf to pick up two thirds of their previous salary every month. Inflation adjusted.

It also means that a good many companies are finding that their businesses are at the mercy of the pensions regulator – a CEO told me a few weeks ago that his final salary pension deficit is such that he can make no new investments in the company without thinking of any impact on the pension first. The tail wags the dog.

I’m sorry about the end of the final salary pension (largely because I haven’t got one, and it is too late for me to start a new career as a middle-ranking civil servant). But the truth is that while gilt yields might have sped their demise up a little, they have long been on their way out.

In the private sector at least, final salary pension schemes belong to a paternalistic past – a time when you worked at the same company for your entire working life, and one in which the company had obligations and loyalties to you as you had to them.

We don’t have that any more. Instead, we shift jobs frequently; we freelance; we take on short term contracts; and we run web businesses on the side. So it makes no sense for us to have bits of pension stuck with institutions to which we have no long-term connection. Admin hell.

What’s more, it is impossible to make a case for those institutions to take on the long-term risks of our pensions when we aren’t working for them over the long term. What if I had a final salary pension at MoneyWeek and then left to work at, say, The Economist? Why should MoneyWeek take on the long-term risk of managing me as a liability while I enrich (as of course I would…) a competitor? Nuts, really.

So, while I wish we could all still delegate the financial risk of our futures to our employers, I think we have to accept that it just isn’t possible any more. In an era in which we end up taking more responsibility for our careers, we also, I think, have to take responsibility for our pension arrangements.
PS One point I tried to make on Newsnight was that all this pension disaster stuff is put out by the pensions industry, and it is worth remembering that we aren’t all undersaving. Instead, some of us might actually be oversaving – more on this here.

  • Boris MacDonut

    Demographics Merryn.C’est tout.
    By the way the late 1600’s were the years 1606 to 1609. You mean the 1690’s or the late 17th Century. The Bank of England was founded in 1692.

  • JT

    Boris, if you’re going to be a pedant I suggest you first learn to write correctly.

    ‘1600s’ and ‘1690s’; not ‘1600’s’ and ‘1690’s’.

  • Ellen

    ese students would understand exactly how the government planned to rob them to pay for today’s oldies!

    Kirsty Wark muted the idea that people take total charge in investing their own pension money in equities, property and, did I hear her say, gold?

    But, like the whole panel acknowledged, the pensions crisis has been brewing for decades and everyone just ignored it, passing the buck to future generations. At least it is being discussed now.

  • JT

    Ellen, I agree. And it’s not just ‘younger people’ who find themselves in this position. I’m 43 and, like most of my generation following in the wake of our baby boomer parents, will very likely have to work into my 70s to provide for old age. I say that not as a complaint, incidentally, but simply an observation.

    Successive governments have indeed ignored the problem and none more so than Labour under Blair and Brown who consistently failed to address the issue as it relates to the public sector. Things are now unravelling, as ponzi schemes always do. As one respected financial journalist recently commented:

    “This financial model [for public sector pensions] is so fundamentally unstable that it is illegal in the private sector. No private company or insurer would be allowed to carry on as a series of British governments have done”

  • Boris MacDonut

    #2 JT . Thanks for the grammar lesson. I clearly need it. On the matter of pedantry you win at overrating small details.
    I was going for historical accuracy. Merryn was out by 90 years in 320, an error of 28%. Mine was a misplaced apostrophe.
    #JT. I’m surprised to find someone born in 1969 calling his parents “baby-boomers”. Were your dear old mum and dad under 23 when you were born?

  • Addsj

    I am in a define contribution scheme now. The big issue with them is that you have no say and no idea where your money is invested. I have no idea what the charges are and have to use the scheme the company provides… All the ingredients for a scam. Why can’t the government get to grips with the DC alternative to final salary, give more choice and tempt people away from final salary schemes through proper competitive free market pension choices.

  • NeutronWarp9

    For ‘WE shift jobs frequently; WE freelance; WE take on short term contracts; and WE run web businesses on the side’, read ‘I’ (Merryn).
    For years CEOs have tried to get rid of FSP schemes and (like the government and the state pension and benefits system) the current climate has provided the perfect opportunity – whilst still paying themselves huge, inflation-busting salaries. One day I hope people will say enough is enough and kick off against the arrogance and double-standards we see all around us.
    Yes, I saw Merryn on Newsnight. Talking of earlier eras, is it time for a new photo?

  • Romford Dave

    ‘An etiquette lesson for anonymous internet man’ by Bryony Gordon never found its way onto your reading list then Neutron?

  • Richard Warmington

    I’m sorry to say it, but the biggest threat facing our generation isn’t final salary pensions. It’s not even the wider pensions crisis. It is vastly overpriced housing (particularly for youngsters in London). Oh merryn, why did you break with your principles and buy in Scotland?! Yes, family reasons I know, but aren’t some investment tenets sacred?!

  • Sam Cow

    Final salary schemes relied on leavers and inflation to be viable. I discovered this around 1980 when negotiating the sale of a company with a substantial pension fund and discussing the intricacies with our retained actuary. Fundamentally, anyone who left had their transfer value calculated on an assumed investment yield of say 10% nominal, nil or negative real, and nil future salary increases. On this basis, the employees in the deal were told their pension rights would be preserved, when in fact their FSPs were more or less halved. Rules on transfer values were gradually changed from the early 90s and coupled with current yield levels, have killed the concept.

  • Paul

    Why do we still have employer-provided pensions schemes? The self-employed provide for themselves. Why not everyone? A retirement scheme should not be part of an employment contract. The Government could take a lead by stopping pension schemes for all new civil servant recruits – including the Armed Forces, NHS, MPs etc

  • Boris MacDonut

    #11 Paul.Interesting idea. On my calculations the Government would need to increase civil service salaries by about 23% to be on a par with today’s offer. So we’d come back to the same argument used by those who wish to restrict minimum wage. What the moaners call “knock on effect”. Paying all civil servants 23% more could put serious pressure on other employers t o inflate wages.

  • Critic Al Rick

    @11. Paul, good idea. I take it you meant for civil servants to fund their pensions entirely from present salaries, in which case there would not be the “knock on effect” alluded to by Boris’ alleged moaners.

  • Boris MacDonut

    #13 Rick . Don’t be silly. If he meant fund from current salaries that would envisage a real pay cut of 20%. The knock on effect would be to reduce salaries in the private sectorby a similar amount…….according to your ridiculous analysis. It would be like a 20% deflation and a maasive downturn for the economy.
    Deflation is the big enemy that Mervyn has gallantly fought on our behalf these 5 and a half years,despite you moaners.

  • Critic Al Rick

    Boris, if we don’t allow a suitable deflation rate over the next few years, a relatively soft landing, we’ll get a very rude awakening in the fullness of time.

    The UK, quite simply, is living way beyond its means. One way or another that has to change. Unfortunately, human nature being predominantly what it is, the course of least resistance will be taken and we’ll get the hard landing. And what the likes of the Greeks are presently experiencing will be a walk in the park by comparison.

  • Geoff

    When the general public, (PRIVATE sector), finally realise just how much it’s costing them to keep the government-pampered PUBLIC sector in their lush pensions, there will be riots in the streets. Before any union members try to point out that their ‘members’ do not have lush pensions, may I point out that similar private sector employees have not a hope in Hell of matching even those ‘lowly’ public sector drones. Is it any wonder that most government workers regard their ‘sick entitlements’ as extra holidays.. to be taken or lost!! How many private sectors get sickness pay of six months full pay and the rest at half pay. We are being royally fleeced. .

  • Geoff

    Oh.. and no, I’m not a bloody socialist.

  • Geoff

    Oh.. and no, I am not a socialist.

    (Apparently, BL**DY gets censored) !!

  • Boris MacDonut

    #16 Geoff. Lush is a word to describe succulent grass.
    The reason some public sector workers have decent pensions is that they never got a choice.It was provided for them, the money taken from their salary with no option to keep it. That is the fatal error of many in the private sector,rather than provide for their old age by setting aside 15% of their pay, they chose to keep it and spend it . Have now pay later, like the ads in the furniture shop windows. It is/was open to anyone to opt for a public sector career and your sour grapes are of your own making. You want to deny decent pensions to decent people because you belatedly realised you’ve messed up.

  • MacMillan

    Why is there no requirement for employers and employees to lodge their pension money in a national bank, which then pays the total, plus interest gained, to the pensioner when he wishes to retire? It wouldn’t matter if you are employed by Boots or the Bank of England, provided a minimum sum was contributed, under present beneficial taxation arrangements, and whenever you changed jobs the new employer and beneficiary would agree the sum to be put in the fund. The money is all yours, but you have to wait to get it out. No change for self employed.

  • JT

    sions at the expense of their own, and public sector workers will continue to enjoy certainty of income in retirement until the day they die, paid for by the 80% of the workforce who will never enjoy such certainty.

    For all your emotive rhetoric you are really just motivated by a self-centred desire to preserve your own free lunch.

  • Neil Cleere

    The contributions that public sector workers in no way entitles them for anything like the pensions they draw. Say a policeman pays in 15% of his salary over 35 years on a wage of £30k. That means over a working lifetime he pays in just over £157K. However, they take out £125K as a tax free lump sum leaving £50K to retire on (If it was in the private sector) In normal private pensions if you are retiring at 55 on an indexed pension you would get a 3% annuity or thereabouts. That would equate to £1,500 per annum. Instead they get 75% of £30K (£22.5K) per annum. It simply does not stack up. Clearly public sector workers are not contributing nearly enough for their pension and it has impoverished the private sector workers that pay for it

  • Boris MacDonut

    #22 Neil. In the Civil Service salaries are depressed to reflect the fact that the Employer contributes between 17% and 22%. It is part of the deal. All Civil servants make a conscious decision to forego a bigger salary in return for job security and a decent pension. Now those in the private sector who failed to make sufficient provision seek to rob us because it helps them feel better about their own failures.
    It is effectively cutting public pay drastically and when you pay peanuts you get monkeys.

  • Critic Al Rick

    @23. Boris

    The employer (the taxpayers) of civil servants pay 100% of the latter’s remuneration.

    Well, quite simply, the employer can’t afford to keep all of his staff on or to pay those he does keep in the manner he has done in the past; couldn’t afford to for a long time.

    It is the employer who is being robbed. When you pay too much you get Parasites.

  • JT

    Boris, it is nonesense that private sector workers earn more. The Centre for Economic Performance published a study last year which concluded that, for men, the two sectors start off quite similarly at the age of 21; and although private sector employees develop an income advantage during the middle part of their careers, it is only about £5,000 a year and only until the age of about 50. From 53 onwards, men in the public sector are better off, and this persists throughout their retirement years. Women are better off in the public sector throughout their lives. This despite workers in the private sector working longer hours and retiring later.

    I see you are also choosing to ignore the inequality your pension is imposing on your children and grandchildren. Very magnanimous of you.

  • Chris

    I have a story to tell which neatly sums up this issue.
    I’m a 50 yr old investment banker, well paid six figure salary and bonuses (before taxes) who got a Maths degree then ACA qualification before 25yrs in banking, last 10 as a consultant. I’ve save diligently over the years and have accumulated a respectable pension pot.
    My friend at the local club is also fifty, but he left school at 18 and went into NHS hospital administration (no degree / no medical qualification). He worked hard and progressed modestly through the ranks, then aged 49 he was made redundant and his full DB pension entitlement vested with effect from his 50th birthday. He now gets an index linked pension of £45k p.a for the next 35 yrs or however long he lives.
    My fund certainly can’t generate that kind of money.
    So who is the FAT CAT – private sector banker or public sector administrator !!!!

  • Chris

    No.19 Boris : “You want to deny decent pensions to decent people because you belatedly realised you’ve messed up” … I just want to warn decent people in Public Sector Final Salary Schemes that their largesse is such that they will soon come to realise that this is the biggest Ponzi Scheme ever devised. Bernie Madoff will pale into insignificance besides Blair / Brown for their actions at stoking the scheme

  • Boris MacDonut

    #26 Sorry Chris. Are you saying you deserve to be paid more because you are a banker, because you have a degree or because you are in the private sector? Or is it just a belated realisation you made a poor choice many years ago?
    #25 JT. As annoying as ever. i am not referrring to pay differentials today,but when I made my choices in the mid 1980’s. I had to weather the disdain from the likes of Chris earning his “big bucks” at the bank. As a whole the public sector is a bit better paid ,but that is because it employs doctors ,generals and the like…….even so it doesn’t employ the Carlos Kickaballs or the investment bank trough guzzlers.

  • 4caster

    I have to agree with Boris in this argument.
    As a civil servant from 1961 to 2001 I always knew that some 15-20% of my government department’s staff budget was not paid to the staff, but was diverted into the Principal Civil Service Pension Scheme, which immediately used it to pay the pensions of retired civil servants. Thus it remains today, except that my department (the Met Office) is now a profit-making government-owned trading fund, which earns its revenue in the market place, from customers who are free to switch to a competitor. I do not regard myself as a parasite sponging off taxpayers.

  • 4caster

    I do not recognise the index-linked pension of £45K of an NHS administrator who retired aged 49. He or she must have reached the very upper reaches of the NHS.
    If Chris (#27) had saved 15% of his salary into a good pension fund for 40 years, his pension would now be akin to that of a career public servant. As Merryn will testify (See her book “Love is not the only thing”), money invested is a pension during the first decade of one’s working life yields the biggest reward on retirement.

  • 4caster

    Correction to #30: the penultimate line should read ‘ money invested IN a pension during the first decade of one’s working life yields the biggest reward on retirement.’

  • Paul

    Interesting comments 12-31, most of which would be superfluous if we could break the link between pensions and employment (see 11). The employee pension scheme has no logic in the 21st century – it an outdated concept but one which no government is likely to change. The vested interest momentum is, sadly, just too big. As it is, how we can justify any government employee receiving a pension of more than, say, £25K pa, regardless of final salary, beggars belief. Anyone wanting more should make private arrangements.

  • Nev

    Like 4caster, I do not recognise a £45 K pension as that of a modestly successful public servant.
    This is top of the tree for the public sector, where the average pension is between £3k and £8k per annum.
    I worked in a professional grade for 21 years in public service – my pension is £5k per annum. I then worked in my own business in the private sector for 10 years and accumulated a pot that can pay 10 times that. The work was no harder.
    Everyone should have a decent pension. Robbing public servants of their security will not help other workers.

  • Nev

    Incidentally, we are also fully maintaining two adult children in their own home out of our retirement income.
    Thats intergenerational justice, that is.
    Has no-one noticed that families distribute wealth through the generations. There is no conflict between generations outside of the press. There is love and commitment.

  • JT

    It is laudable that you are able to maintain two children in their own home out of your retirement income. But you are in a very small minority. And your individual circumstances don’t alter the fact the vast majority of young adults will be forced to pay for the public sector pensions of their parents’ generation, at the expense of their own.

    When civil servants complain about contributing more and working longer, they characterise this inter-generational injustice as a “race to the bottom” – a classic piece of socialist spin. They are just as self-interested as anyone else – which is not of itself surprising – but it is certainly hypocritical to pretend otherwise.


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