Members of final-salary pension schemes shouldn’t take them for granted. Many members of such schemes don’t receive the benefits they’ve been promised.
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Members of final-salary pension schemes who are expecting generous payouts in retirement shouldn't take these for granted. Nearly one in three members of final-salary schemes have only a 50% chance of receiving the benefits they've been promised, according to new research from the Pensions and Lifetime Savings Association (PLSA), a trade association for the pensions industry.
All told, around three million members of final-salary schemes in the UK including deferred members who have left money in the plan but moved to another employer are at risk of retiring without all the benefits they expect. That's because the employers backing the schemes will struggle to meet the cost of their pension commitments, either because they're already in financial difficulties or because the funding deficit in their pension schemes is so large.
Savers whose employers aren't able to keep their promises will have access to the Pension Protection Fund (PPF), the industry lifeboat fund. But the PPF only protects in full the funds of pensioners who've already retired. Those yet to do so can only claim 90% of their benefits from the fund and then only up to a cap (£34,650 in this financial year). And future pension increases may not be as generous as your scheme promises.
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Unfortunately, final-salary-scheme failures are likely to become more routine, reckons the PLSA. For this reason, employers may have to be given more freedom to manage the cost of their schemes, or even to walk away from their liabilities. For example, those that meet certain conditions could be allowed to transfer their schemes into a tightly regulated industry "superfund". However, any such reform would be open to criticism that employers were being allowed to renege on promises made to employees. Below, we look at what to do if you're worried about your final-salary pension.
Should I transfer out?
Financial regulators have put a number of obstacles in the way of savers trying to switch benefits out of final-salary pension schemes into their own arrangements. If your fund is worth more than £30,000, you'll have to take independent financial advice before being allowed to move on the grounds that giving up a guarantee rarely make sense. But if you're one of the three million people the PLSA thinks have only a 50% chance of receiving that guaranteed income, that might not be the case.
However, it's still important to tread carefully. Start by looking at the financial position of your scheme the size of the funding deficit it has in relation to the size of the sponsoring employer. Also consider the finances of your employer and its long-term prospects. Even if you think there's a good chance the employer is going to be forced to renege on its promise, taking your money out isn't necessarily the best option. Most people will still be entitled to receive 90% of their pension from the Pension Protection Fund (or 100% if you're already claiming it), subject to the cap on compensation, so you're not losing a guarantee altogether.
By contrast, other types of pension scheme leave you dependent on the uncertainties of investment returns after costs. Can you be sure you'll be able to generate an income that is worth even 90% of what your final-salary scheme has to pay? For this reason, while your instinct may be to cut and run from a final-salary scheme that's in danger, you need to proceed cautiously. Get professional advice on your best options.
Savers still aren't putting enough aside
Record numbers of Britons are now saving towards retirement, but savers may still be complacent about how much they need to generate decent levels of income in retirement. More than 39 million people were members of an occupational pension scheme by the end of 2016, according to data from the Office for National Statistics a 17% increase on 2015. Of these, 13.5 million were paying into a workplace scheme. The increase is accounted for by the continuing roll-out of the auto-enrolment pensions system, under which employers must offer their staff an occupational pension scheme. Those earning more than £10,000 a year must be automatically signed up for the scheme, unless they have explicitly chosen to opt out.
However, the average contribution rate of employees paying into a defined-contribution scheme was just 1% last year, down from 1.5% in 2015. This is the minimum rate currently required from employees, which is then topped up by a minimum 1% from the employer. Significant numbers of people may therefore be building up much smaller pension entitlements than they expect. For example, a 30-year-old earning the UK average salary of £27,000 a year would achieve an annual income in retirement of just £9,734 with such contribution rates, according to research by pensions provider Scottish Widows.
Tax tip of the week
The Treasury is mulling a crackdown on Enterprise Investment Schemes (EIS), likely to be announced in the next Budget on 22 November, reports The Daily Telegraph. At the moment, someone investing in an EIS will get 30% income-tax relief, and can benefit from capital-gains-tax relief. However, the Treasury is "alert to claims that the schemes are being exploited as a means of tax avoidance". To combat this, it's been suggested that the government might cut the tax relief on offer, restrict the companies that qualify for funding, or make investors hold the companies for longer. More than £1.8bn was invested in 5,500 companies last year through the EIS and the related Seed Enterprise Investment Scheme.
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David Prosser is a regular MoneyWeek columnist, writing on small business and entrepreneurship, as well as pensions and other forms of tax-efficient savings and investments. David has been a financial journalist for almost 30 years, specialising initially in personal finance, and then in broader business coverage. He has worked for national newspaper groups including The Financial Times, The Guardian and Observer, Express Newspapers and, most recently, The Independent, where he served for more than three years as business editor.
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