How the government's Pension Protection Fund works

published 9 October 2019

Thomas Cook flight crew © Thomas Cook — Defined-benefit scheme members at Thomas Cook will be protected

The Pension Protection Fund deals with defined-benefit schemes when an employer goes bust.

Thousands of Thomas Cook employees facing an uncertain future can take comfort in the knowledge that their pension savings are largely protected. The Pensions Protection Fund (PPF), the government-backed lifeboat fund, exists to ensure members of a defined benefit pension scheme do not suffer financial hardship if the scheme's sponsoring employer goes bust and there aren't enough assets in the fund to pay the pensions promised.

Thomas Cook's defined-benefit scheme has 13,500 members. With the company no longer around to stand behind this guarantee, the PPF is reviewing the scheme's finances.

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Who gets what when

In such cases, the PPF guarantees that scheme members already drawing their pension and over the scheme's official retirement age will continue to receive their benefits in full. In some cases, however, the pension increases they receive each year may not be as generous as their scheme had promised.

The pensions of those yet to reach retirement age are also protected. However, they are only guaranteed to receive 90% of the pension they would otherwise have expected. Payouts are also subject to a cap set as a cash sum related to your age at the time when your employer goes bust. In the current year, someone who was 60 when their employer went under wouldn't be able to receive benefits worth more than 90% of £34,285.

The 90% calculation and the cash cap apply to current employees who are active members of the scheme and to deferred members who used to work at the company. But they also apply to those who took early retirement, but have yet to reach retirement age; their pensions could then be cut.

The PPF also guarantees future pension increases for members, with pay-outs raised in line with inflation each year, but only up to a maximum of 2.5%. Members of schemes whose policies on pension increases were more generous may therefore miss out, especially in years when inflation is higher.

In other words, while the PPF provides a crucial safety net, it doesn't give all scheme members complete protection. Higher earners who had been expecting sizeable pensions worth more than the cap can sometimes be big losers.

Remember, however, that the PPF only steps in where the scheme doesn't have the assets to keep pension promises. Better-funded schemes may still be able to pay benefits out in full without the help of the PPF even after the employer has gone. Indeed, Thomas Cook's defined benefit pension scheme is understood to be in relatively good financial shape. Its trustees are currently in talks with insurers exploring options that could see it avoid the need for PPF support.

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.