EDITOR'S LETTERMerryn Somerset Webb
How safe is your pension?
Think your final-salary pension is safe? You might have to think again. A paper from the Pensions Institute suggests that around 1,000 of the 6,000 UK private-sector pension schemes offering defined benefit pensions (the ones that pay you a percentage of your final salary, inflation-linked for life) are “highly unlikely” to be able to pay out all they owe in full. That’s because they have a combined pension deficit of £45bn that they will never be able to make up. The situation is so bad, says the Pensions Institute, that radical measures are needed: they want pension schemes in trouble to be able to restrict members’ benefits even if their pensions are already in payment. Doesn’t sound good, does it?
What’s gone wrong with these schemes? And who should you blame? The answer looks complicated at first glance. First, Gordon Brown removed the pension fund dividend tax credit, which cut the total return to any money the funds had invested. Secondly, companies took holidays from paying into their funds when stockmarkets were booming, and they looked fully funded. That looks stupid now, but probably seemed perfectly justified then. Third, life expectancy has risen much faster than trustees expected – so the schemes have to pay out on average for way longer than they intended. And fourth, in a desperate effort to cut their investment risks, pension funds have dumped equities and poured into bonds, the yield on which has completely collapsed. But the answer isn’t really as complicated as it looks. The last point is the one that matters – the one that is overwhelming these funds. The lower the projected yield is on a fund, the more cash it needs to meet its future obligations.
The lower interest rates go, the bigger pension fund deficits get. And right now interest rates are ludicrously (and clearly damagingly) low. That brings us back to who we might blame. How about the people who set super low interest rates in the first place?
• Read the full editor’s letter here: How safe is your pension?