I often hear people say “I don’t trust pensions” which, irks me somewhat. They say “Well, look at BHS” and “my Granddad lost his whole pension the day before he retired”. I think however people don’t trust them because they don’t necessarily understand them. It is also probably because of the press and headlines such as those above.
Pensions – what you pay in dictates what you get out.
In my post “What is a pension?” (which you can read by clicking here), I spoke about Defined Contribution Pensions. This is where whatever you put in, where your money is invested, the charges and how and when you take the money out dictates what you get back. With these types of pensions, the value can rise and fall in value throughout the term of your investment. If, the day before you come to retire, the stock-market falls or the bottom falls out of property and you were invested heavily in this area, your pension fund will suffer. It isn’t always as clear cut as this in reality. Gone are the days when you have to take your money out of your pension to buy an annuity. Therefore, you may not need to crystallise this loss. Having an on-going relationship with an adviser will help to ensure you are not invested inappropriately to your attitude to investment risk. They will also ensure you draw your pension in retirement in an appropriate manner.
A promise of a pension
Other pensions such as the one provided by BHS are defined benefit schemes or Final Salary Schemes. This is basically where an employer will promise their employees a retirement income based upon their years of service and calculation of their salary. This is usually 1/60 of their final salary for each years’ service. They usually also provide a spouses or dependent pension at 50% of the employee’s.
In a simplified example:
Sue worked for XYZ Company for 10 years, her final salary was £30,000 and the scheme pays a pension of 1/60th of this amount for each year she worked.
Her promised pension is therefore £30,000/60 x 10 = £5,000 retirement income.
If Sue lived for 20 years and her spouse for a further 20 years, it would cost the pension scheme £150,000 to provide their pension income. In reality, the annual pension income will increase on an inflationary basis dictated by the scheme so it could be substantially more than this.
Difficulties with promising a pension
With life expectancies increasing and no way to predict how long scheme members and their spouses will live for, it is impossible to predict how much money will be required to pay the promised pensions. The scheme’s liabilities will continue until the last member or the last member’s spouse dies.
The money (assets) held within the scheme also has to be invested and therefore, like a DC scheme, the value of the money can rise and fall in value. The Trustees of the scheme have a balancing act around getting the best return for the least amount of risk. They cannot predict what their assets will be worth in the future.
They therefore have a very difficult task balancing the assets and liabilities of the scheme.
It is hardly surprising that at the end 2016, the vast majority of pension schemes were in deficit. In 2016, the deficit across the FTSE 100 companies was £25bn (FT Adviser https://www.ftadviser.com/pensions/2017/06/15/ftse-100-companies-pension-deficits-worsen/)
Companies have taken steps to reduce their deficits by changing the future build-up of monies. Such as:
- Changing from final salary to Career average earnings average earnings,
- Amending the multiple of salary from 60 to 80,
- Making lump sum contributions,
- Asking employees to increase their contributions,
- Closing schemes to new members and
- Eventually closing the scheme to future build-up of money for existing members.
The number of DB pension schemes open to new entrants in FTSE 100 Companies has reduced from 100 in April 1993 to 1 in October 2012 (LCP Accounting for Pensions 2013).
The pension Protection Fund (PPF)
So, BHS, their pension scheme was in deficit however, it is unlikely that this is what caused them to go into liquidation. The BHS pension scheme members’ benefits are now in the Pension Protection Fund (PPF) which does what it says. It protects people’s pensions so that people won’t lose their whole pension the day before they retire (or at any other time for that matter).
For anyone in retirement (post the scheme retirement age) at the time BHS went bust, they will receive 100% of their pension with inflationary increases capped at 2.5%. For anyone yet to retire, they will receive 90% of their entitlement subject to a cap (currently £37,420.42 for a 65 year old). There would also be caps on how the money increases in payment. So Sue would receive £4,500 under the PPF if the company she had worked for went into liquidation before the scheme normal retirement date.
I’d say this is better than a kick in the teeth given that a lot of these schemes were non-contributory or were relatively low. However, if your pension within the scheme was significantly higher than this, it would hurt. There are usually options around defined benefit pension schemes which I will explore in a later blog. I still think anyone who has a defined benefit pension is very lucky (I don’t – too young) and I love pensions. Although pensions may not be right for everyone, having a plan for retirement is important.
If you would like to plan for your retirement, even if it seems like ages away and even if you don’t trust pensions. Or if you would like to discuss your options with regards to an existing pension arrangement, do get in touch.
The information contained within this document is correct as at 2017/18 tax year and is based on current government legislation. This can change.
The value of investments and the income from them can fall as well as rise. You may not get back the full amount you invested.