There is so much bad press at the moment
regarding final salary pension schemes
- should I consider transferring my
funds elsewhere?
BHS and Tata Steel are the latest
companies whose pension
funding has come under intense
scrutiny, as the extent of the black
hole in their final salary schemes
(also known as ‘defined benefit’,
or DB schemes) becomes clear.
In 2014, struggling steel-maker
Tata reported a £2 billion deficit
in its scheme: despite subsequent
investment, it is still underfunded
to the tune of £700 million3. BHS’s
prognosis is also dire; its pension
scheme is £571 million in the red4.
In naming his original pension
deficit rescue plan ‘Project Thor’,
Sir Philip Green, former BHS owner,
may have unwittingly suggested
that only a hammer-wielding
superhero could put things right.
Yet the hammer blow may be felt
by Sir Philip himself if he decides to
pay reparations of more than £100
million to members in an effort to,
as he put it, “sort out” the pension
schemes.
Most DB schemes have become
a luxury that companies simply
cannot afford. A small number
remain open, but the majority
have been closed to new
members for years. They now
exist under the strain of having to
meet their promises to remaining
members; battling against the
headwinds of low interest rates
and rising longevity.
The unfortunate demise of both BHS
and Tata’s UK steel operations throws
a spotlight onto other companies
that continue to operate DB
schemes. The Pension Protection
Fund estimates that there are over
11 million people in funded DB plans
with over £1 trillion in assets and
liabilities. As of May 2016, there were
4,864 schemes in deficit and 1,081
schemes in surplus.5
DB or not DB?
Experts say that the bad publicity
surrounding DB schemes could
motivate members to transfer out,
especially with the greater flexibility
now offered to people with defined
contribution (DC) schemes. But some
warn that transferring out might not
be the right thing to do, even if the
DB scheme is heavily underfunded.
There are a few circumstances
where transferring out might be okay,
but I always start from the position
that it would be a bad idea. Defined
benefit, or final salary, schemes are
still the ‘gold standard’ – they are
arguably more secure and more
generous than DC pensions and pay
an income that increases in line with
inflation.
All DB plans pay a levy to the
Pension Protection Fund (PPF), the
state-backed safety net, which
pays compensation to members
of eligible schemes if a DB scheme
cannot meet its obligations. If
there are insufficient assets to pay
members, the PPF normally takes
over and pays 100% compensation
to members who have already
reached their scheme’s normal
retirement age. For those who are
yet to reach this age, it offers up
to 90% compensation (capped
at £33,678.38 p.a. for someone at
age 65) to members on reaching
the normal pension age of their
scheme.
If a DB scheme goes into the
PPF, the compensation could still
represent more income than an
annuity purchased with the lump
sum received from transferring out
of the scheme.
Take somebody in a DB scheme
with £8,000 a year guaranteed
income, that scheme might have a
transfer value of around £100,000,
which at age 60 may only get you
an annuity of £3,000 or £4,000 a year
on the open market.
Even if the PPF had to step in, it
would be hard to replicate the
advantages of a DB scheme.
While it is clear that many of the
laws surrounding DB pension
schemes are outdated, members
shouldn’t rush to transfer out, even
if their scheme is in deficit. They
should, however, seek financial
advice on how they might be
able to mitigate the risks that their
scheme could face.
To receive a complimentary guide covering wealth management,
retirement planning or Inheritance Tax planning, please contact Paul
Brady on 0121 355 2473 or email [email protected].
1. www.bbc.co.uk 19 May 2016
2. Legal Services Consumer Panel, Legal Tracker Survey 2015 - data tables for general public sample November 2015
3. British Steel Pension Scheme: Public consultation, Department for Work and Pensions, 26 May 2016
4. Work and Pensions Committee & Business Innovation and Skills Committee Oral evidence: Pension Protection Fund and Pensions Regulator HC 55, 8 June 2016
5. PPF 7800 Index, 16 June 2016
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