Final-Salary pensions Ė the reality check
I donít know if you know it or not, but this week we reach yet another milestone on the long walk to pension reform that the Government started out on so long ago now.† This time itís final-salary occupational pension schemes that are in the frame.† If youíve been to any of my seminars or conferences over the last four years or so youíll know Iíve been going on about the new scheme information requirements for some time now.† Basically, people who are members of occupational final-salary pension schemes are bit by bit being let in on the many secrets that the ruling pension priesthood have erstwhile kept very much to themselves.† The idea is that things should be more open and people should know the true nature of the valuable benefits they are building up in their employersí schemes.† Ignorance isnít bliss.
Over the last few years I guess people have finally got the hang of the idea that final-salary schemes may not always have been as secure as they may previously have thought them to be.† The newspapers have been full of horror stories of schemes closing without sufficient funds to provide the benefit promises accrued and I doubt there are many in our country today who are not familiar with the new term of Ďpension black holesí.† The Government took a strong line back in 2003 by effectively making it impossible for solvent employers to walk away from their pension promises.† They also eventually put in place the Pension Protection Fund (PPF) to pick up the tab for any underfunded final-salary schemes falling out of employer insolvency.† The PPF is essentially an insurance fund paid for by levies on solvent schemes to help the unfortunate members of companies that hit the wall.
New Regulations also require employers who run final-salary schemes to fund them on a different basis that is intended to make pension black holes a thing of the past within the next decade; the old and failed funding standard, the Minimum Funding Requirement, that was introduced in 1995 in the wake of the Maxwell affair, has been kicked into touch.† Its replacement will mean employers running final-salary schemes will feel the pinch as they are required to top them up to higher levels asap.† That, of course, is part of the reason why employers have sort of gone off the idea of final-salary pension provision all of a sudden, but thatís not what Iím writing about today really.
This Friday, the 22nd of September, is the latest date by when most private-sector final-salary schemes are required by new legislation to send funding statements to their members explaining the funding position of their particular scheme.† For the first time ever final-salary pension scheme members will be let in on what pensions black holes mean to them personally.† The statements will effectively give a snapshot of the funding position at a fixed point in time (now) and as the years go on the members should see the improvements that will be brought about by the new levels of funding that have been imposed on employers.† Thatís all very well, of course, but I guess the initial reaction to finding that your expected pension is only, say, 65% funded on an insurance company buyout discontinuance basis (the position of the average UK scheme today) will be for the knees to give way a bit at the very least; probably accompanied by a bout of bottom-lip trembling too I should say.
This reality check for pension scheme members will obviously come as a bit of a shock to those who have managed to keep their heads in the sand thus far and Iím sure itís something that will come up as advisers speak to their clients about their overall pension position from now on.† The thing is; a decent final-salary pension could for many people today be the largest financial asset that they own.† For someone earning £25,000 a year (around the national average) their prospective pension from a typical final-salary pension scheme offering a 60th of salary for each year of service could be somewhere around the £16,500 mark.† For older employees that could represent a capital value of well over £400,000; much more valuable potentially than the average UK house these days.† For many long-serving employees lucky enough to be in final-salary schemes it is highly likely that their pensions are worth more than their houses.† Worrying then to be told that the money underpinning your pension hopes is a bit on the thin side.
People obviously shouldnít panic if they find out that their pension scheme is not fully funded.† These days they are covered by the PPF if their employer goes into insolvency and thereís little or no chance that their employer could renege on their past-service promises while they remain solvent; but itís human nature to worry about things like this isnít it?† Itís ironic really that just as people are coming to understand the real value of the pension promises their employers have made to them they are also getting an uncomfortable explanation of the moving sands those promises have been built on.
Around ten million people* are estimated to be in line for getting this new funding statement that has to be issued by private sector employers operating final-salary schemes.† About two million of the recipients will be current scheme employees; four million will be people with deferred pension benefits left with old employers; and another four million will be pensioners who are in receipt of monthly pension payouts from private sector schemes.
That last one may come as a surprise to many of you.† Itís never been that unusual for private sector occupational pension schemes to pay out pensions directly from the fund and, believe it or not, they donít need to purchase annuities for their pensioners once they turn seventy-five either.† Thatís something thatís not generally understood, the age seventy-five rule isnít universal.† In fact my father-in-law, Albert, who celebrated his eightieth birthday last year (I wrote about his party on the BeeHive if you remember.† (Actually I wrote about it whether you remember or not I suppose, but you know what I mean) ). Anyway, heís just found out that his pension is in a bit of bother as his former employer has gone into liquidation and the schemeís not well funded and he needs to wait and see if the PPF will bail him out. In the meantime heís lost his annual increases for starters.† The thing is a lot of people who have their pension assets tied up in occupational pension schemes either with their current employer or with a previous employer will all be getting these new statements showing how well funded (or otherwise!) their schemes are.† I think itís something theyíll have more than a passing interest in.† These statements will probably do more for the cause of improving the level of knowledge of pensions in the population than any initiative to get more finance stuff on the school curriculum.† Mind you, whether that knowledge will make people more or less keen on pensions remains to be seenÖ..
20 September 2006
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*Source - IPE.com - 18 September 2006