A new report from the Pensions Institute suggests up to 1,000 defined benefit pension schemes (final salary schemes) are in deficit and at ‘serious’ risk of falling into the Pension Protection Fund (PPF). Is your defined benefit pension scheme in deficit? If the worst happens and your scheme falls into the PPF what can you expect to receive?
The Pensions Institute calculates approximately 600 defined benefit pension schemes ‘will never pay full pensions’, while 400 are at risk of company collapse meaning those with a defined benefit pension may only expect pension payments from the pension protection fund. For 15% of schemes the situation is already critical as they attempt to manage ‘unmanageable stresses’. The report predicts some businesses will be driven into insolvency by their defined benefit pension deficit while others will actively seek to secure agreement to pay less than full benefits in an effort to survive.
The Pension Protection Fund was set up in 2005 to pay compensation to members of eligible final salary pension (defined benefit) schemes, when an employer becomes insolvent and/or where there are insufficient assets in the pension scheme to cover its commitments. To be a member of the PPF a business must pay an ongoing levy to fund the scheme.
When a pension scheme applies to the PPF an assessment period begins. During the assessment period (which can take up to 2 years) pensions are paid at PPF specified levels (see below). While most businesses running defined benefit schemes are members some are not. You can read more on eligible funds on the pension protection fund website. It is important to note that once a PPF assessment period is entered or a PPF funding scheme is in place it is highly unlikely any defined benefit pension scheme transfers will be allowed.
If already in retirement when the PPF takes over a fund then the position is relatively straightforward as those scheme members already in receipt of benefits will generally receive 100% of the amount they were receiving before the the employer became insolvent. The same applies if early retirement on health grounds can be proven to the satisfaction of the Pension Protection Fund. Payments rise in line with inflation each year (to a maximum of 2.5%) but only for the portion of your pension fund that accrued from working life from 5 April 1997 onwards. Payments relating to pensionable service before this date will not increase.
Members of pension schemes who have not yet retired will receive up to 90% of their entitlement on reaching their normal pension age. The pension entitlement is calculated based on the salary of the pension scheme member at the point the pension fund applied for PPF protection. The level of the pension payment is subject to a cap that currently limits the annual pension payment to a maximum of approximately £36,000 regardless of final salary. This cap is age related and is recalculated each year, it is designed to ensure that those who paid into the pension scheme for longer receive more.
Pension entitlement is capped at approximately £23,000 p.a for a 35 year old, £25,000 p.a for a 45 year old and £29,000 p.a for a 55 year old at the point the pension scheme is taken over by the PPF. These amounts are then subject to the 90% derating factor. For those who have earned high average salaries over their working life or (depending on the scheme rules) are nearing retirement on a high salary these caps can have a significant impact.
As an example assume a 57 year old on a salary of £45,000 p.a expects to be on a similar salary at the point they retire at 65 year old. If the scheme falls under PPF control their maximum annual pension will be somewhat lower than they may expect at approximately £27,500 p.a
The number of schemes at risk may be concerning but what is more shocking is the statistic that 25 of the largest defined benefit schemes in the UK are highly unlikely to pay their member benefits in full. It is therefore worth considering if a scheme is at risk in good time as once a scheme enters PPF alternative routes such as final salary pension transfers can be closed.
Fortunately the Pension protection fund is in place as a backstop if the worst happens but it is important to understand that (unless already retired) entitlements will not be paid in full. For a no obligation initial chat about what your defined benefit (final salary) pension options may be please do not hesitate to get in touch on 0800 043 8341 or Email email@example.com. Or, if you have any questions simply complete the contact box below and we will Email you an answer. We are authorised and regulated by the FCA and have advisers based across the UK.