According to consulting firm JLT the total private sector final salary pension scheme deficit has increased to an all-time high of £390bn. This is a potential issue for those with a deferred final salary pension or in an ongoing scheme.
This deficit increases the risk the terms of some pension schemes will be re-negotiated at some stage or, worst case, fail. In this post we discuss the issues driving the deficit and potential options for those who wish to address the risk their conditions may change or their scheme fails. As will be discussed there has never been a better time to consider one of those options – a pension transfer.
Final salary pension scheme deficit is also a real issue for the public sector. The National Audit Office recently reported the UK government’s public sector pension liability increased to £1,493bn, rising by approximately 30% in 5 years. It is often difficult to grasp the impact of such large numbers but to put it into perspective £1.5bn is roughly four times the total value of UK exports in 2015.
Why The Sudden Increase In Final Salary Pension Scheme Deficit
Final salary pension scheme deficit has actually been an increasing problem for a number of years. The BHS pension scheme failure, the ongoing issues with the British Steel pension fund and the impact of Brexit have all, within just a few months, significantly raised the profile of the issue.
In the public sector, successive governments have distanced themselves from the ticking pension time bomb. Raising the issue and debating the implications is not the type of conversation any political party wants to have with the electorate – it is a career limiting move.
Very low UK interest rates over a number of years and demographic factors including rising life expectancies are two major factors behind the rise in deficits. The level of employer contributions in the past, tax changes and an increasing administrative burden have also had an impact. In the short term Brexit has caused uncertainty, volatility in stock markets and, crucially, driven down the yield on Gilts to record lows.
What The Deficit Means For Those With A Final Salary Pension
It is important to note a final salary scheme deficit does not automatically mean the scheme will not pay out benefits in full or (worst case) fail. For those in the private sector the employer may make up the deficit by increasing contributions but this could impact on business investment in other areas and therefore growth and employment.
Alternatively, interest rates and the yields on Gilts could improve. For those in public sector schemes ultimately the government (and taxpayer) stands behind those schemes but if the burden on the taxpayer and the public purse becomes too great it is probable a political debate will be forced at some point.
If deficits cannot be made up then difficult discussions on changing inflation measures (RPI to CPI), increasing retirement ages, increasing contributions or moving to career average rather than final salary pensions may be forced.The issues surrounding the British Steel Pension Fund have already forced a government consultation process on a number of these potential solutions.
The pension consultation has raised a further potential risk raised by many pension specialists, politicians and legal experts. Should the government seek to change existing pension law (even if they state it is to cover a one-off case) to resolve the British Steel pension issue then it potentially provides a legal loophole that other businesses with a significant pension deficit may wish to exploit.
It is true many employers may stand behind their final salary pension schemes and not exploit any loopholes that may appear but it is clear others will not. There is a long history of some businesses using creative means to reduce their exposure to a pension deficit. The Pensions Institute recently published a report entitled “Milking and Dumping – The devices businesses use to exploit surpluses and shed deficits in their pension schemes” that covers this issue.
In the worst case if a pension fund fails there is the Pension Protection Fund lifeboat (PPF) that currently guarantees to pay existing pensioners in full and those yet to retire 90% of their benefits when they do retire. However, index linking of future payments and a salary cap can have significant implications for both pensioners and those yet to retire. Some question the long-term viability of the PPF (which is financed by a levy on all final salary pension funds) if a significant number of schemes fail.
The Final Salary Pension Transfer Option
Entitlement to a yearly pension from a final salary pension scheme may be swapped for a cash (transfer) sum. This sum must, in the first instance, be invested in a registered personal pension scheme. An individual may then drawdown on the sum invested to fund their lifestyle in retirement. Drawdown may be in the form of lump sums and/or income withdrawals.
There are both advantages and risks involved in a final salary pension transfer that must be considered carefully based on individual circumstances. For pension fund values exceeding £30,000, there is a legal requirement to take Independent Financial Advice but it is a good idea to take appropriate advice before transferring a pension of any value.
A critical input to the decision-making process is the transfer value offered by the pension scheme. As a baseline, many pension schemes have traditionally based the calculation of transfer value on twenty times multiple of the initial annual payment. For example, those entitled to a final salary pension of £25,000 p.a may be offered a transfer value of £500,000.
In an attempt to reduce the final salary pension deficit discussed above some pension schemes are offering up to a forty time multiple of the initial annual payment to transfer out. History shows as Gilt yields fall transfer values tend to increase. This explains why transfer values are currently at an all-time high.
A transfer offers a number of potential advantages including increased control (minimise risk a final salary scheme will deliver reduced benefits or fail), the potential to leave a legacy to beneficiaries and increased flexibility but the key issue to consider is will the transfer value offered when invested deliver (as a minimum) the returns that may be offered by the final salary scheme (if it pays out in full).
Should you wish to discuss if a final salary pension transfer may be an option given your personal circumstances then please do not hesitate to get in touch on 0800 043 8341 or email firstname.lastname@example.org. We specialise in final salary pension transfers, are authorised and regulated by the FCA and operate UK wide. Alternatively, should you have any questions simply complete the contact box below and we will Email you an answer.