28th January 2013
The schemes have always been more generous and have seen the employer, not the employee, shoulder the risks of poor stock market returns. The scheme also shoulders the risk of retired members of the scheme living a long time.
Unfortunately just like a Rolls Royce automobile, the pensions have proved very expensive and now may be on the way out.
The latest annual survey from the National Association of Pension Funds shows what could be a terminal decline. In a survey of 1,018 schemes currently in operation, just 13 per cent were open to new joiners in 2012, down from 19 per cent in 2011. Some 31 per cent of schemes are now closed to existing staff while 23 per cent had been closed to existing staff the previous year. The moves have not been popular. Last year, Unilever's decision to close its defined benefit scheme caused several strikes.
Joanne Segars, chief executive of the NAPF, is blaming quantitative easing, at least in part. She said: “The pressures on final-salary pensions have proven too great for many businesses. The growing liabilities fuelled by quantitative easing will have been a factor behind the record hike in closures.”
Effectively because the Bank of England has bought many billions of pounds worth of government gilts, it has put up the price of running defined benefit pension schemes. Schemes buy longer duration bonds which helps them meet their pension liabilities. Those liabililities comprise what the scheme will pay out in pensions and what it calculates it will have to pay out in future payouts.
It is likely that the schemes would have declined anyway because the costs are very high particularly the costs of coping with the fact people are living longer. There have also been some party political blunders. The Labour government was slated for tax changes to dividend paying shares, which meant schemes could no longer claim a tax credit. Even further back, the Conservative government famously allowed supposedly overfunded schemes to take payment holidays on their contributions. Subsequently schemes proved to been anything but overfunded. Many other aspects of regulation have also seen the schemes come under pressure and face extra costs.
This had led to a situation where some schemes have actually threatened the continued solvency of their sponsoring employers. Indeed some firms have gone bust and been unable to meet liabilities. If this happens today, the scheme is taken over by the Pension Protection Fund a collective, goverment organised insurance fund that actually operates like a big scheme itself. The PPF will take over the scheme assets and then pay 90 per cent of promised benefits up to a cap of £30,644.85, though if you have been promised and are expecting more, it will still be upsetting.
Compared with other options, the PPF is still a very good deal when you consider how much you would have to save and invest to achieve a similar payment from a defined contribution pension scheme.
If you are lucky enough to be in a defined benefit scheme, the advice almost always is to stick with it while you can. If you are a new employee and are in the lucky 13 per cent who still can join, it probably makes a lot of sense to do so, even if you are expected to make a reasonably high contribution yourself.
The fact is a defined benefit scheme gives you a huge bang for your buck when you come to retire. The other workplace plans are simply not as good.
Of course, the new system of workplace pensions, also known as auto-enrolment, is certainly better than nothing. It will see employers having to contribute at least three per cent of your salary, if you put in four per cent with one per cent coming from the government.
If you are at a young age contributing this amount for your working life, should see you build a reasonable but certainly not a spectacular pension.
However contributing more than eight per cent is advisable if you want to get anywhere near maintaining the standard of living you had while working and if you are much older and haven't had a company pension before, you will need to set aside a lot more.
Unfortunately the move away from defined benefit has also seen many employers cutting what they contribute to alternative defined contribution pensions.Another threat is that as employers are forced to extend their pension across the workforce (unless individual employees opt out) they may cut further to the government required minimum.
There is a chance that the reforms increase the number of people with a private pension, but cut the average amount being contributed – something the pension industry usually refers to as dumbing down.
Under defined contribution, it is you who carries the risk that your investments will not perform well. If you accumulate a relatively small sum you will probably be better off converting it into an annuity which then pays you an income for life. Unfortunately the price of annuities has also been increasing.
In short, if you are work in the private sector and are in a defined benefit scheme you really should count yourself among the lucky ones.