Final final salary schemes?

According to research undertaken by the Association of Consulting Actuaries, more than four out of every ten final salary (defined benefit) schemes have been closed to new entrants during the past five years. A further one in twelve have ceased accruing future benefits for existing members, while a similar number have reduced the basis for future accruals.

So many doors are closed

Interestingly, only a quarter of firms with 250 or more employees currently auto-enrol employees to their pension scheme (the level is just one in fourteen of firms employing fewer people).

This is important, because the new National Employment Savings Trusts (NESTs) – that we have until now been told to call Personal Accounts – start to come into effect gradually from October 2012, starting with the largest firms and then moving down to cover all employers.

What are NESTs?
NESTs are a new form of compulsory pension scheme that will require employers to enrol all employees between ages 22 and state retirement age into the scheme, if they earn more than a very modest amount (probably above £100 a week). Employers will have to pay a contribution of 3% if earnings between that and an upper level about six or seven times higher. In addition, employees will have to pay 4% of earnings and the government will add 1% of ‘band’ earnings.

Employees will have the right to opt-out, but will need to do so every three years, or they will be automatically enrolled into the scheme.

Employers have no alternative but to enrol people unless they have a suitable workplace scheme that includes automatic enrolment (with an opt-out) and employer contributions.

Great, so employees are all looked after …
Unfortunately, the new NESTs will be ‘defined contribution’, rather than ‘defined benefit’. The difference is that unlike old defined benefit (or final salary) schemes, where the employee carried virtually no risk at all and employers had to ensure there was sufficient money in the scheme to pay benefits, the new defined contribution schemes place all the investment risk on the employee. (In the event that the employer becomes insolvent while a defined benefit scheme is in deficit, the Pension Protection Fund will provide benefits to cover part or all of any deficit.)

This means that employers can actually afford to be slightly more generous in some cases, because they are not giving an open ended commitment. On the other hand, there is no guarantee that there will be enough money at retirement to fund an acceptable lifestyle.

We all need to pile money into retirement planning

Why have final salary schemes largely disappeared?
The reasons for this change are many – and not directly related to the recent recession. In fact, the rot started to set in many years ago when employers had to increase the level of guarantees they provided in respect of future inflation, as well as showing any pension scheme deficit on their balance sheets. What is more, they were not allowed to create massive surpluses within the scheme as a bulwark against future hard times – which was a real shame, as matters turned out.

What does this all mean?
The upshot of all this is that NESTs are unlikely to be adequate, on their own, to provide a realistic retirement income, because the contribution limits are too low.

Unlike the old days of employer paternalism in respect of pensions, it is now incumbent on each one of us to ensure that we (and our employers) are investing sufficient for our own retirement. This is especially true since Gordon Brown’s infamous £5 billion a year raid on pensions from 1997 onwards, when he removed the ability of pension scheme administrators to recover the 10% tax deducted from all UK dividend payments (or £3.5 billion a year raid, if you prefer the BBC’s version).

It is important always to seek independent financial advice before making any decision regarding your finances. For further information, please contact us. The value of investments is not guaranteed; you may get back less than you put in.

NOTHING CONTAINED IN THE ARTICLE SHOULD BE CONSIDERED AS GIVING INDIVIDUAL FINANCIAL ADVICE. PLEASE NOTE THAT THERE MAY BE VARIATIONS FOR THOSE LIVING IN SCOTLAND AND NORTHERN IRELAND. 

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