6 questions answered about final salary pensions
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You may have seen the recent news about BHS and Tata Steel. It’s a worrying time for those affected; not only are their jobs at risk, but their future security too. As they head towards retirement, they hear the devastating news that their workplace pensions might be uncertain, sending so many plans into a tailspin.
This could also be alarming for anyone else keeping an eye on the news. It’s hard to imagine the panic when you think that your pension is not there for you when you and your family need it, and after so many years of hard work.
What may not be clear from the news, however, is that this isn’t affecting everything.
In this entry, we answer 6 questions to give you a clear overview of what’s happening, and what you can do to protect your financial future.
The news has been warning about pensions being in trouble. Are all of them affected?
No, not at all. It’s certainly easy to think that, though, because the media reports have tended not to fully explain the situation.
The key thing to remember is this: the problems being reported only affect so-called final salary schemes – and not all of them are in trouble.
One of the things the media has spoken about is a ‘deficit’ concerning some of these pensions. What does that mean for you?
Let’s rewind a little bit, and give some context.
There are two main types of workplace pension: a ‘defined contribution’ scheme and a ‘defined benefit’ scheme (often called a ‘final salary’). With a defined contribution pension, you – and probably your employer – pay into the scheme and the money is invested. The money in that scheme is yours, and you can take as much as you want from it once you reach the minimum age.
A final salary scheme is different. Although you still pay into it, you don’t have a sum of money available to you. Instead, your employer promises you a certain income when you retire, for the rest of your life. In a sense, it’s like they are still paying previous employees a salary.
That’s a big, expensive commitment, and it’s these schemes that are in the news.
So what’s the ‘deficit’ that has been reported?
Simply put, when an employer has promised to pay out more money than they have available, there is a gap. That gap is called a deficit.
I’m not sure what type of pension I have. How do I find out?
It’s easy – your employer will be able to tell you if you are in their workplace pension. They can also tell you whether it’s a final salary or defined contribution scheme. Alternatively, you can talk to a financial adviser.
Why is there an issue with some final salary pensions?
Part of it can be blamed on tinkering from politicians over the years, but the main reason is that they’re very expensive. A lot has changed in recent decades, from the amount of people in these schemes to how long people are expected to live. That means the company has to pay a lot of money to a lot of people over a long period of time.
There is also very little flexibility – if a company hits hard times, it can choose to reduce costs, restructure, not to employ more people, or to even fire people to reduce its costs. It can’t avoid the pension payments, though.
I have a final salary scheme – should I be worried?
First of all, not all of them have a deficit. Secondly, a deficit isn’t always a problem. The money isn’t all paid out at once, and some of the issues may be resolved by the time you actually retire. That gives the companies a long time to turn around any shortfalls. (That’s far from certain, though, considering the turmoil that we’re currently seeing.)
Even if your scheme is at risk, the Pension Protection Fund (PPF) is there to support people. If your employer can’t pay what it has promised to pay, the PPF takes the payments on instead. The amount you would then be paid depends on whether you are retired or not, so let’s have a quick look at the rules:
- If you are already retired and started taking the pension income after the scheme’s normal retirement age, the Pension Protection Fund usually pays the full amount you are entitled to. In other words, you won’t experience a drop in income.
- If you retired early, and were under the scheme’s normal retirement age when the PPF got involved, it usually pays an income of 90% of what you were entitled to, up to a certain amount each year (we’ll get to that shortly).
- If you are not retired then in the future you will receive an income that is 90% of your entitlement, again subject to an annual limit.
- Annual limit: To help keep things more affordable, the PPF has introduced a limit to the amount of income an individual can receive each year. From April 1 2016, that limit for a 65-year-old is £37,420.42. If you are younger when you retire the limit may be lower, because you are likely to receive payments for longer.
What if the worst happens and my pension is in deficit?
You might be absolutely fine. Many companies are still able to make the payments even though there’s a deficit, because they have enough money to cover the gap. It does make sense to check though, particularly as bigger gaps are much more difficult to afford.
If yours isn’t in that situation, then the impact on you really depends on your wants and needs for the future. Although the PPF annual limit would cover most expectations, if you were promised an income of £60,000 a year then a drop to less than £40,000 would be disappointing.
The bigger problem, though, is once your scheme enters the PPF, you lose your options.
Because it’s usually not possible to leave a scheme once the PPF has taken responsibility of it, the choices you had before will disappear.
That means you couldn’t use the recent pension freedoms, which allow you to take money from your pension as and when you need it, and even pass on an unspent lump sum after you die.
The question you need to ask is, would you be happy to cut off your choices before you’ve seen what they are?
The good news is even if your retirement date is only a few years away, you still have time to check the situation and make any necessary changes.
With more pension freedom than ever before, you have the ability to find your right blend of security and freedom.
What can I do if my scheme is in deficit?
The first thing to do is talk with a financial adviser, and that’s where we can help. Over 14,000 people trust us with more than £1/2 billion of their savings, and with our no obligation review you can decide if we’re right for you, too. We can:
- See if your pension is on target or in deficit
- Give you a clear recommendation on whether we think you should stay put or switch to a modern private pension instead
- Tell you how much money your current pension would give you if you moved into a private scheme
If you’d like the peace of mind of knowing how your pension is doing and how free it will allow you to be in the future, we’re here to help you.
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