Private sector final salary pensions have been closing their doors to new staff at the fastest rate on record, while experts predict more companies could collapse due to the pressure of increased pension deficits.
However, if you have a final salary scheme from a previous employment this is the best time ever to transfer it into a personal pension - as long as you are happy with the risks entailed. This is because transfer values are 80 per cent higher than they were six years ago.
Britons living longer, red tape and poor investment returns are to blame for the acceleration in the percentage of the UK’s final salary schemes refusing new members, the latest study by the National Association of Pension Funds (NAPF) reveals.
A final salary (also called defined benefit) pension scheme is one that promises to pay out a certain sum each year once you reach retirement age.
This is normally based on the number of years you have paid into the scheme and your salary either when you leave or retire from the scheme (final salary), or an average of your salary while you were a member (career average).
These formerly 'gold-plated’ pensions have long been under pressure from rising longevity, red tape, and poor investment returns. But the NAPF believes the higher liabilities created by quantitative easing and low gilt yields have prompted a barrage of fresh closures.
Meanwhile, Nigel Green' the chief executive of independent financial advisory firm deVere Group, is warning that final salary scheme deficits of FTSE 100 companies are likely to increase by at least a further £20bn, following a decision to retain the current method of calculating the retail prices index (RPI).
Mr Green says: "As at 31 December 2012, FTSE 100 companies had a combined deficit of just over £50bn. An extra £20bn on top of this is very alarming indeed.”
He explains: "The shock decision not to amend the RPI formula has led to expectations for a rise in inflation by up to 0.3 per cent. While the announcement was good news for members of a strong final salary scheme, it piles on the pressure for companies with pension schemes linked to RPI, many of which are already struggling with, and being held back by, ballooning and unsustainable pension commitments.
"Smaller companies could even collapse due to the increased deficits that they are unable to fund."
SIX REASONS TO LEAVE A FINAL SALARY SCHEME
You have other assets to fall back on.
You don't trust your former employer to keep funding the scheme.
You think your former employer is in trouble.
Your pension will not be fully covered by the Pension Protection Fund if your former employer becomes insolvent (the cap at age 65 for 2012-2013 is £34,000 annual income)
You are in bad health and won't likely see an average length pension.
You are happy not to ever buy an annuity and want more flexible benefits.
While this makes grim reading if you are a member of a final salary scheme, low gilt yields are creating an unprecedented opportunity for deferred members (former employees of a company who have retained pension benefits) to transfer out of former final salary schemes into self-invested personal pensions (Sipps).
A Sipp is a type of do-it-yourself personal pension where you pick the investments and take on stock market risk. There are no guarantees for the performance of your investments.
But don't switch from your existing occupational pension scheme into which both you and your employer are currently making contributions. No private pension scheme can match the benefits provided by your employer. A transfer should only be considered if you have left your employer.
The Financial Services Authority is generally against transfers out of final salary schemes. I stress that staying in a final salary scheme makes sense for the majority of deferred pensioners and for people who have small benefits a transfer is probably not suitable.
However, for deferred members with substantial benefits - for example, if you are expecting a final salary pension of £30,000 a year or more - it makes sense to request a transfer value from the scheme and consider your options.
Nearly all final salary schemes allow you to transfer what is known as the Cash Equivalent Transfer Value (CETV), which represents the value in cash terms of your existing benefits. These transfer values are more generous now than they have ever been. Also, the options for withdrawing benefits from the personal pension to which you transfer the value are more flexible than in the past. So there are many circumstances where it can make sense to transfer out.
If you were a member of a final salary or a career average scheme, you are entitled to a preserved pension rather than to a fund of money. In this situation the transfer value is the scheme actuary's assessment of how much needs to be invested now to produce a pension equal to the preserved pension payable at the scheme's normal retirement age. The rate of return used in this calculation is based on the return from equity investments with an allowance for an element of gilt returns.
Transfer values are high because 20-year gilt yields have fallen from 11 per cent in 1990 to less than 3 per cent in 2013. This means for a typical final salary scheme paying 3 per cent a year benefit increases, deferred benefits have gone up by around 20 per cent while transfer values have risen by around 80 per cent over the last six years.
Increase in transfer values:
|Example||Deferred Pension||Typical Transfer Value Offered|
|Benefit in 2006||£50,000 per annum||£1,000,000|
|Benefit at the end of 2012||£59,700 per annum||£1,800,000|
Source: Tideway Investment Partners
This trend may not continue in future. James Baxter, partner at Tideway Investment Partners, says: "Gilt yields are now at rock bottom and many warn of a potential bubble in prices. If gilt yields start to rise, transfer values will fall."
However, this is almost certainly an area in which you should seek independent financial advice. The Financial Services Authority requires companies advising on pension transfers to have a specific permission. The advice must be given, or checked by, a pension transfer specialist who has a specialist qualification.
Taking a transfer is a complex, irreversible and large transaction. Mr Baxter says: "You need to have a conscious review of your biggest financial asset and decide to stay with it for the right reasons."
A useful measure to look at is the critical yield. This is the growth rate that the transfer value would have to achieve if it was reinvested into a Sipp in order to provide the same income promised under a final salary scheme.
A critical yield of 10 per cent demands that your transfer value would need to deliver 10 per cent a year growth in your Sipp in order to match the benefits in the final salary scheme. This would be difficult to achieve and some pension advisers advise a critical yield of 6 per cent is the upper limit for transfers, while others would consider 8 per cent.
While there are obvious downsides of leaving a final salary scheme - for example, taking on the market risk that was formerly with your employer and the removal of your employer’s guarantees - there can be benefits.
Once you have secured £20,000 pension income from a combination of state pension and an annuity bought with your new Sipp, under the new flexible drawdown rules you are free to draw down the rest of the money as you like. Via a Sipp you can also pass on a capital sum to the next generation. Under a final salary scheme the income (and capital) would die with you.
FINAL SALARY FIGURES
Just 13 per cent of final salary pensions were open to new joiners in 2012, a drop of a third from 19 per cent in 2011, and the steepest fall since comparable data began in 2005, when 43 per cent were open. (Source: NAPF)
The NAPF also revealed that these 'defined benefit' pension funds are increasingly closing to the workers who are already in them. The number that shut their doors to existing staff climbed to 31 per cent in 2012, a hike of over a third from 23 per cent in 2011.