The collapse of services provider Carillion (CLLN) is the latest in a string of high-profile company blow-ups, including Toys R Us and BHS, that have hit defined-benefit (DB) pension savers. And this comes as the Pension Protection Fund reports that roughly two-thirds of the DB pension schemes in operation in the UK are in deficit.
DB or final-salary pension schemes pay a retirement income calculated as either a percentage of an employee's final-year salary or an average of the income they earned during their employment. DB pensions have become much less common in recent years, with most younger employees likely to be offered defined-contribution (DC) schemes. While less valuable than DB pensions, DC schemes are fully protected in the event that an employer goes bankrupt as the savings in them are the property of members, unlike with a final-salary scheme where assets are owned by the scheme.
When Carillion filed for compulsory liquidation on 15 January its DB pension schemes had a reported deficit of £587m. The Pension Protection Fund is taking over management of Carillion's DB pension schemes, which have 28,000 UK members. Of these, 12,000 are already claiming their pension and they will be fully protected by the Pension Protection Fund. But those who are not yet drawing their pension will only get up to 90 per cent of what their pension was worth, subject to a cap, when they retire. In both cases any inflation-linked income rise will be capped at 2.5 per cent a year.
"This now all too frequent turn of events should be a wake-up call to pension savers," says Nigel Green, chief executive of deVere Group. "Despite rising stock markets and a positive global economic outlook, companies, including some of the biggest brands and household names, are severely struggling to fund their pension funds for a variety of reasons. These include falling gilt yields, which have driven up transfer values. This is good news for those wishing to take money out of DB schemes, but these larger payouts put further pressure on the pension schemes themselves – many of which are already critically underfunded."
Keep tabs on your DB scheme
If you are a member of a DB pension scheme, it is a good idea to regularly review it. This should include looking at the annual report that your DB pension scheme sends you. This is likely to include the scheme's accounts which show how well funded it is, an investment report indicating how its investments have performed, and the number of scheme members and other people who are entitled to its benefits.
If a DB pension scheme is in deficit its trustees have to submit a recovery plan to return it to full funding with the Pensions Regulator, so you can also ask for a copy of this.
"Quite often employees have a sense of whether things are going well or badly for the business they're working for," says Tom McPhail, head of policy at Hargreaves Lansdown. "If it starts laying people off that would be something to pay attention to. If it is a publicly listed company, you can look at public records such as company accounts to get a sense of how the company is doing."
But many pension experts believe DB scheme members are better off seeking independent financial advice if they are worried about how safe their pension is.
Kay Ingram, director of public policy at financial planning firm LEBC, says: "You'd have to be an actuary to understand the liabilities of the scheme and whether it has enough assets to meet them. You've probably got to be a forensic chartered accountant to understand the fortunes of the business, as well as a bit of an economist to predict the prospects of the business. Trying to assess all that is probably beyond most people's capability."
If you are going to seek advice, make sure you choose a reputable firm and check that your financial adviser is authorised by the Financial Conduct Authority (FCA), using the FCA register. You can find qualified independent financial advisers who specialise in pensions at www.unbiased.co.uk.
The Pensions Advisory Service, a body which is part of the Department of Work & Pensions, delivers information and guidance on pensions and has set up a dedicated phoneline for Carillion members unsure about their options on 020 7630 2715.
"Whenever a DB scheme faces difficulties, sharks looking to fleece people out of their hard-earned retirement savings will inevitably circle," says Tom Selby, senior analyst at AJ Bell Youinvest. "These people might contact you through cold calling or via the internet, and often promise outlandish returns on investments if you move your money to them."
The Pensions and Lifetime Savings Association reports that one in six pension holders have been contacted by a company other than their own provider to discuss making changes to or transferring their pension.
Should you stay or should you go?
Despite high-profile company failures like Carillion, if you are a member of a DB scheme you shouldn't panic and before considering transferring out of a DB scheme give it serious thought. If you are thinking of leaving a DB scheme worth more than £30,000 you are required by law to speak to a regulated financial adviser first.
"While it’s understandable that people will be spooked by what looks like some quite bad business practices recently, [a company going bust] is still unusual," says Kate Smith, head of pensions at Aegon. "The majority of companies are not in Carillion's position, they are funding their DB scheme and doing the right thing."
The guaranteed income that DB schemes provide mean that typically you are better off sticking with them rather than transferring out, even if the scheme is in deficit.
"Generally, [DB schemes'] funding position is better than it was a couple of years ago," says Mr McPhail. "Even where a scheme does go bust, there is a well-managed insurance scheme in the form of the Pension Protection Fund to make sure members still get most of what they were promised."
He adds that only one in 20 of the people who contact his company about a DB transfer go ahead with it because most of their DB pensions offer greater benefits than they would get otherwise. And DB schemes do not require any investment management by the scheme member, which could be attractive if you don't want to be making investment decisions into old age.
And although in theory the Pension Protection Fund might come under pressure if several large DB schemes needed to be rescued at present it appears to be in good shape. As of March 2017 it had £28.7bn in invested assets and cash reserves of £6.1bn. The Pensions Protection Fund has a funding ratio – its assets versus its liabilities – of 121 per cent.
But that does not mean there aren't some instances when it might be appropriate to transfer your DB scheme.
"You have to work out how big a loss you face, ie what's being in the Pension Protection Fund scheme going to cost you," explains Andy James, head of retirement planning at Tilney Group. "If you were going to get a pension of £3,500 a year and would lose 10 per cent of that, or £350, from your scheme moving into the Pension Protection Fund, is that enough to take on the investment risk and having to manage your own money? Probably not."
However, Mr James previously had a client whose DB pension scheme was due to pay around £60,000 a year and if the scheme had fallen into the Pension Protection Fund its annual cap would have meant that individual losing almost half their annual income. "As a result he decided to transfer his pension so he could stop worrying about whether the company would survive or not," says Mr James.
It may make sense for you to transfer out of a DB into a DC pension if you are in serious ill health as an enhanced annuity might pay a larger income stream than your DB pension. Or if you have multiple DB schemes or other sources of secure income, you might want the flexibility of a DC pension with some of your savings.
DC schemes are also typically a more a tax-efficient way of passing on assets after death. If you die before age 75 and have not yet touched your DC pension your heirs can inherit it tax-free. If you die after 75 and have started taking benefits your beneficiaries will pay income tax on any income taken from the pot at their marginal rates.
