How safe is your pension?
If there’s one thing the last year has reminded us of, it’s that life isn’t always predictable. 2016 was certainly a year of surprises, and the first three months of 2017 have been no different. In some walks of life, many of us hope for the best and expect the worst. But, when it comes to our retirement savings, should our attitude really be the same?
The past year’s events have unfortunately heightened fears regarding the ‘security’ of our pensions. With the BHS pensions debacle hitting the headlines, with Tata Steel UK agreeing to cuts in pensions to secure jobs, and ongoing debate about state pensions, you’d be forgiven for thinking your pension might simply not be there when you reach retirement.
But how substantiated is the fear that our pension money isn’t safe? The key point is that not all pensions are created equally, and therefore, are protected in a variety of ways. In fact, in many cases, you may have more security than you realise.
Pensions – how much and where?
Pensions is a big issue in the UK, with around US$2,868 (£2,299 billion in April 2017) invested in various pension funds, according to the Willis Towers Watson Global Pensions Asset Study 2017*. That is a huge number, so to put it in perspective, that’s the equivalent of almost 20 years of NHS funding based upon 2015/16 levels.
Most of this is invested in occupational pension funds with 82% in old style ‘gilt-edged’ final salary or defined benefit (DB) schemes, according to the Willis Towers Watson study.
DB schemes, recently brought to our attention with the collapse of BHS, commonly promise an income for life equal to a known (defined) percentage of an individual’s career average earnings or their last pensionable salary before retirement, or when they left the scheme. They often have annual increases, perhaps linked to inflation and other benefits for spouses and dependents.
However, well before BHS made the headlines, their ‘gilt’ was looking decidedly tarnished. The costs to employers of offering these generous schemes had risen dramatically, calling into question their future. That’s exactly why the government has launched a consultation into how to make them more sustainable – albeit with a possible hit to inflation protection of member benefits.
The remainder of the pension market is held in defined contribution (DC), or money purchase schemes, which produce a fund that at the point of retirement is used to provide income. For these, while the main concern in previous years was the investment return you could expect from your savings, in today’s market, an equally big question for many is, who is protecting your pension?
From a security perspective, the issues are very different between DB and DC. There are also big differences if your scheme is run on a standalone basis or through a regulated pension provider. In the latter case, scheme assets are held separately from the employer so benefits built up to date are unaffected by the collapse of a company.
So, what protections are there?
Long before recent events, the government and regulators have been putting in place measures to protect members of DB schemes.
Since 2005, the Pension Protection Fund (PPF) has provided a safety net for final salary pension members whose employer goes bust. It levies a charge on all DB schemes and takes over the pension schemes orphaned by failed businesses and has built up £26 billion of assets which are invested to meet future pension entitlements of members.
Despite certain limitations on the benefits it pays out, for example limiting payments to those not yet retired to 90% of entitlements subject to a further monetary limit, the PPF offers a strong reassurance that if your employer goes under, you won't kiss goodbye to all of your pension plans as well.
For DB schemes winding up before April 2005, there is also the protection of the Financial Assistance Scheme.
Protections within regulations?
The PPF only applies to DB schemes, but that doesn’t mean DC funds do not have safeguards.
Most DC schemes are administered by financial organisations which in turn are subject to stringent regulations. Your pension funds are ring-fenced within the financial organisation to protect them. In other words, providers hold the money separately and the employer neither has access to it nor has the right to access it in the event of bankruptcy or financial difficulty.
The Financial Services Compensation Scheme (FSCS) offers individual consumers a further guarantee against loss if they have a valid claim against a pension provider – or financial adviser – that has gone out of business where they have suffered a financial loss covered by the scheme.
Peace of mind
While there have been some very unfortunate incidents making the pensions headlines recently, it’s important to feel reassured that pensions are more secure than media headlines sometimes suggest. Whether DB or DC – and particularly if your scheme is protected by a regulated pension provider – you can take some confidence that there are a range of protections in place. The riskiest approach for retirement saving would certainly be to rely solely on the state pension and opt out of workplace schemes available.
* Figures are converted back from dollars at a June 2016 exchange level to avoid distortion from the volatility that followed the Brexit and Trump election outcomes.
Transferring or investing your pension may not be the best option for you, you should compare the benefits from your current pension with the estimated benefits of your new pension, including any guarantees and penalties. If you're unsure whether this is right for you or need advice, please speak to a financial adviser.