How secure is my defined benefit scheme? – Active Members
This Factsheet presents some of the main issues relating to the security of your pension and how this can affect your retirement benefits.
It is written for people who are active members of a defined-benefit scheme.
Introduction
This Factsheet looks at some of the issues about the security of your pension that YOU should be thinking about when it comes to retirement planning.
It is essential that you understand the main issues associated with the security of your pension, as it will affect YOU and your dependants, and your retirement planning. This Factsheet is designed to make you think about the various issues associated with security, WHY these occur and HOW these could have a bearing upon your pension benefits.
Some of the points are more obvious than others, but they are all important.
If you are intending to get advice from a Financial Adviser these are some of the things you should be discussing with them.
How secure is my pension?
Until quite recently, most members of traditional ‘company pension schemes’ (what we call defined benefit schemes) would have considered their pension benefits to be guaranteed. It’s not too difficult to understand how this happened. The vast majority of members retiring from defined benefit schemes over the last 30 to 40 years received the full benefits they were expecting (and sometimes more).
Large surpluses, contribution holidays and buoyant stock markets all led to a sense of security. Brochures, documents and leaflets provided by many pension schemes, Government organisations and Financial Services regulators sometimes referred to the guaranteed nature of salary-related occupational pension schemes.
Sometimes these specifically stated that defined benefit schemes provided guaranteed pension benefits. Quite often, the guaranteed nature of these schemes was implied. If you go searching on the internet, it is not too difficult to find websites which continue to state – incorrectly - that defined benefit schemes provide guaranteed pensions!
Comment
Defined benefit schemes provide a promise – which is not a guarantee.
The promise is valid only as long as the sponsoring employer supporting it is able to (or chooses to) keep that promise.
As an active member, it is important you understand what level of security you have, as well as any risks that you face which could affect your pension scheme and the benefits it has promised to provide.
What is a Guaranteed Minimum Pension (GMP)?
You will only have a Guaranteed Minimum Pension if:
- You earned your pension between 6th April 1978 and 5th April 1997.
and during that period
- You were ‘contracted-out’ of SERPS by virtue of your service as an active member of the scheme.
Being in contracted-out service means that your National Insurance contributions and those paid on your behalf by you employer between those two dates were paid at a lower rate than would have applied had you not been contracted out. Instead of building up benefits in the State Earnings Related Pension Scheme (SERPS), your scheme will have to provide a Guaranteed Minimum Pension benefit within the pension scheme. This benefit is paid as part of your overall pension scheme benefits. Your entitlement to a Basic State Pension is NOT affected by this arrangement.
As the term guarantee is used in the name Guaranteed Minimum Pension (GMP), it is easy to confuse you into believing that the whole of your pension benefit is guaranteed. In fact, if you do have a GMP it is quite likely to form only a small part of your overall pension benefit.
If you have no Contracted-out service in relation to your pension scheme before 6th April 1997, you won’t have a GMP.
The ability to build up a Guaranteed Minimum Pension ceased on 5th April 1997.
The difference between private and Public Sector pension schemes
Private sector pension schemes are funded by a sponsoring employer. The employer pays contributions, and in the majority of those schemes, the members also pay contributions, which maintain the scheme and help pay pensions to retired scheme members.
Public Sector pension schemes can be divided into two types:
- ‘funded’ pension schemes (e.g. Local Government Pension Scheme)
- ‘unfunded’ pension schemes (e.g. NHS, Civil Service and Teachers’ Pension Scheme).
Funded public sector pension schemes are broadly similar to private sector schemes in that they also build up assets to meet the cost of paying pension benefits, but these benefits still rely on the promise and are therefore technically not guaranteed. However, it is unlikely that the Government would allow the Local Authorities, for example, to default on this promise (yet!).
Unfunded public sector pension schemes have, as the name suggests, no physical ‘fund’ or ‘pot’. The sponsoring employer – the Government – doesn’t make contributions. Any contributions paid by the members of unfunded pension schemes pass into the general Government ‘kitty’ (but these figures are recorded for each member and taken into account in pension calculations). The schemes rely on a promise by Government to pay pension benefits. There is no build up of assets to provide further member security.
What is a ‘Crown Guarantee’?
A Crown Guarantee (CG) is where Government has undertaken to guarantee the pensions benefits of certain companies in the event that the employer goes bust. These guarantees were generally made as a result of privatisation in the eighties and nineties, and include pension schemes (or sections of schemes) such as BT and British Coal. In the last year, the CG has become a major issue for these companies. Where the guarantee applies in relation to a part of the scheme membership, the levy due to the Pension Protection Fund is reduced. Needless to say, some current private companies have been working through privatisation papers to see if they might benefit from a CG.
The Pension Protection Fund has confirmed that it is aware of up to 20 schemes with such guarantees. If one of these schemes fail, then the taxpayer will ultimately be called upon to meet those liabilities specified as a result of the Crown guarantee.
Opting out of your pension scheme
Opting-out of your pension scheme is probably one of the biggest decisions you could make in terms of your pension provision – and not one that you should embark upon without specialist advice which requires considerable expertise.
Opting-out means giving up a lot of potentially valuable benefits and transferring your pension is not considered to be in the best interest of the greater majority of pension scheme members – indeed it is nearly always treated with suspicion. There are however legitimate reasons to consider this such as if you have a genuine concern about your employers financial position; you want to access your pension benefits but you cannot do so directly from your scheme, or you simply cannot afford your contributions.
Opting out is a course of action which should only be considered in extreme situations having taken detailed independent financial advice from a pensions specialist.
If you ‘opt-out’ of your pension scheme whilst continuing to work you could retain your benefits within the scheme (and so you would become a preserved member). Alternatively, you could transfer your pension benefits away from the scheme. The transfer could be to a private arrangement such as a Personal Pension Plan, Section 32 Buyout or Self-Invested Personal Pension Plan (SIPP). There are a number of alternatives – each with its own advantages and disadvantages.
A full analysis should ideally be performed on your behalf by a specialist adviser instructed by you. Your adviser would compare benefits you have within your pension scheme against those that would be available if you transferred them.
What was the pension mis-selling scandal?
Many hundreds of thousands of scheme members had previously transferred benefits out of their defined benefit schemes into private pension arrangements.
In the early nineties, Financial Services regulators conducted a review on the quality of advice that members had received in deciding whether to transfer or not.
Their findings revealed that in the greater majority of cases, the client files retained by advisers did not hold sufficiently detailed information to show whether the client could have made an ‘informed decision’ about the transfer. In a number of cases, this was simply a matter of not keeping full copies of documentation on file. However, it was mistakenly reported as ‘bad advice’ at the time and no doubt there were cases of poor advice.
Advisers were instructed to conduct a review of cases and that became known as the pension mis-selling scandal. It made major headlines for several years.
Billions of pounds of compensation were paid out by pension providers and advisers, and many scheme members were encouraged to rejoin (and in many cases to transfer back-into) their former pension scheme.
In an unfortunate twist of irony, many of these schemes are now suffering financial difficulties themselves and some have wound-up or are in the process of winding-up, perhaps leaving some members worse off than would have applied had they remained outside the scheme.
Summary & Key Points
When making enquiries about your pension benefit it is very important that you make it clear that you are an active member rather than a preserved member or pensioner member. Active, preserved and pensioner are different classes of membership of a pension scheme and any definitions and paragraphs contained within your Scheme Rules or scheme literature relating to any benefit may differ considerably between these categories.
You need to consider the following items:
- Is your pension scheme a funded pension scheme or unfunded?
- If your pension scheme is funded, is it in deficit? How big is the deficit?
- How secure is your pension scheme’s sponsoring employer?
- If your pension scheme failed, would you be eligible for (and what would you get) from the Pension Protection Fund?
- Keep informed. Your scheme may modify benefits and Rules. Legislation may change. Your circumstances may alter.
- Rules differ from scheme to scheme and are wide and varied in content. Don’t assume that what applies to one of your pension schemes will necessarily apply to others that you may have.
- HMRC impose rules which registered pension schemes must conform to.
- People seldom have identical pensions and you should avoid drawing comparisons with colleagues whose circumstances may at first appear the same but could emerge as having significant differences.
This is not an authoritative document. Seek professional advice from an appropriately experienced and qualified adviser.
How secure is my defined benefit scheme v1.2 Active Member
Last updated 11/12/2006
