The effect of the employer’s covenant to support the scheme - Active Members
This Quicknote is written for people who are active members of a defined-benefit scheme.
The ability to pay for scheme benefits is called the covenant – it reflects the sponsoring employer’s commitment to the pension scheme and its ability to meet that commitment by coming up with the contributions when they are required - not just now - but many years into the future.
The covenant for Public Sector pension schemes is provided by the Government, which uses taxation to support its promises.
If your employer is making redundancies, this could be an early sign of financial problems – although there may be a number of reasons an employer makes redundancies. It may sometimes appear to be part of a profit-driven exercise. However, a redundancy program might be part of a steady downsizing of the business because of trading difficulties.
Where the employer only pays the minimum redundancy payment, this could be an indication about the company’s financial situation and its continuing ability to support the pension scheme.
Pension benefits are very expensive, and the value of all the members’ scheme benefits can be substantial. Where the scheme’s liabilities exceed the scheme’s assets, these liabilities now have to appear on the sponsoring employer’s balance sheet. In these circumstances, the pension scheme can drive a weak company into receivership. If your pension scheme is in deficit and you are concerned about this, you should take advice on the merits of leaving your pension benefits within such a scheme.
As part of its overall financial considerations, even where the future stability of a company is not in question, your employer may look at the viability of continuing to fund a defined benefit scheme for those employees still in service such as you. It may decide to close the scheme at some point in the future in which case the options open to your employer would be to:
- Close the scheme to new employees (existing active member like you continue to build up future pension benefits)
- Close the scheme for all members, in which case you cease to be an active member and immediately become a preserved member. Your pension benefits are ‘preserved’.
If an employer which sponsors a defined benefit scheme goes into administration, scheme members may be eligible for compensation if the scheme is accepted by the Pension Protection Fund (PPF). The PPF is not the full safety net many people believe and you should make yourself familiar with what you might receive in the event that your employer fails and your scheme qualifies for compensation for its members. Not all schemes are covered by the PPF.
Comment:
Most pension scheme members would be surprised to learn just how much their employer pays into the pension scheme to fund retirement benefits. Many employers are currently paying 20% to 25% of their payroll into the pension scheme (which is in addition to any contributions paid by active scheme members such as yourself). Furthermore, if the scheme is in deficit, the sponsoring employer will be paying extra contributions to fund the shortfall.
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Summary
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 Quicknote forms part of our Module ‘How secure is my pension?’ and should be read alongside the other Factsheets and Quicknotes in the series.
This is not an authoritative document. Seek professional advice from an appropriately experienced and qualified adviser.
The effect of the employer’s covenant v1.5 Active
Last updated 11/12/2006
