High-profile collapses of final salary pension schemes and reports about rising deficits are prompting thousands of people to transfer out of final salary pensions from former employers to safeguard retirement assets against a possible collapse of the company scheme.
Financial advisers, actuaries and pension providers report growing interest from individuals looking to cash in final salary pensions. “The relentless bad news about the collapsing pensions industry has meant some employees have been tempted to take a transfer value rather than hang on for final salary scheme promises because they fear the financial strength of their employer is shaky,” says David Lamb, marketing director at St James’s Place, who has been approached by a number of clients with final salary pensions keen to switch into self-invested personal pensions (Sipps).
Final salary schemes, also known as defined benefit schemes, have long been seen as something of a golden nest-egg as they promise members a set income on retirement without them having to shoulder any investment risk. But these schemes have dominated headlines in recent months over fears that some companies will struggle to meet their promises. As life expectancy rises and investment returns fall, final salary liabilities for employers have been increasing.
Pensions advisers say senior executives in particular, who may have accumulated significant final salary benefits, are being tempted to transfer out of their scheme because of concerns that only a small portion of their pension would be covered by the Pension Protection Fund should their employer go bust. The PPF covers only 90 per cent of final salary pensions up to an annual income cap of £26,050.
Some members of BA’s pension fund, in particular, have expressed concerns that the company could be unable to meet their pension promises, according to some advisers. BA’s pension liability increased from £2.19bn to £2.29bn last year and the accounting deficit in the main fund, the New Airways Pension Scheme, rose by £101m to £2.1bn, according to figures released this week by actuaries Lane Clark & Peacock.
BA has proposed reducing future benefits and raising the retirement age and has also offered to make a one-off cash contribution to the fund of £500m. But this has still not stopped some people from transferring.
“I am not surprised people are transferring out of final salary schemes with companies that have large deficits,” says Pat Wynne, director of actuary and pension company Entegria. “They are probably thinking a bird in the hand is worth two in the bush. Some people will not mind taking a lower payout if it means they can be certain of getting more than they would if the PPF had to step in.”
Lane Clark & Peacock’s annual Accounting for Pensions survey released this week estimated the combined deficit of FTSE 100 company pension schemes is £36bn. BAE Systems topped the shortfall table with a scheme deficit of £5.3bn – equivalent to 43 per cent of its stock market value. In second and third place were BT (£4.8bn) and Royal Bank of Scotland (£3.7bn). The LCP report predicted the majority of Britain’s 100 biggest companies would shut their final salary schemes to existing workers within six years.
“Ahead of this possibility many directors and senior executives who have accrued significant final salary benefits could find it advantageous to switch from a defined benefit to a self-invested personal pension,” says Nigel Chambers, director at Alexander Forbes Financial Services, which advises companies and individuals. “This would give them added flexibility and added security.”
He also makes the point that final salary pensions include spouse’s pensions, which are of no value to those who are divorced, planning to divorce, have no partner or a same sex partner, if their scheme does not recognise civil partnerships.
There can also be inheritance tax benefits. Death benefits paid after retirement from a final salary scheme are effectively limited to spouse’s pensions. But in a Sipp any remaining funds can usually be passed on to spouses, civil partners and financial dependants free of IHT, even after age 75.
On top of these benefits there is also the possibility of an enhanced payout from the scheme you are transferring out of. Many companies are offering enhanced lump sums of an additional 5 per cent on top of the standard transfer value if employees forsake final salary promises. “The company will be grateful for the reduction in pension fund liabilities in balance sheet terms and because of the reduction in Pension Protection Fund levy charges,” says Paul McGlone, an actuary at Aon Consulting.
“Lots of pension trustees are offering enhanced payouts to get people off the company’s books. If the scheme is in deficit they will only be allowed to pay out a certain amount but some companies are making up the difference out of company funds.” He says that, for a typical member, this is a far more cost-effective use of company money than paying companies such as Legal & General or Prudential to take on their liabilities.
But, before making the switch, investors need to be certain this is the best road to take. Transferring out of a final salary scheme means saying goodbye to benefits such as a known income in retirement as well as the security of a spouse’s pension.
It is also advisable that individuals do their sums before taking a transfer value. In most cases, they are unlikely to to be able to replicate the foregone pensions benefits. On a typical transfer value, investors will need an annual fund performance of about 10 per cent to match the pension promise they have given up, although this can vary significantly from scheme to scheme.
“Even with an enhanced payout you would need to make your money work very hard to get the same benefit as a final salary scheme,” says Penny Cogher, solicitor at Speechly Bircham. “But if you think your employer is going to go bust then this could be a viable option.”
The Financial Times Guide to Sipps, sponsored by St James’s Place Partnership, is available free on 0845 345 5699
