When big companies such as Carillion or BHS go to the wall, there is understandable concern about the jobs of the many people working for such firms.
However, there are likely to be many more people – former employees as well as existing ones – worrying about whether their pension is at risk. Insolvencies raise some crucial questions for people generally, about how safe their company pensions are and what happens if their employer goes under, leaving the pension fund short of cash.
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Pensions in peril
At this point it is worth mentioning that some pension schemes are affected by a company insolvency and others are not.
The newspaper headlines tend to be about salary-related pensions (often known as defined benefit pensions). These are more traditional pension schemes, where the amount you get depends on how much you earned and how long you worked.
In effect they are ‘pensions with a promise attached’. As long as the company you work or have worked for remains in business and still puts money into its pension scheme, your pension will continue to be paid as promised. But problems arise if a firm becomes insolvent at a time when there isn’t enough money in the fund to meet all its pension promises.
In contrast, the newer ‘pot of money’ pensions (known as defined contribution pensions) are not affected if your employer goes to the wall. This is because the money is held for you either in a personal pension product with an insurance company or in a separate trust, so the value of your pension is unaffected.
The good news is that big company collapses make the headlines precisely because they are unusual. In most cases, firms keep going from one year to the next, and pensions go on being paid as promised to millions of people every month.
To give a sense of perspective, in 2017 there were around 1.3 million private sector workers still building up rights in private sector salary related schemes, 4.9 million workers under pension age with past rights but not building up new rights, and 4.2 million pensioner members. In total, over 10.4 million people were either already receiving such a pension or due to receive one.
In contrast, the number of people who have been picked up by the Pension Protection Fund (which steps in when a firm goes bust with an under-funded pension scheme) stands at around 0.4 million, a figure that includes those rescued by the Financial Assistance Scheme, the precursor to the PPF. In short, the number of people who are not getting their full pensions is around 4 per cent of the number of people who have ongoing entitlements to salary-related company pensions.
The key to whether your salary-related pension will be paid in full or not is whether your company continues to trade and whether it can put enough money into its pension scheme to meet future pension promises. Pension costs have risen in recent years as we live longer and the returns on pension fund investments have fallen. Both these factors have put pressure on pension scheme funding, which is why most pension schemes now have a deficit.
Solid safety net
Every three years a pension scheme’s assets and liabilities are revalued, and the employer and the pension scheme trustees have to agree a ‘recovery plan’ to deal with any deficit.
If the employer becomes insolvent while there is a significant deficit in the fund, the assets of the scheme are generally passed over to the PPF, which then pays out pensions to scheme members.
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Under PPF rules, those already over pension age at the time of the insolvency should get 100 per cent of their pension, while those under pension age get 90 per cent. However, the PPF rules that govern increases in pensions each year to account for inflation are often less generous than the rules of the original schemes, so members may get smaller annual increases once their pensions are in the PPF. Moreover, there is a cap on pension payments to very high earners.
Most companies are likely to last long enough to deliver on their pension promises. For those that do not, the PPF is a well-funded and robust safety net that should provide some peace of mind the next time the headlines are full of doom and gloom about company pensions.
This article was first published on our sister publication Money Observer
This article was originally published in our sister magazine Moneywise, which ceased publication in August 2020.
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