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Headlines about pension scheme deficits and wind ups have alarmed private scheme members. Pam Atherton looks at their options.

FRS 17, which requires pension schemes to disclose their current market valuations, has highlighted the huge deficits lurking in many UK pension schemes.

The traditional SSAP 24 method of accounting for pension scheme assets and liabilities, which allowed scheme actuaries to smooth liabilities over many years, served to hide such deficits from finance directors and scheme members alike.

Where deficits occur, companies are obliged to plug the gap from their own pockets within a specified timeframe. Because these deficits are likely to grow over time due to stockmarket volatility, increasing longevity and falling annuity rates, many companies are reviewing their pension arrangements and ditching final salary schemes for cheaper money purchase arrangements.

Members of occupational schemes often forget that their scheme is only as good as the strength and generosity of their employer and that employers are not obliged to contribute to a pension scheme. Under current law, an employer’s minimum obligation is to provide access to a stakeholder pension scheme if there are five or more employees, but they are not obliged to contribute to it.

Employers’ options
Where an occupational scheme has a deficit, the employer has a number of options. It can make up the deficit over time, close the scheme to new employees, shut the scheme for all members or transfer members into a money purchase scheme. Closing a scheme to new members may offer only limited relief as actuaries estimate this only reduces scheme costs by 5% and that further cost reducing measures may be necessary at a later date.

Money purchase
A transfer to a money purchase scheme means that scheme members have to make their own investment decisions: if the fund underperforms there is no one to top up the fund. Benefits such as spouse’s and children’s pensions have to be paid for at variable expense (depending on the spouse’s age). Retiring early, whether out of choice or due to ill health, is prohibitively expensive. Furthermore, employers often pay much lower contributions to money purchase arrangements (typically around 5 – 6% of salary) than to final salary schemes where they often contribute over 12%.

At retirement, a money purchase scheme pays a tax free lump sum and the remainder of the fund must be converted into an annuity, so members are always at the mercy of stock markets and annuity rates, both of which are currently extremely low.

There are four types of money purchase arrangement:

• occupational money purchase
• simplified money purchase
• individual or group personal pension
• individual or group stakeholder pension.

An occupational money purchase scheme will generally pay a tax free lump sum of 1½ times final salary, whereas the other three arrangements will normally pay up to 25% of the fund. The most generous of the above options is the occupational money purchase arrangement because of the large tax free cash lump sum; the least attractive is the stakeholder, because the employer has no obligation to make a contribution. With simplified group money purchase and group personal pensions, the employer must make a contribution of at least 3% of members’ salaries.

Challenging your employer
If the level of your employer’s contribution is set to fall significantly, this can be challenged, initially via the trustees. Trustees are obliged to act in accordance with the trust deed and for the benefit of the members. If the scheme is being closed, the trustees can only allow this if the trust deed permits it. If you believe the trustees are acting incorrectly, you can make a complaint via the scheme’s internal dispute resolution – the procedure will be set out in your scheme booklet.

Members of the Ernst & Young and Big Food Group final salary schemes have successfully taken legal action against their employers for trying to reduce their pension benefits without consultation.

If you were promised a final salary scheme in your contract of employment, the removal of this benefit could be deemed to be a breach of your contract of employment, although scheme booklets often refer to the employer’s right to terminate the scheme. Even where there is no explicit contractual promise of a final salary scheme, employers must treat employees fairly and act with “trust and confidence” towards their employees.

Alternative options
There are a number of alternative pension arrangements which your employer may implement which are less expensive than a final salary scheme, but which are preferable to a money purchase scheme from the point of view of employees.

These include:

• reducing the accrual rate from, say, 1/60ths to 1/80ths
• basing benefits on “career average”, rather than final earnings
• a “cash balance” scheme which looks like a money purchase arrangement, but is, in fact, like a final salary scheme
• “sharing of risks” arrangement, whereby the employer offers a combination of final salary and money purchase arrangements.

Worst case scenario
The worst case scenario would be if your employer went bust and the pension scheme had to be wound up. This is because current and ex employees (called deferred members) would stand to lose out the most. In wind up, current pensioners and their pension increases have priority over any benefits due to deferred and current scheme members. These priority rules means that members close to retirement can lose up to 90% of their expected benefits.

If your employer transfers you to a group personal pension arrangement or you choose to move to a personal pension yourself, you must accept responsibility for your investment choices and that you will have to purchase an annuity with 75% of the fund at retirement.

Pam Atherton is a freelance journalist

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