What should final salary pension savers do?


Increases in life expectancy have made defined benefit (DB) pension schemes expensive to fund, with figures from the National Association of Pension Funds revealing that only 23% of schemes are still open.

And, with some of these set to close or alter their benefits in the future, it's important to understand your options if your scheme does change.

Some schemes, for instance the one offered by BP, close to new members. If this happens and you're an existing member, Malcolm McLean, chief executive of The Pension Advisory Service, recommends sitting tight.

"Carry on as normal," he says. "It's usually better to have the certainty of a defined benefit than to rely on investment performance in a defined contribution scheme."
Other companies take more drastic action with their DB schemes. For instance, in 2009 several firms including Barclays, Trinity Mirror and Dairy Crest, closed their schemes to existing members.

"You will usually get some form of benefit inflation, depending on the scheme details, but you won't accrue further benefits," explains Hannah Edwards, head of new clients at BRI Asset Management.

Transfer value

Rather than sitting tight, many schemes, whether closed or not, will look to reduce future liabilities by offering members a transfer value to leave the scheme. "Some schemes will offer other inducements, such as a cash bonus, as an incentive to move.

"Don't take this until you've taken advice from an independent financial adviser who holds J04 and J05 pension qualifications," adds Edwards.

They will run a transfer value analysis to assess what annual growth rate, known as the critical yield, you'll need to achieve to match the benefit.

"If this figure is high you'll struggle to replicate the benefits you'd have got under the DB scheme but if it's less than 6% you might be all right," says Tom McPhail, head of pensions research at Hargreaves Lansdown.

As well as assessing the critical yield you should also consider the size of the pension deficit and the financial strength of the company. "Many pensions have large deficits: these aren't an issue unless the company's struggling," adds McPhail.

Where companies do go bust, the Pension Protection Fund will pay compensation to members of the DB scheme. For anyone already retired this is 100% of the pension they would have received, while those yet to retire will receive 90% of the benefits they had accrued, subject to a cap.

This rises each year and at April 2009 was £28,742.69 for a 65-year-old. "If you've built up a pension entitlement greater than the cap and the company looks unstable, you might want to transfer out, even if the critical yield doesn't look achievable," adds McLean. 

There's nothing to stop you asking for a transfer value either. For instance, each year McPhail asks his former employers to provide transfer values for his pensions so he can assess whether it's worth shifting his cash.

Where a DB scheme is closing, it's also important to weigh up its replacement if you're still an employee. Most employers will move to a defined contribution scheme, passing the risk on to you that investment returns won't be high enough.

"Push for the best deal you can in terms of employer contributions," says McPhail. "Once this is established it'll be very difficult to get your employer to increase it."

Generally a DB scheme requires funding levels of between 15% and 25% of earnings so an employer wouldn't be overly surprised if you started negotiations within that range. 

... take advice. The Pensions Advisory Service can help or speak to an IFA.
... weigh up the financial strength of the company to assess the likelihood of benefits being paid.
... negotiate a good deal on employer contributions into a replacement defined contribution pension.
... be won over by financial incentives to transfer. Only assess whether it's a good deal once you know what growth rate you need to replicate benefits.
... be afraid to ask for a higher transfer value. Schemes can be open to negotiations.
... forget the cap on the Pension Protection Fund, especially if you've built up a large pension entitlement.

This article was originally published in Money Observer - Moneywise's sister publication - in March 2010