In this post-Brexit climate of historically low interest rates and market uncertainty, it is more important than ever to seek advice to establish the best approach for your pension.
In this post-Brexit climate of historically low interest rates and market uncertainty, the value of UK pensions is an area of concern.
For final salary (‘defined benefit’) schemes, the stability of providers is less secure as it becomes increasingly difficult for them to meet payments promised to members. Meanwhile, members of ‘defined contribution’ pension schemes may find that they have to save more, for longer, to get the income they need for a comfortable retirement.
In uncertain times like this, it is a good idea to consider all the options for your pension savings, particularly if you are in a defined benefit scheme. While there may be attractive opportunities available, it is more important than ever to seek personalised advice to establish the best approach for you.
The problem for defined benefit pensions
Around 15 million people in the UK are in defined benefit schemes, which guarantee a proportion of an employee’s salary for the rest of their life.
The funding behind these schemes is usually underpinned by UK government bonds (‘gilts’), which makes them extremely vulnerable to fluctuations in bond values. The lower the bond yield, the higher amount of capital a scheme needs to secure the fixed level of income for its members.
With all-time lows in interest rates and gilt yields following the Brexit vote, the cost of providing pensions today has become much more expensive. The 4.5% yield you could expect from 15-year government bonds five years ago, for example, now barely fetches 1%.
It is not surprising, then, that the capital behind UK defined benefit schemes has shrunk by tens of billions of pounds in just a few months. And it is a widespread problem. Of the FTSE 250 companies – representing Britain’s biggest businesses – only 37 have shown themselves to be in the black by disclosing a pension surplus.
Add to that the fact that people are living longer; many companies now face a situation where they simply do not have enough to finance their pension liabilities over their members’ lifetime.
What happens to pension schemes in deficit?
It is much harder for a scheme in deficit to meet its liabilities and keep its payment commitments to members. Unless economic conditions improve or the parent company is able to divert resources to fund the deficit, the scheme may collapse through bankruptcy. You only need to look at the £571 million pension deficit of BHS for a recent high-profile example.
However, the government provides a safety net for members of defined benefit pension schemes. The Pension Protection Fund (PPF) offers compensation of 90% of members’ pension rights if a scheme fails, up to a maximum of £33,678 a year.
In June, of almost 6,000 pension schemes with final salary features that come under the PFF, 5,020 were in the red to the tune of a combined £408 billion. According to pensions consultants Hymans Robertson, that deficit has now grown to £1 trillion.
What does this mean for members of defined benefit schemes?
In an attempt to stifle the growing pension deficit, many companies are offering members incentives to leave, with an option to ‘opt out’ in exchange for a large cash lump sum.
Recently, the values of lump sums being offered has soared, revealing just how eager companies are to offload their pension liabilities. Calculated as a multiple of a member’s future pension payment, it is not unknown for pay-outs to have doubled from 20x two years ago to around 40x post-Brexit. That means if you had a final salary of £30,000 per year, you may have been offered a £600,000 pay-out two years ago – but £1.2 million today.
If bond yields continue to fall, it is possible that these cash incentives may climb even higher.
Establish what makes financial sense for you
While inflated pay-out offers sound tempting, transferring from a defined benefit pension comes with risks and many members may be better off staying where they are. It is essential to seek professional advice to carefully weigh up the advantages and disadvantages of transferring your pension to understand the long-term implications.
At the most basic level, an adviser can confirm your current transfer value and let you know whether your pension scheme is in danger of falling into the Pension Protection Fund. The PPF will only compensate up to £33,678 a year, so if your pension is worth more than this and your scheme is vulnerable, it may be worth considering transferring.
Other things an adviser can help you with are the tax implications, in the UK as well as your country of residence. For expatriates, guidance from an adviser who understands UK pensions and the implications for UK nationals living abroad has never been more valuable.
Even if you do not have a defined benefit pension or have no intention of cashing in, now is a good time to review your pension arrangements. You can help ensure peace of mind with a plan of action that keeps up with any pension developments the post-Brexit landscape may bring.
Any questions? Ask our financial advisers for help.