The end of final salary pension schemes is near!
Many experts believe that in 10 years time almost all private sector final salary pension schemes will have been wound-up or closed to new members.
Worse, increasingly, companies are closing these schemes altogether, not only for new members but also for existing members.
What are final salary pension schemes?
In a final salary scheme all the money coming in is pooled into a large pot which is then managed by the trustees and investment managers.
Employees would pay up to 5 percent of salary into their final salary pension scheme, while employers would pay the equivalent of 10 percent of salary. In the good old days even 15 percent.
During the latter parts of the 1990’s and the early part of the 21st century many companies closed their final salary pension schemes to new members. Following the introduction in 2005, of the Pension Protection Fund a number of collapsed final salary pensions have been saved.
Are there any final salay pension schemes left?
Currently, there are only about 7,000 solvent final-salary schemes left. Some 2.5 million workers are currently signed up for these pension plans which provide retirees with a guaranteed annual income when they reach the appropriate age.
Save Tesco Plc and Diageo Plc, all other FTSE100 listed companies have closed their final-salary schemes for new employees.
An increasing number of companies have gone a step further and closed their final-salary schemes altogether, not only for new members but also for existing members, including Barclays, Trinity Mirror, DSG International, Alliance Boots and Aviva. A number of other companies are now also considering closing these schemes.
As an aside, public sector workers’ pensions, many of whom are still on generous final salary schemes, are completely paid by the taxpayer.
Why has all this happened?
The decision to remove the so-called dividend tax credit has been largely blamed for the demise and closure of many final salary pension schemes.
Up until the 1997 Budget, pension funds received a tax credit of 20 per cent on dividends received from British companies. This was to offset corporation tax already paid by companies on their profits. Dividends were assumed to be net of income tax, but pension funds were exempt so received money back as a tax credit.
The then Chancellor Gordon Brown cancelled the dividend tax credit on company pensions in 1997 and this has had a devastating effect on many people's retirement pots.
Is anybody asking for this to be changed?
Although it was mooted that the Conservatives would reinstate the dividend tax credit once they were back in government, the Emergency Budget has been silent about this issue.
The National Association of Pension Funds supports such a move, arguing the restoration of the dividend tax credit should happen 'when the public finances permit it'.
However, bringing back the dividend tax credit would cost the Treasury billions, at a time when it needs to save money.
So, I guess, this is unlikely to happen anytime soon.
What has replaced final salary pension schemes?
Many final-salary schemes have been replaced by inferior money purchase schemes. Over 8 million workers are now currently subscribed to these newer company pension schemes.
With a money purchase scheme people's retirement pot is primarily determined by:
- The level of contributions made by the employer and employee,
- Stock market performance
- Prevailing annuity rates
Employers are paying an average contribution of just 6 per cent into defined contribution schemes.
Are money purchase schemes risky?
In money purchase schemes the employee bears the risk of pension funds losing value if stockmarkets fall. Unlike final-salary schemes, the value of your company pension is now increasingly uncertain.
Average employees’ relative lack of financial knowledge and aversion to risk is also leading to poor investment performance over the longer term which can have a significant impact on retirement income.
During the current economic downturn employers have been steadily cutting pension benefits, while poor investment returns at many schemes are hampering their performance.
Some employees have been offered the choice between a pay cut or a reduction in pension benefits, with most opting for the latter.
Employers' contributions are likely to fall much further from 2012 onwards, when the Government introduces lower minimum funding levels with the
launch of the National Employment Savings Trust (NEST).
Have you heard of the next disaster to happen
An increasing number of companies are considering the introduction of so-called ‘profit-linked pensions’. These schemes link pension payments to companies’ profits with employees set to receive lower pay-outs in leaner years.
Linking pensions to profits would enable companies to minimise contributions in difficult times, while avoiding the need to stop them altogether.
The introduction of profit-linked pensions is likely to further erode employees pensions’ entitlements.
The final nail in the final salary pension scheme?
In July 2010, the Goverment announced the removal of the link between company pensions and increases to the Retail Prices Index which includes housing costs such as mortgage interest payments.
During 2011, the Government plans now to link increases to the Consumer Prices Index instead, which is typically lower.
This will not only affect already retired people but also employees who are still building up their benefits.
The RPI traditionally rises considerably faster than the CPI, affording much greater protection against inflation. On average the CPI has been almost 1 per cent lower than RPI over the last 25 year. Over 30 years, pensions may well be 25 per cent smaller than they would have been if the current system would have been maintained.
What to do next?
With the ongoing downward trend of employers’ contributions and retirement benefits it is clear to me that the future for the pensions of everyone in the private sector is getting increasingly worse, unless you take action yourself immediately.
Taking care of your retirement is
increasingly your own personal responsibility!
I suggest, you need to act NOW, and start building wealth, or suffer the consequences.
The pensions for the majority of workers and employees in the private sector are becoming increasingly dismal and the future is only getting increasingly worse.
Retire instead in relative comfort: act NOW!
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