Record high deficits for UK employer defined benefit pension schemes but should you transfer?
Written by Sam Barrie on July 09, 2015.
Earlier this year the Pension Protection Fund released figures showing record high deficits for employer pension schemes in the UK. What this means in simple terms is that the assets held in these defined benefit (DB) or final salary schemes are not sufficient to cover the pension pay-outs owed. The figures involved are rather alarming:
• 5,175 company schemes face pension deficits compared to just 882 schemes in surplus
• The total balance of the deficit has risen to £367.5bn from £46.4bn in just one year
• In one month (January 2015) liabilities rose by 9.2%
• Six FTSE 100 companies (including Sainsbury’s, British Airways and Royal Bank of Scotland) had pension liabilities in July 2014 larger than their equity market value
There are a number of reasons for these deficits. A fall in equities (traditionally an investment mainstay for these schemes), a fall in bond yields, increasing life expectancy and recent Bank of England quantitative easing measures combined with low interest rates are all factors.
For companies, the effects are catastrophic as they are obliged by Pensions Regulator policy to make every effort to clear the deficit by diverting assets into topping up their pension funds to cover pay-outs due. This in turn affects cash flow, impacting on their investment decisions and the development of their businesses as well as reducing in mergers and acquisitions activity. There is also often a negative impact on dividends and pay and a reduction in demand for credit because borrowing could increase levies owed to the PPF. Some large companies have paid tens of billions of pounds into their pension schemes year on year and still not managed to halt the growth of their deficits.
Clearly companies are suffering but what are the implications for holders of these defined benefit schemes? If you have one, should you be worried? Well, traditionally these schemes have been regarded as the ‘Rolls Royce’ of pensions. They pay a guaranteed set income each year based on a multiple of the number of years worked in a company (typically 60th’s or 80th’s) and a proportion of final salary which continues to be paid to your spouse upon your death. DB schemes were generally considered to be more secure and more generous than their successor - defined contribution (DC) schemes, which provide a pension based on how much you contribute and underlying investment performance.
However, there can be advantages to transferring your defined benefit pension. Obviously protection of your assets is the biggest incentive, but with bond yields falling, transfer values rise so individuals are actually seeing highly favourable transfer quotations compared to just a few years ago. In addition, taxation governing pension funds on death can also make it more interesting for those wishing to pass their funds on to their children. Another key point to note is that the Lifetime Allowance (LTA) is currently £1.25M, and will be reduced again next year to a flat £1 million. For those with pensions exceeding this level, a tax of 25% would be applied to funds over and above the LTA when beginning drawing an income or if transferred out of a DB scheme overseas, both of which are classified as a ‘benefit crystallisation event’. If the excess above the LTA is taken as a lump sum then the tax applied is 55%. Essentially, the 25% tax is unavoidable if you fall into this category but one can avoid this tax on further growth by taking advantage of their expatriate status and moving their pension overseas. For those breaching or even having exceeded the current LTA, seeking professional advice now is imperative prior to the imminent changes coming into place on 6th April 2016.
Transferring a pension is certainly not a decision to be taken lightly and there are a lot of factors to take into consideration. That is why I would always recommend taking professional and objective advice on this issue. For a non-obligatory review of your existing private UK pension scheme, please feel free to contact me at firstname.lastname@example.org.