This is the first in a series of articles regarding pensions. Over the next few articles I will cover different types of pensions from Company Pensions to the new UK State Pension. My preference is to keep each article factual (not salesy!) so if you want the raw facts … read on!
Company (Occupational) pension schemes can be Money Purchase or Defined Benefit Schemes, or a combination of the two, known as hybrid. Historically, the most common type of company pension would have been a Defined Benefit Scheme, and in this article I will focus on Defined Benefit Company Pension Schemes.
IN THE GOOD OLD DAYS …
If you have previously been a member of a Defined Benefit company pension you were said to be ‘made for life’! Why was that? Let’s take a look at both the benefits and drawbacks …
| BENEFITS | DRAWBACKS |
What income is paid to the member in retirement? | It provides a secure income for life | Once in payment the income cannot be varied |
| Will usually increase in line with inflation | When the member dies the income ceases (unless a survivors pension is included within scheme rules) |
| Liability for payment remains with the trustees and sponsoring employer | Payment of the pension income is subject to the continued financial solvency of the scheme and the sponsoring employer |
| | |
Death benefits following the death of the member | Will usually provide a spouses pension (including civil partners and same sex marriage) | There is a huge variation in the definition of spouse and dependant, and often payment of benefits is at the discretion of the trustees |
| Benefits will generally increase in line with inflation | Spouse and other pension benefits will be taxable as the recipient's pension income under PAYE |
| The scheme may provide a dependants/children's pension up to age 23 | Payments of spouse benefits can be reviewed, reduced or withdrawn all together based on the scheme rules, eg; in the event of the spouse re-marrying |
| | A survivor's pension must cease when the survivor dies (ie; there is no income/lump sum to pass on to later generations) |
| | |
General | Easy to understand with no need for ongoing advice | It's the most inflexible option for the client |
| Provides certainty of income throughout life for the member as long as the scheme remains able to honor its pension promises | |
For many people this type of scheme is still the Rolls Royce of pensions. However, as you can see above it does come with drawbacks.
More recently deferred members have become increasingly concerned about their scheme’s funding position. Let’s look at the reasons behind these concerns …
Defined benefit schemes were introduced to the workplace at a time when interest rates and gilt rates, which affect annuity rates, were much higher than they are today. It was fairly easy for an employer to make a promise of a guaranteed income for life to members when interest rates on investments and gilt yields were 14%+ pa. This meant that it was easy for a scheme to benefit from good investment returns and build a sizeable scheme fund in the knowledge that because annuity rates were also high, that the cost of providing an income for life to retired members was easily achievable and required a much lower starting value than today.
However, over the last 40+ years there has been a steady decline of both interest rates and gilt yields, affecting both the growth potential of the contributions made to the scheme and the annuity rates relied upon to provide the guaranteed income for life. The reduction in investment returns has resulted in the majority of defined benefit schemes being underfunded. Schemes that are still open to new members are in fact the worst funded, with an aggregate funding level of 84.3%! (Pension Protection Fund The Purple Book 2018)
The next few charts demonstrate this decline, with an all-time low in gilt yields following BREXIT in 2016!
Turbulent stock market returns have also resulted in many schemes amending their asset mix, which in 2006 incorporated around 52% in equities and 22% in bonds, to around 32% in equities and 43% in bonds by 2018 (Pension Protection Fund The Purple Book 2018). Clearly this further restricts the growth potential of schemes hoping to make up any gap in funding levels.
Of course following the introduction of pensions flexibility in the UK many people now wish to access their pensions flexibly and dislike the restrictions placed upon them by their company pension scheme rules.
Determining how best to access pension benefits
As with all advice, the ‘best’ solution for a client will depend upon a number of factors:
What are the taxation consequences of each possible scenario?
Is an income or a lump sum needed now or in the future and, if so, what is the best way to provide it?
How important is ‘certainty’ of income to the client?
Health – is the client likely to live long enough to benefit fully from the guaranteed income for life provided by a defined benefit company pension scheme?
Family history of longevity
Does the client have a spouse/dependent that would benefit from survivors benefits on death?
At what age is the company pension scheme income available and does this tie in with the clients planned retirement age?
Are there early retirement options and if so at what cost?
This list is not exhaustive and there are also often many differences between company pension schemes and what benefits and options are available. Therefore, the best advice I can give is talk to an Independent Financial Adviser to find out what your own scheme offers and whether this fits in with your needs and objectives for retirement and beyond.
Speed Financial Solutions are a highly qualified financial services provider looking after clients throughout Spain and the UK. We provide a discreet and comprehensive service to individuals, and our service is tailored to suit your needs taking advantage of tactical opportunities as they arise in respect of your investment planning. We seek innovative solutions for our clients and employ our skills, based on many years of experience, to apply tax legislation to your advantage. Our relationships are built on trust and mutual respect. We are ready to answer your questions, giving you the confidence you want when dealing with a sensitive issue such as discussing your pensions, investments and savings.
Our Principal, Andrea Speed, is a Fellow of the Personal Finance Society (PFS) which is the professional body for the financial planning community. The PFS is part of the Chartered Insurance Institute (CII), which is the world’s largest professional body for insurance and financial services in the world.
Fellowship is the highest qualification awarded by the CII and is universally regarded as the premier qualification. It is a major achievement in the financial industry and demonstrates the acquisition of skills and knowledge at the highest of levels.
Along with a Fellowship, Andrea is a CII Chartered Financial Planner specialising in Investment, Taxation and Trusts.
Please take a look at our website – www.speedfinancialsolutions.com
For further information contact us on Tel 951 315 271 or 951 318 529
We are happy to discuss your own situation in more detail. One of our advisers would be pleased to spend some time with you either in your home or at our office to review your current savings, investments and pensions, so do call to make an appointment. Our Financial Review is completely free of charge and without obligation. Follow us on Facebook for regular updates.
The contents published are not recommendations or decision aids for your investment decisions and they do not constitute any type of advice. We are not tax advisers and independent tax advice should always be sought.
Andrea J Speed FPFS (DM), M.A.
Principal, Fellow and Chartered Financial Planner
Speed Financial Solutions
29 April 2019