Defined Benefit Pension Schemes
Also known as final salary or career average pension schemes, defined benefit schemes offer a guarantee of an annual pension from a given retirement age. They usually include a promise of a dependant’s pension, payable after the member's death and inflation linked increases. This type of guaranteed pension is very valuable. What happens to these promises when the employer sponsoring the scheme fails?
Whether an employer's insolvency will affect delivery of the guaranteed pension depends upon the solvency of the pension scheme, which is separate from that of the employer.
Just because an employer is insolvent, it does not automatically follow that the pension scheme cannot meet its obligations to pay pensions to its members.
Fully funded schemes
If the scheme is well funded and in surplus, or if the trustees have transferred the scheme liabilities to an insurance company, the insolvency of the employer may be immaterial for pensioners and former employees yet to draw their pensions.
Those still working and accruing pension, will cease to accrue future service when their employment ends but will not lose the promise of what they have already built up.
Those with more than a year to retirement age may transfer their pensions to a new scheme, but should not do so simply because the employer has ceased to trade. An insolvent employer could still be offering a promise of a pension from a solvent pension scheme.
All members should still be able to draw their pensions when they fall due in line with the scheme rules. Where there is no longer a sponsoring employer the trustees will wind up the scheme for future accrual and can, with the Pension Regulator’s permission, take steps to secure the benefits with an insurance company. If there is still a surplus left over when this has been done, it can be returned to the administrator of the sponsoring employer. In the unlikely event that the insurer was to fail, the member would be able to make a claim under the Financial Services Compensation Scheme.
Scheme in deficit
Where a defined benefit scheme is not fully funded and has a pension deficit, the future security of members’ pensions will be managed by the Pension Protection Fund (PPF). The PPF was established by government but is funded by the pensions industry. It assesses the financial stability of the pension scheme and helps the trustees establish a rescue plan.
If the trust’s assets and liabilities can be managed to secure members’ pensions, the scheme may continue and members will be able to draw benefits in line with the scheme rules. During the period of assessment members lose their right to transfer away from the scheme.
If liabilities cannot be met from the scheme assets, the scheme will be taken over by the PPF which will secure benefits as follows:
- Pensioners and those over scheme retirement age will generally get 100% of pensions.
- Those yet to draw their pensions or under the scheme retirement age generally get 90% of their pension accrued, paid from their normal retirement age. This is subject to a cap of £38,505 per annum from age 65 currently, so the maximum paid out is £34,655 pa. The cap is less for lower retirement ages and more for later ones. It is increased for members with more than 20 years service by 3% for each extra year of service.
- Increases on pensions accrued before 1997 are lost, but increases in pensions post 1997, before and after retirement are capped at the higher of CPI inflation and 2.5%.
- The right to transfer out benefits and the right to seek early retirement terms, except on the grounds of serious ill health, are also lost when a pension plan is in the PPF.
- Members at retirement may take 25% of the fund as a tax free lump sum and the pension given up to produce this is on a more generous basis than would be the case if the scheme was solvent.
Losing a job due to an employers’ insolvency is clearly a stressful experience. It does not mean that pension benefits built up will automatically be lost too. The law protects these benefits from the firm’s creditors and the PPF has been successful in maintaining most of the pensions due to the majority of scheme members. Anyone faced with this should seek professional advice.
Kay Ingram
Director of Public Policy, LEBC
Please remember, no news or research item is a recommendation or advice to buy. LEBC Group Ltd is not responsible for accuracy and may not share the author’s views. If you are unsure of the suitability of any investment or product for your circumstances please contact an adviser. All investments can fall as well as rise in value so you could get back less than you invest.
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