Following some high profile corporate insolvencies, many employees, past employees and pensioners may be concerned about the security of their pension benefits. Here we explain what happens to pension benefits when the sponsoring employer goes bust.
The good news is that pension regulation and an industry sponsored lifeboat mean that the majority of scheme members and pensioners are protected and will keep most or their entire pension in these circumstances.
The exact position will depend upon the type of pension scheme and the funding position of that scheme. It is important to note that pension scheme assets are separated by law from the sponsoring employer. So even if the employer is placed in liquidation, pension benefits are ring fenced. The immediate consequence for all scheme members is that future employer contributions and accrual of benefits ceases when the contract of employment ends.
Varying schemes protect benefits that have already been built up in different ways:
Contract based pensions
A contract based pension is typically offered by an insurance company including personal pensions, stakeholder pensions and some auto-enrolment pensions. These schemes are a series of individual policies, owned by the employee, into which employer and employee pay. Each member has their own ring fenced policy. The value of the pension policy will depend solely on returns from the investments, which are not affected by the employer's financial status.
With most schemes of this sort the member can:-
- Retain the funds invested until they are ready to start receiving payments in retirement.
- Carry on paying in, if they want to, by establishing payments from their bank account.
- Receive contributions into the plan from a new employer.
- Change the investment funds to suit their individual appetite for risk.
- Change their nominated beneficiaries who receive payments after the member dies.
- Transfer the plan to a new pension arrangement.
Trust based schemes
Trust based schemes are sponsored by an employer but are overseen and run by trustees. The trustees must look after the members’ interests. They must abide by strict rules or face legal sanctions. Trust assets are legally separate from those of the employer. The scheme rules determine how pensions are paid.
Trust based schemes are divided into 2 sub categories; they may be Defined Contribution or Defined Benefit.
Defined Contribution
These are also known as money purchase schemes. Each member has an invested fund which they can convert to a guaranteed income by buying an annuity; or can transfer to a drawdown pension plan and withdraw income and cash from the accrued fund, once over age 55. The amount of income is dependent on the rate offered by the annuity provider or for drawdown, any amount can be withdrawn until the fund is exhausted.
The employer’s insolvency will not alter the individual’s fund value or the income it can produce.
- Members can leave the fund invested but will not be able to make ongoing payments into it, as these are made by payroll deduction.
- They may transfer the fund to a pension plan in their own name, which would facilitate contributions to recommence.
- They can usually change the funds in which they are invested and can change the nomination of beneficiaries to receive funds after their death, in line with the scheme rules.
- Trustees will usually wind up the scheme and arrange a bulk transfer of members’ funds into individual contract based schemes, owned by each member, who then have the same options as those with contract based schemes.
Defined Benefit
These are also known as final salary or career average pension schemes, defined benefit pensions 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. 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.
For an explanation of how these schemes benefits are protected, our next post will focus on the Pension Protection Fund.
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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