Latest Trends in Final Salary Schemes

Please click on the PDF link below  – this is a very interesting article published by The Financial Times on the 31st December 2016 (New Years’ Eve – so you’d be forgiven if you missed it!) and admittedly several years ago  – however it remains incredibly valid today.

It mentions what is going on in the UK right now with regard to Final Salary schemes and how sentiment is rapidly changing.

Somewhat amusingly it also features a comment by Baroness Altmann – the former UK pensions minister as to why she transferred 2 of her own final salary schemes.

Final Salary (DB) Scheme Trends – Financial Times  (PDF uploaded to this site)

Factors which have impacted Defined Benefit Schemes

As of January 1st 2005, accounting standards were adopted that meant any pension scheme deficits had to be disclosed in company accounts resulting in companies gaining higher risk ratings. This typically means that companies must pay more for credit or see its share price negatively affected or both.

The costs of running a DB scheme have risen. This has caused companies to change or at least consider changing to a defined contribution scheme (DC) The main 4 factors that affected the cost of DB schemes are as follows;

  • members living longer
  • falls in pension fund values
  • loss of advance corporation tax (ACT) relief, which has indirectly reduced investment returns
  • compliance with new and more stringent regulatory requirements for pension funds, such as the need to meet a minimum funding requirement

The advantages of DB schemes are;

  • The member knows roughly what they will receive;

However this is a ‘promise’ which the scheme plans to pay and not a Guaranteed Minimum Pension (GMP) amount which is typically a lot less.

  • The member benefits from a statutory revaluing to keep place with inflation

These are typically linked to CPI or a newer pension benchmark amount the Limited Price Index (LPI) which is a special RPI linked index designed for UK defined pension schemes.

It is capped at 5%  (or 2.5% since 2005) and has a minimum of 0%. Last year it was set at 0%

At the point the member starts to draw on the pension an annuity is created. Please see below for more detail on annuities.

  • Aides attraction and retention of employees particularly as such schemes have become incredibly rare.

DB schemes may disappear completely unless the government introduces methods of decreasing the financial burdens on employers. Ideas include providing additional tax incentives  or even allowing amendments to the guaranteed benefits when good reasons require it.

These type of schemes have typically been closed to new employees for many years now as employers have had to accept that they can not afford them and a huge deficit has been created – circa £76 billion. (Note: One thought: 1 million seconds is 12 days, 1 billion seconds is 32 years – to put that in perspective a little!)

2017 was a good year for the financial markets so there has been some recovery to reduce it to £76 Bn, see here for a FT article from January 2018

However the beginning of 2018 also saw the collapse of Carillion and its reported pension deficit of £587m – right click and open a new tab to read an article from The Telegraph here

Some independent pensions consultants warn that the real hit to the PPF could be around £800m.

The PPF is a statutory corporation but funded by a levy on eligible schemes, to see a list of all the company schemes that have entered the scheme  – see this link to their web site

Whatever benefits you may have built up to the point when an employer is wound up or the pension scheme is placed into the PPF are capped at age 65 and from 1 April 2017, £38,505.61

If you are yet to retire then the level reduce to 90% of the cap maximum.

It’s surely devastating to have worked all your life to have this happen to you  – but sadly it seems to be an increasing trend  – this is a significant contributor to people choosing to transfer out and secure their benefits by moving them into a SIPP – see the link below for more info.


Annuities have been on a downward trend since the early 1990’s. Since the introduction of ‘pensions freedom and choice‘ on the 6 April 2006 (so called ‘A’ Day), individuals have more flexible retirement income options. Annuities are still considered a secure method of obtaining a regular guaranteed income however, this comes at a cost.

If a member wants to ensure that their pension benefits increase in retirement they will need to obtain an annuity with an ‘escalation option’.

This is possible, but the initial annuity amount will be greatly reduced in the early years (just at a time when people are likely to spend more) and by some calculations, so much so that it will take roughly 12 years for income levels to match the amount that could have been taken immediately as a level pension, and a further 8 years to have actually have received more money then the ‘level’ option from the annuity provider. Put another way, if a member started to take their pension at 60 years old they would need to live until 80 years to benefit from this option.

The alternative is to take a level term annuity. The real value of the will obviously erode with time. So again let’s say the annuity provided a pension of 10,000 p.a. ; in 20 years time that would be effectively 5,500 p.a. (with inflation calculated at 3%) Therefore spending power is affected dramatically in the later years.

To aid greater expenditure requirements in the early years of retirement a Pension Commencement Lump Sum (PCLS) typically of 25% can be taken, this would obviously affect the amount available for the annuity.

The Alternative

To create a perpetuity. To understand more about this and its strategy, see the SIPP page and please contact Phil here