For those of you with a defined benefit/final salary pension in the UK, even non-UK nationals, there has never been a more important time in which to review its value, benefits, and the schemes overall health.
I have highlighted below the key reasons why you should put a pension review at the top of your to do list.
Unless you have been on a different planet for the last few months, you will have definitely heard of this phrase.
For those of you that don’t know, Brexit is an abbreviation for the UK vote to leave the European Union on June 23rd 2016.
The decision to leave the EU by the UK public came as quite a shock, nobody really thought that it would happen. However, now that it has, there has been a further negative impact on the security of UK defined benefit schemes.
In a nutshell, this is down to the deficit between funding levels of UK pension schemes, and the so called ‘guaranteed’ benefits that the scheme members should be entitled to.
The value of defined benefit schemes is calculated from UK government gilt (bond) yields. The lower the gilt yields fall, the higher the pension value. Since the Brexit vote in June, UK Gilt yields have fallen below 1% for the first time in history, and there is certainly no end in sight for a recovery.
The UK pension deficit is currently over GBP 900 billion and has been rising steadily for the last 30 years. Put simply, there is currently GBP 900 billion missing from these schemes. In the next 15-20 years when people come to retire, the reality is there will not be enough money in their pensions to pay their full entitlement.
The buzzwords surrounding defined benefit schemes, such as ‘guaranteed benefits’ and ‘gold-plated pensions’, are also misleading as they discourage scheme holders from checking up on their pension pots – blindly assuming that the money will be there for them when they retire, which is looking less and less likely.
An additional problem the UK is currently facing is low interest rates. The Bank of England has recently cut the UK base rate to 0.25% as a result of the Brexit vote. The effect of low interest rates increases the cost of pensions to scheme providers. The pension deficit rose by over GBP 70 billion alone after the recently interest rate cut. Many western economies now have negative interest rates, and if the UK were to follow suit this would heap the pressure onto the already strained scheme providers.
Pension Protection Fund (PPF)
There is a fund in the UK designed to protect pension holders if their scheme becomes illiquid and unable to pay benefits. Although on the face of it this seems to be a good idea, there are some fundamental flaws relating to the fund.
The PPF is funded by the pension schemes themselves, and the annual levy is higher for the higher risk pension schemes. This leads to a situation whereby the most underfunded schemes are paying the highest fees to the PPF, which creates a vicious circle and only heightens the problem.
There is also a cap on the annual benefit a scheme holder would receive should the pension fund be placed within the PPF, potentially causing the scheme holder to lose out on some of their otherwise ‘guaranteed’ benefits.
If you would like to talk about any of the topics covered in this article, please contact me on the channels below.
LinkedIn: Chris Keeling DipFA CeSRE
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