What are final salary pensions?
Final salary pensions are occupational or workplace pensions where your income in retirement is calculated based on your final salary, and number of years of service. Because of this guarantee contained in final salary pensions, they are regarded as high quality pensions and superior to defined contribution pensions, which carry no such guarantee.
Final salary pensions carry a considerable risk for employers, because of their promise of a guaranteed payout. When stock markets were performing well, final salary pensions were flooded with cash, and some were even able to offer contributions ‘holidays’ to employees in the form of months when they did not have to pay money into the scheme.
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In recent years, however, final salary pensions have paid the price for carrying a payment guarantee, as many large final salary pension schemes have suffered from the downturn in the stock markets, and yields from investments have been inadequate to meet their liabilities. When final salary pensions fail to generate enough cash to cover their obligations, and this perhaps continues to be the case for several consecutive years, ongoing pension payments to former workers become a massive drain on the scheme and its resources are quickly depleted. No matter how much money is left in the final salary pensions scheme, the guarantees do not go away – and the company is forced to dig deep into its own resources to make up the shortfall – often with alarming consequences for the company’s financial wellbeing.
Big names forced to close final salary pensions
The list of big-name UK companies that have withdrawn or are proposing to withdraw from final salary pensions during 2010/11 includes the construction firm Taylor Wimpey, newspaper group Trinity Mirror, Pirelli, Fujitsu, Barclays Bank, supermarket chain Morrissons, Vodafone, BMI, Dairy Crest, IBM and Costain.
Each of these companies is labouring under existing guaranteed pension commitments not just to current employees, but to all the former employees who are now already drawing their final salary pensions in retirement. This has left employers struggling to make up the shortfall from their own cash reserves, in order to meet the guarantee to retiring and retired employees.
As a result of these often crippling cash commitments that have arisen for larger employers with final salary pensions schemes, many schemes are no longer accepting new members and are being gradually run down.
Workers leaving final salary pensions assume greater risk
Many such employers are placing new employees in defined contribution pension schemes, or closing final salary pensions now, and offering current employees only the option to save into a defined contribution pension scheme, moving forward.
Defined contribution pension schemes are dependent solely on the returns of the underlying investments.
Employees switching away from final salary pensions are generally seen as suffering a disadvantage, as they can no longer predict their income in retirement. Furthermore, by losing the guarantee that comes with final salary pensions, the risk of the investments is effectively carried by the workers, not by the company.
Pensions contributions already made to final salary pensions are safe, however, provided that the company remains in existence.
Are you confused about your company pension? It may not be the best place for you to save for your retirement. Discuss your options with one of our advisers who can evaluate the scheme based on your personal needs. Call 0800 678 5929 to speak to an adviser or make a pension enquiry for a callback
