Final Salary Pensions / Deficits / Benefits (long post)

martncags said:
I don't think a DB transfer is as straightforward as you suggest. In fact, i don't think it's possible for some schemes
Click to expand...
It’s not possible for certain schemes (teachers, armed forces, NHS etc), but seeing as I’ve been doing them for 15 years then I’m fairly certain of how they are done.
 
SWP's back said:
OK so the Carillion thread has brought to light the fact a lot of people are very much in the dark over Final Salary (Defined Benefit - DB) Pension Schemes. They have always been held up as "gold plated" and guaranteed and by and large they have been fairly excellent.

I'm going to run through a number of pros and cons and explain why so many DB Schemes are in deficit and why it's not always a case of the directors of a company taking the piss and buying more yachts.

So the majority of final salary schemes work on a 60ths or 80ths basis. That basically means if you work somewhere (in a 60ths scheme) for 30 years, your pension benefits will be half (30/60ths) of your final salary. These are obviously very attractive to the average person for obvious reasons. The problems now being faced by companies that run these schemes are two fold;
  • Firstly, people are now living a lot longer than was expected when these schemes were first put in place. When people were retiring at 65 and dying at 72, the scheme was paying out the full retirement income for only 7 years. Now life expectancy is far higher and increasing year on year, the actuaries have to show a higher liability. Unlike Defined Contribution (DC) or "Money Purchase" Schemes, a scheme has to show on their balance sheet - the total possible liability, even if they have been well funded and well invested. Using an example of a scheme member being in a 60ths scheme, having worked for 30 years and finished on £60,000 per year, the pension trustees know that they have a liability of (around) 20 years paying £30,000 per year. That means the liability for that one member is a minimum of £600,000 (plus any indexation/escalation) in income. Now the member may have paid in 5% every year and the company funds the rest for that guaranteed annuity (30/60th final salary) but the member may have had an average salary over his service of £24,000 meaning they have paid in around £24,000 over their employment (at 5% employee contribution). That is some jump compared to the assumed liability (£600,000) and it is the company/scheme that has to fund that gap.
  • The second (and huge) issue these schemes have is that the liability of a scheme is based on interest (namely 10 year treasury gilt) rates. When a member starts taking benefits then the scheme bases their assumed growth on gilt yield rates. As interest rates have been at record lows over the last ten years, the scheme has to assume that the growth on their holdings are tiny, if anything at all. This means the liability is much higher that it would have been 15 years ago, even if the scheme has been well funded and has seen good investment growth. In our example above, when a scheme member starts taking their benefits and the liability is £600,000, rather than 15 years ago when the scheme could assume 3-5% growth in low risk gilts (meaning the £600,000 could be satisfied over the next 20 years with potentially only a cost to the scheme of £300,000) the low rate of return makes it much more expensive on the balance sheet.
So that's why, despite the best efforts of some companies (such as BA who have ploughed £3.5bn into their pension scheme over the last 15 years but still have a £3.7bn pension deficit), huge deficits are still showing and the figures are increasing. The only way that trend would be reversed (if everything else stayed the same) would be for people to start dying sooner or interest rates rising again. As I say, these schemes with deficits have them based on future liabilities.

What happens if the company goes under?
The Department of Work and Pensions run the Pension Protector Fund via a levy on solvent pension funds. It currently has around £6bn in cash and over £240bn in net assets. It exists to ensure that if a company becomes insolvent then the scheme members aren't completely shafted. Once a scheme enters the PPF then there's an immediate 10% reduction in benefits for those that have not already starting benefits and it becomes impossible to transfer your benefits out the scheme into a Self Invested Personal Pension (SIPP) but at least members know that they will be able to retire on something.

Options if you are worried about your scheme
So everyone is welcome to a full valuation and to be told of all benefits accrued by the DB (or even DC) Scheme. Most people don't know the position of their scheme and what they are entitled to, which to my mind is crazy. It is usually either their highest or second highest asset after a property. People should be enquiring of their pension trustees as to;
  • The scheme's funding position
  • Their accrued benefits (how much they will receive)
  • What age they will receive
  • What their spouse will receive (50% as a rule)
  • What their kids would receive if you and your spouse pass away (Zero if they are over 18)
  • Is a tax free lump sum available on retirement?
  • What indexation applies to the benefits once crystallised (i.e. you start receiving funds)
  • What is the transfer value if the member wanted to transfer to a personal pension (usually somewhere between 15 to 40 (FORTY) times the accrued annual income - i.e. if a member was entitled to £10,000 per year, the transfer value may be somewhere between £150,000 to £400,000 - transfer values are now actually at record highs due to the same interest/gilt rate calculation as mentioned before)

If people wish to look at transferring out of the DB scheme
If any scheme member is unsatisfied with the answers they receive then they are fully entitled to transfer their pension pot from a DB scheme into their own personal pension. They would lose some of the guarantees that a DB scheme has, however;
  • They could leave all of their pension pot to their spouse or kids free of tax (although if the member was over 75, their kids would pay income tax at their marginal rate). This is usually a huge point as very few members of DB schemes are aware their spouse would only get 50% and that their kids would get nothing at all.
  • They have the option of a 25% tax free lump sum.
  • They can take benefits from age 55 onwards (as opposed to some DB schemes which are 60 or 65 and may penalise the benefits for taking them earlier)
  • Flexible Drawdown - Where as a DB scheme will pay a flat (or indexed) monthly income, a personal pension now allows flexible drawdown, meaning you can take more income in the earlier years when you are younger and in a position to enjoy it.
  • Investment control - Unlike a DB or even a DC scheme, personal pensions (or SIPP) members have full control over their investment decisions. This means that a member can choose the level of risk that suits them without a trustee making those decisions on their behalf.
  • Also, if you transfer into a personal pension, it means that no board of directors can fuck up and instantly lose you 10 to 20% of your pension by forcing the scheme into the PPF.

As with all things like this, if you are concerned or want more information about your personal scheme and situation then get personal and professional advice. Transferring from a DB scheme is a big decision and it wouldn't be the right choice for everybody (due to the "guarantees" that they offer), but everyone should at least be educated on all of their options and the pros and cons of staying put or leaving.
Click to expand...
I have a frozen db pension wit Vauxhall just asked for my transfer value to find the trustees have voted to reduce the value by 20%
 
SWP's back said:
OK so the Carillion thread has brought to light the fact a lot of people are very much in the dark over Final Salary (Defined Benefit - DB) Pension Schemes. They have always been held up as "gold plated" and guaranteed and by and large they have been fairly excellent.

I'm going to run through a number of pros and cons and explain why so many DB Schemes are in deficit and why it's not always a case of the directors of a company taking the piss and buying more yachts.

So the majority of final salary schemes work on a 60ths or 80ths basis. That basically means if you work somewhere (in a 60ths scheme) for 30 years, your pension benefits will be half (30/60ths) of your final salary. These are obviously very attractive to the average person for obvious reasons. The problems now being faced by companies that run these schemes are two fold;
  • Firstly, people are now living a lot longer than was expected when these schemes were first put in place. When people were retiring at 65 and dying at 72, the scheme was paying out the full retirement income for only 7 years. Now life expectancy is far higher and increasing year on year, the actuaries have to show a higher liability. Unlike Defined Contribution (DC) or "Money Purchase" Schemes, a scheme has to show on their balance sheet - the total possible liability, even if they have been well funded and well invested. Using an example of a scheme member being in a 60ths scheme, having worked for 30 years and finished on £60,000 per year, the pension trustees know that they have a liability of (around) 20 years paying £30,000 per year. That means the liability for that one member is a minimum of £600,000 (plus any indexation/escalation) in income. Now the member may have paid in 5% every year and the company funds the rest for that guaranteed annuity (30/60th final salary) but the member may have had an average salary over his service of £24,000 meaning they have paid in around £24,000 over their employment (at 5% employee contribution). That is some jump compared to the assumed liability (£600,000) and it is the company/scheme that has to fund that gap.
  • The second (and huge) issue these schemes have is that the liability of a scheme is based on interest (namely 10 year treasury gilt) rates. When a member starts taking benefits then the scheme bases their assumed growth on gilt yield rates. As interest rates have been at record lows over the last ten years, the scheme has to assume that the growth on their holdings are tiny, if anything at all. This means the liability is much higher that it would have been 15 years ago, even if the scheme has been well funded and has seen good investment growth. In our example above, when a scheme member starts taking their benefits and the liability is £600,000, rather than 15 years ago when the scheme could assume 3-5% growth in low risk gilts (meaning the £600,000 could be satisfied over the next 20 years with potentially only a cost to the scheme of £300,000) the low rate of return makes it much more expensive on the balance sheet.
So that's why, despite the best efforts of some companies (such as BA who have ploughed £3.5bn into their pension scheme over the last 15 years but still have a £3.7bn pension deficit), huge deficits are still showing and the figures are increasing. The only way that trend would be reversed (if everything else stayed the same) would be for people to start dying sooner or interest rates rising again. As I say, these schemes with deficits have them based on future liabilities.

What happens if the company goes under?
The Department of Work and Pensions run the Pension Protector Fund via a levy on solvent pension funds. It currently has around £6bn in cash and over £240bn in net assets. It exists to ensure that if a company becomes insolvent then the scheme members aren't completely shafted. Once a scheme enters the PPF then there's an immediate 10% reduction in benefits for those that have not already starting benefits and it becomes impossible to transfer your benefits out the scheme into a Self Invested Personal Pension (SIPP) but at least members know that they will be able to retire on something.

Options if you are worried about your scheme
So everyone is welcome to a full valuation and to be told of all benefits accrued by the DB (or even DC) Scheme. Most people don't know the position of their scheme and what they are entitled to, which to my mind is crazy. It is usually either their highest or second highest asset after a property. People should be enquiring of their pension trustees as to;
  • The scheme's funding position
  • Their accrued benefits (how much they will receive)
  • What age they will receive
  • What their spouse will receive (50% as a rule)
  • What their kids would receive if you and your spouse pass away (Zero if they are over 18)
  • Is a tax free lump sum available on retirement?
  • What indexation applies to the benefits once crystallised (i.e. you start receiving funds)
  • What is the transfer value if the member wanted to transfer to a personal pension (usually somewhere between 15 to 40 (FORTY) times the accrued annual income - i.e. if a member was entitled to £10,000 per year, the transfer value may be somewhere between £150,000 to £400,000 - transfer values are now actually at record highs due to the same interest/gilt rate calculation as mentioned before)

If people wish to look at transferring out of the DB scheme
If any scheme member is unsatisfied with the answers they receive then they are fully entitled to transfer their pension pot from a DB scheme into their own personal pension. They would lose some of the guarantees that a DB scheme has, however;
  • They could leave all of their pension pot to their spouse or kids free of tax (although if the member was over 75, their kids would pay income tax at their marginal rate). This is usually a huge point as very few members of DB schemes are aware their spouse would only get 50% and that their kids would get nothing at all.
  • They have the option of a 25% tax free lump sum.
  • They can take benefits from age 55 onwards (as opposed to some DB schemes which are 60 or 65 and may penalise the benefits for taking them earlier)
  • Flexible Drawdown - Where as a DB scheme will pay a flat (or indexed) monthly income, a personal pension now allows flexible drawdown, meaning you can take more income in the earlier years when you are younger and in a position to enjoy it.
  • Investment control - Unlike a DB or even a DC scheme, personal pensions (or SIPP) members have full control over their investment decisions. This means that a member can choose the level of risk that suits them without a trustee making those decisions on their behalf.
  • Also, if you transfer into a personal pension, it means that no board of directors can fuck up and instantly lose you 10 to 20% of your pension by forcing the scheme into the PPF.

As with all things like this, if you are concerned or want more information about your personal scheme and situation then get personal and professional advice. Transferring from a DB scheme is a big decision and it wouldn't be the right choice for everybody (due to the "guarantees" that they offer), but everyone should at least be educated on all of their options and the pros and cons of staying put or leaving.
Click to expand...


Great post SWP and should be much appreciated by everyone with a vested interest.
 
That’s not exactly how mine worked before a bankruptcy robbed me of it.

Mine was 36 of highest Final Average Earnings in last 120 months, times longevity times a multiplier.
e.g. if I finished on an FAE of $100,000 after 30 years and the multiplier was 1.5%, then my pension annuity would be $45,000, or 45% of my FAE.

The actuarial exercise behind the pension was determined by (IIRC) 5% of my annual pay invested at 3.75% every year for the ongoing liability. In your example, that £600,000 liability is a snapshot that really has a long tail. In short, it is a long term liability, but it also has a long term ability to be covered by a favorable investment environment.

In the States, there are two things (three when things go bad) that greatly affect the DB Plans, and are the reason most companies now have a DC Plan (Direct Contribution, or 401K-type, Plan). One is a thing called 5 yr smoothing, the other is ERISA (a law designed to protect pensions, but which actually kills most of them) and the third is that when things go bad, the Pension Benefit Guaranty Corp (PBGC) assumes the assets at a “mark to market” valuation, which is entirely different than they had been valued inside the Plan. Depending upon timing, and most Plans go bump during negative economic cycles, it further exacerbated the shortfalls.

The 5 yr smoothing seeks to take out the peaks and troughs of the economic cycle, allowing companies to “smooth out” the valuation, and thus funding required, of the assets in the Plan. So, an asset is carried at a value that is not always reflective of it current value, and a company doesn’t have to fund a plan during a down economic cycle and can wait to do it until times improve. Post 9/11, and again Post-2008/09, valuations were devastated and quick acting corporations sought to use that to greatly overstate losses in their plans by showing their mark to market value, much as the PBGC would do if they took it over. This led to many union groups seeking to “freeze” their pensions and to move to a DC Plan. ERISA, in the other hand, does not allow a company to restate prior years liabilities by changing any parameters. However, it also does not allow a union to do it for their own members to help adjust their pension to a more favorable status, and thus make it possible to maintain. This happened to mine. Pilots sought to reduce the multiplier and cap longevity to reduce liabilities, thus, with the stroke of a pen, the pension was much healthier and liabilities reduced. From there, with a much healthier pension, we could either further adjust as necessary or freeze what we had and switch to a DC Plan, with the frozen DB Plan as a retirement backstop. ERISA doesn’t allow this, even when the people whose pension is in jeopardy agree to do it!! Therefore, the company was able to use the Internet bubble of 1999 and the 5 yr smoothing to make it seem like it was very well funded, but then after 9/11, when all hell was breaking loose, especially in the airline industry, the losses piled up, they asked for and received a funding holiday (meaning they didn’t have to fund the pension shortfall for two years) and then bled it to the point that the PBGC stepped in to stop the bleeding any further because it was going to be their liabilities that were increasing.

So, on Dec 30, 2004 (last business day of the year and the last date on which they could avoid rolling into the 2005 Payout limits) they took United Airlines Pensions out of the bankruptcy, assumed the liabilities, and charged United Airlines with a $1,500,000,000 payment against future profits to provide lost funding to the Plan. It had $7.1B in liabilities when they took it over and was about 50% funded when the underlying assets were marked to market.

Pensions in America were a corporate scam to not pay workers upfront and then play the timing of that float in the market for their own good. However, workers actually PAY IN TO THEIR OWN PENSIONS USING THIS DEFERRED COMPENSATION MODEL believing the company is actually investing that money wisely and judiciously and NOT overpromising what they can afford downline when that employee has put in their 30+ years of work. It is immoral that corporations are allowed to walk away from pensions in bankruptcy while executives reap bonuses and some executive reap even larger bonuses for “managing the company through bankruptcy.” My CEO got a $40M payoff for the bankruptcy, then had the balls to ask for it in stock, not cash, because the capital gains tax was lower than income tax!! And, Congress did not lift a finger to help the millions of workers who lost their pensions. Shocker!

Conversely, in Canada, they held a Special Session of Parliament over the rights of Canadian workers working for United Airlines. They demanded that if United wanted to continue to fly in Canada, they would pay employees EVERY PENNY OF THE PENSIONS THEY HAD ALREADY EARNED. To this day, Canadian employees of United are the only ones who kept their pension! THAT is what a moral and dignified country does for its hard working citizens when corporations try to leverage their hard earned and contractually promised money!!

So, at age 43 and a required retirement age of 65, I had to start my retirement planning all over again, almost from scratch, because the $170,000 of UAL stock I had in my retirement, that I could not sell because it was part of an ESOP(!!!) became worthless and my pension went from being planned at tens and tens of thousands at retirement to about ten from the PBGC....if they are still around when I retire, as they have no govt funding and the monies are not guaranteed!!

If you did some back of the envelope math in 2005, I think it was determined that for pilots at about 40 yrs of age at Plan termination, with a 10% Stock market return you could recoup your losses if you maximized every form of retirement savings available. However, for every year older, the picture got worse and worse, and that was at the max achievable...and 2008/09 took care of anything even approaching that for most people.

DC Plans are the way to go for new workers as they are portable, not kept inside company treasuries, and, although not a great thing for everyone, their investments are controllable by the employee not the employer. And, for those who bothered to read this far, a simple Three Fund Portfolio provides simple and easy to understand diversification to weather almost any storm.
 
SWP's back said:
OK so the Carillion thread has brought to light the fact a lot of people are very much in the dark over Final Salary (Defined Benefit - DB) Pension Schemes. They have always been held up as "gold plated" and guaranteed and by and large they have been fairly excellent.

I'm going to run through a number of pros and cons and explain why so many DB Schemes are in deficit and why it's not always a case of the directors of a company taking the piss and buying more yachts.

So the majority of final salary schemes work on a 60ths or 80ths basis. That basically means if you work somewhere (in a 60ths scheme) for 30 years, your pension benefits will be half (30/60ths) of your final salary. These are obviously very attractive to the average person for obvious reasons. The problems now being faced by companies that run these schemes are two fold;
  • Firstly, people are now living a lot longer than was expected when these schemes were first put in place. When people were retiring at 65 and dying at 72, the scheme was paying out the full retirement income for only 7 years. Now life expectancy is far higher and increasing year on year, the actuaries have to show a higher liability. Unlike Defined Contribution (DC) or "Money Purchase" Schemes, a scheme has to show on their balance sheet - the total possible liability, even if they have been well funded and well invested. Using an example of a scheme member being in a 60ths scheme, having worked for 30 years and finished on £60,000 per year, the pension trustees know that they have a liability of (around) 20 years paying £30,000 per year. That means the liability for that one member is a minimum of £600,000 (plus any indexation/escalation) in income. Now the member may have paid in 5% every year and the company funds the rest for that guaranteed annuity (30/60th final salary) but the member may have had an average salary over his service of £24,000 meaning they have paid in around £24,000 over their employment (at 5% employee contribution). That is some jump compared to the assumed liability (£600,000) and it is the company/scheme that has to fund that gap.
  • The second (and huge) issue these schemes have is that the liability of a scheme is based on interest (namely 10 year treasury gilt) rates. When a member starts taking benefits then the scheme bases their assumed growth on gilt yield rates. As interest rates have been at record lows over the last ten years, the scheme has to assume that the growth on their holdings are tiny, if anything at all. This means the liability is much higher that it would have been 15 years ago, even if the scheme has been well funded and has seen good investment growth. In our example above, when a scheme member starts taking their benefits and the liability is £600,000, rather than 15 years ago when the scheme could assume 3-5% growth in low risk gilts (meaning the £600,000 could be satisfied over the next 20 years with potentially only a cost to the scheme of £300,000) the low rate of return makes it much more expensive on the balance sheet.
So that's why, despite the best efforts of some companies (such as BA who have ploughed £3.5bn into their pension scheme over the last 15 years but still have a £3.7bn pension deficit), huge deficits are still showing and the figures are increasing. The only way that trend would be reversed (if everything else stayed the same) would be for people to start dying sooner or interest rates rising again. As I say, these schemes with deficits have them based on future liabilities.

What happens if the company goes under?
The Department of Work and Pensions run the Pension Protector Fund via a levy on solvent pension funds. It currently has around £6bn in cash and over £240bn in net assets. It exists to ensure that if a company becomes insolvent then the scheme members aren't completely shafted. Once a scheme enters the PPF then there's an immediate 10% reduction in benefits for those that have not already starting benefits and it becomes impossible to transfer your benefits out the scheme into a Self Invested Personal Pension (SIPP) but at least members know that they will be able to retire on something.

Options if you are worried about your scheme
So everyone is welcome to a full valuation and to be told of all benefits accrued by the DB (or even DC) Scheme. Most people don't know the position of their scheme and what they are entitled to, which to my mind is crazy. It is usually either their highest or second highest asset after a property. People should be enquiring of their pension trustees as to;
  • The scheme's funding position
  • Their accrued benefits (how much they will receive)
  • What age they will receive
  • What their spouse will receive (50% as a rule)
  • What their kids would receive if you and your spouse pass away (Zero if they are over 18)
  • Is a tax free lump sum available on retirement?
  • What indexation applies to the benefits once crystallised (i.e. you start receiving funds)
  • What is the transfer value if the member wanted to transfer to a personal pension (usually somewhere between 15 to 40 (FORTY) times the accrued annual income - i.e. if a member was entitled to £10,000 per year, the transfer value may be somewhere between £150,000 to £400,000 - transfer values are now actually at record highs due to the same interest/gilt rate calculation as mentioned before)

If people wish to look at transferring out of the DB scheme
If any scheme member is unsatisfied with the answers they receive then they are fully entitled to transfer their pension pot from a DB scheme into their own personal pension. They would lose some of the guarantees that a DB scheme has, however;
  • They could leave all of their pension pot to their spouse or kids free of tax (although if the member was over 75, their kids would pay income tax at their marginal rate). This is usually a huge point as very few members of DB schemes are aware their spouse would only get 50% and that their kids would get nothing at all.
  • They have the option of a 25% tax free lump sum.
  • They can take benefits from age 55 onwards (as opposed to some DB schemes which are 60 or 65 and may penalise the benefits for taking them earlier)
  • Flexible Drawdown - Where as a DB scheme will pay a flat (or indexed) monthly income, a personal pension now allows flexible drawdown, meaning you can take more income in the earlier years when you are younger and in a position to enjoy it.
  • Investment control - Unlike a DB or even a DC scheme, personal pensions (or SIPP) members have full control over their investment decisions. This means that a member can choose the level of risk that suits them without a trustee making those decisions on their behalf.
  • Also, if you transfer into a personal pension, it means that no board of directors can fuck up and instantly lose you 10 to 20% of your pension by forcing the scheme into the PPF.

As with all things like this, if you are concerned or want more information about your personal scheme and situation then get personal and professional advice. Transferring from a DB scheme is a big decision and it wouldn't be the right choice for everybody (due to the "guarantees" that they offer), but everyone should at least be educated on all of their options and the pros and cons of staying put or leaving.
Click to expand...
Excellent post Mate. Another reason why it’s important that those in DB schemes understand exactly where their pension value has got to, especially in the years running up to retirement. The government has been reducing the maximum pension pot value on a regular basis. Last time I looked it was £1m which although it seems a huge amount, can readily be achieved by someone who has been with the same employer for the duration of their career. If you breach the limit the tax on the excess is punitive.
 
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