As an expatriate with a UK pension you may be somewhat alarmed by the significant storm that has erupted in the British financial media around the ongoing pension funds deficit crisis and the potential consequences for members of defined benefit (DB) pension schemes, also known as final salary schemes.
And rightly so you should be, as you could be affected. The bottom-line is that there is considerable uncertainty around the future of the British pensions industry, and what impacts may still emerge in respect of defined benefit schemes. Some analysts and financial commentators are referring to it as the UK’s “pensions time bomb” or “pensions black hole”.
However, there is no need for panic if you take precautionary control, as various courses of action may be available if you should be one of those who could be affected. While not all pension schemes in the UK are in deficit, it is important to assess and fully understand all the relevant details of your pension scheme: know its strategy and policies; know where it is invested; know whether it is considering making any changes to other schemes or structures; establish what your transfer value is at present; and find out what other options are available to you.
If you have your retirement invested in a defined benefit or final salary scheme, even if it is with a major organisation you consider to be “safe”, you should nonetheless investigate the options available to you to minimise any potential risk to you.
But let me stress at the outset that to do so, you should always seek independent professional advice before making any decisions. It is a complicated issue and, as with any investment, making the wrong decision can be extremely costly.
How does the UK pension deficit crisis affect you?
The news headlines have painted a rather bewildering and confusing picture of the crisis in the UK, and what you as the beneficiary of a defined benefit retirement scheme can expect. For those who are not fully versed in the differences between various pension schemes, a defined benefit scheme is a pension scheme to which you contribute throughout your career, with the money being invested into various investments over time.
Often also referred to as a final salary pension scheme, these pension schemes promise to pay a predetermined income when you retire. This can be based on your final salary when you left or retired from the company.
The risk for companies with such schemes – and one of the reasons which contributed to the current deficit crisis in the UK – is that they cannot accurately predict the future assets-versus-liabilities position of the scheme because of a number of factors beyond their control. Simply put, they don’t know in advance how much a pension fund is required to pay out versus how much money is available to pay out and the deficit occurs when there is too little money to pay out.
Among others, these impacting factors include increases in life expectancy where people live longer than initially anticipated and the funds have to pay out more money over a longer period; under-performing investments and currencies, including a fall in the value of equities and bond yields, both of which are often used as investment vehicles for pension funds; underfunding or mismanagement of pension schemes due to poor financial performance or for example, where dividends out of profits are paid rather than funding the pension schemes; the impact of long-term low interest rates on pension deficits, which has been the case in Britain for more than a decade; and economic impacts caused by political events, such as has been the case in Britain in the aftermath of Brexit.
As a result of such factors coming into play, the total solvency deficit of defined benefit schemes in the UK private sector stands at over £780bn. According to the Pension Protection Fund (PPF), two-thirds of the pension schemes which it monitors were in deficit at the end of last year.
The pension schemes of major UK companies once considered to be safe, like Toys-R-Us, Carillion, BT, BAE Systems, BP and Shell, have run into deficits. Some commentators say the problem is that no-one really knows how big the “pensions black hole” is. For instance, Carillion initially said it had pension liabilities of £650mn, which were later found to be closer to £2.6bn, according to reports.
Many of these pension schemes are now calling on the PPF to bail them out. The PPF was set up as a lifeboat for some 11-million holders of defined benefit pension schemes in the event of their collapse or where they are unable to reverse their deficits and meet their commitments. In such cases the PPF takes over their liabilities with guaranteed pension pay-outs to members that have thus been affected, albeit with certain caps and rules that may cause the pay-outs to be lower than the original defined benefit value.
On the upside, the situation has also prompted many companies to channel more funds into these schemes. For instance, the Royal Bank of Scotland put £4.5bn into its group pension fund last year, joining 51 other companies on the FTSE 100 index that did the same, according to JLT Employment Benefits. The scramble by FTSE 100 firms to fill their huge pension black holes, has resulted in the pension deficit of UK blue chip companies falling £9bn since 2016.
It was thought that the interest rate increase announced by the Bank of England late last year, could bring some relief as it may help to lower these deficits somewhat too. But the final pension values of those with a defined benefit scheme or final salary scheme would be adversely affected by the rate hike due to the link between rising interest rates and gilt and bond yields comes.
At the same time the total cost of pension liabilities has increased 20% to £705bn, JLT said. This has caused some companies to shut down their generous defined benefit pension schemes and transfer their final salary pensions liabilities to insurers in “bulk annuity” contracts or through “longevity swaps”, a form of insurance contract that insures schemes in the event that members live for longer than expected. The volume of bulk annuity transactions has rapidly increased in recent years and was estimated to total £10bn in 2017, compared to just £2.9bn ten years earlier.
The current situation has also put tremendous pressure on the PPF. According to the PPF’s annual accounts in 2017, the fund’s position had improved over the previous year and it had invested assets of £28.7bn and reserves of £6.1bn. But some commentators believe this may not be enough to take care of the massive scale of the current defined benefit pension deficits. According to an article in The Telegraph and other news reports, Carillion’s collapsed pension scheme is estimated to likely cost the PPF between £800 and £900m, while BT has a pension deficit of £14bn, Shell £6.9bn, BP £6.7bn and Tesco and BAE Systems each have a £6.6bn deficit, and at least three other FTSE 100 firms have deficits over £2bn.
It is estimated by some that the pension deficits of the UK’s top five biggest company schemes alone could wipe out the assets of the PPF. And experts estimate that the problem of managing the huge defined benefit pension schemes is going to worsen in the coming years.
What you can do about your UK pension fund
Against this background, as a member of a defined benefit scheme, your current and future pension position and the options available to you will depend on a number of factors. Everybody’s circumstances are different and there is no set course of action to take to safeguard your pension and ensure you receive the maximum benefit after a life-time of working for it.
The situation could be exacerbated by the fact, as shown in a recent Moneywise.co.uk poll, that 5% of people with a UK pension don’t know what type of pension they have, while 8% with a workplace defined benefit (final salary) pension said they don’t know their scheme’s strategy, governance or where it is invested.
So for these reasons and because of the often complicated alternative options that are available, it is vitally important that you should always obtain professional advice from a qualified and independent financial adviser who fully understands all the intricacies of defined benefit pension schemes before making any decisions.
Despite the interest rate hike last year, interest rates remain relatively low and therefore many pension schemes offer very good cash-equivalent transfer values (CETV). With most schemes you are entitled to a free CETV calculation every 12 months, and this should be part of the annual review of your portfolio and financial provisions.
If you have a UK-based private pension, you are allowed to transfer your pension elsewhere. There are a number of options available such as a Qualified Non-UK Pension Scheme (QNUPS) or a Self-Invested Personal Pension (SIPP), for investors who want greater control over their wealth and financial assets. A SIPP is a pension wrapper that holds investments until you retire and start to draw a retirement income. But while you have no control over where your regular defined benefit scheme invests, in a SIPP you have control and more flexibility to choose your investments.
It is however important to consider your situation carefully before making any decisions. As leading experts in the field, Carrick has a strong client-centric ethos, putting the client first and looking at each client’s particular financial circumstances and requirements – and not just transferring a pension. We provide our clients with a long-term financial plan according to their personal current and future financial objectives.
If you belong to a UK-based defined benefit or final salary scheme, don’t become a victim of uncertainties or developments beyond your control. Contact Carrick Wealth at [email protected] to arrange for one of our qualified wealth specialists to assist you.