No Final Salary Pension Scheme?

Over the past few years, final salary pension schemes have witnessed volatility in equity markets and a retired workforce that is living longer. Add the two together, and what was once a healthy pension scheme became a huge liability, carrying significant deficits.

To reduce the liability, one by one, companies closed their final salary schemes to new members. The rules of some existing schemes were also amended to require higher contributions to be made.

This means that the number of employees retiring with a pension that pays around 50% of their final salary is forever reducing, and is a trend that will not be reversed. Granted, the number of people staying with the same firm to amass forty years of service to qualify for the maximum pension is also reducing. Greater movement in the labour market will also be a contributing factor in lower pensions at retirement.

So where does this leave employees? Companies that have moved away from final salary pension schemes have turned to offering defined contribution or money purchase pension schemes. Here the employer and employee pays contributions into the scheme, more than likely based on a percentage of current salary. The premiums are then invested in pension funds that can range from with profits to UK equities to Far East funds. At retirement the amount in the kitty depends on the level of contributions but also on how well the funds have performed, increasing the risk to the employee.

The big difference is the level of contributions paid into the respective schemes by the employer. A typical final salary scheme may have received 15% - 20% from the employer with employees paying 5% or 6%. The money purchase scheme will require the employee to contribute at a similar level but the employers premium may have reduced to 5% also, that is to match the employees contribution.

It gets worse still for the employees whose company now offers a stakeholder pension scheme, whereby the employer contribution may be in the range of 0% to 3%.

It's not difficult to see the impact this has on the pension pot. With contributions to money purchase schemes at least 50% lower than final salary schemes the amount of income it generates will drop by a similar amount. This could be less than the amount required to live on.

So from having 100% of salary many people face the prospect of receiving one quarter of that amount. Where does this leave employees in this situation? Well, neither option is easy to swallow. First, you work longer, putting back your early retirement at 55 to a more realistic 65. Another ten years at work definitely doesn't appeal. The second option is to save more. Not always doable with rising living costs such as mortgages, utility costs and petrol, but saving as much as possible will help. For those lucky enough to be just starting out at work, the best option is to start a pension (or savings plan) as soon as you can.