Why taking the bull by the horns is not always enough with pensions
“Sometimes you've just got to take the bull by the teeth.”
The words of legendary movie mogul Sam Goldwyn mean there are times when confronting an issue in the traditional way – ‘taking the bull by horns' – is not enough.
Well, pension industry experts are warning they have spotted such a situation, a shooting firework which may explode into the biggest mis-selling scandal of this decade.
It concerns those of us lucky enough to have saved into a defined benefit pension. The pension's name tells what it does: your benefits are defined, meaning you have a guaranteed, index-linked income for the rest of your life. It's usually calculated on the basis of your final salary and years of service. Hence its more common title, the ‘final salary pension'.
Final salary pensions were quite common in the closing decades of the last century. They were used not only as a strong employee incentive, but also as a means for large companies to use their pension schemes to trim down their workforce. Putting it bluntly, workers in their early 50s who became ‘surplus to requirements' were offered a grand little redundancy package, plus this gold-plated final salary pension.
Well, those generous days are gone and the vast majority of these final salary schemes were closed to new entrants. Now, new employees are offered the less spectacular defined contribution pension, where the amount you pay in is defined, but the company does not guarantee how much you'll get out.
Back to the present. Employers with workers who had been in a final salary scheme still have obligations in relation to that scheme. In other words, even though we're no longer in the boom years of the 80s and 90s, those employers must honour the contract – they still have to ‘pay up' irrespective of how the investments in the pension scheme have done.
As a result, many employees are now being offered the option – some would say ‘encouraged' - to transfer their final salary pension over into a defined contribution pension. This may not be in the employee's best interests. In fact, it may be that the employer's main motivation is cutting his future pension liability.
Some take the view that the transfer option is, therefore, being mis-sold to savers. Do you remember the last mis-selling scandal? Does the term PPI, stands for Payment Protection Insurance, ring any bells?
As a result of such ‘encouragement', we have a growing industry of defined benefit to defined contribution transfers, and these rumblings among financial advisers that giving up the security of a final salary pension usually just isn't a good move.
Also, the Bank of England ‘guvnor' Mark Carney has hinted that the base rate of interest could soon rise to 1 per cent, twice its current level, which will hit the transfer value of final salary pensions. The high transfer values we now see – 30 or 40 times the annual pension – are unlikely to last.
(Just to put the interest rate thing in context, did you know the Bank of England has us spoiled with record low interest rates of 0.5 per cent or less in recent years? Compare that to the daily average since 1694 of 4.71 per cent).
Bottom line: giving up a guaranteed, index-linked income for the rest of your life for a more risky defined contribution pension may well suit your employer's long-term goals, but could be a huge mistake for you.
As ever, talking to a good independent financial adviser will keep you right – far better to leave it to them to grab the bull by the teeth!
Michael Kennedy is an independent financial adviser and pensions specialist, and can be contacted on 028 71886005 . Further information on our Facebook page “Kennedy Independent Financial Advice Ltd”