My old final salary pension scheme is 95% funded, but still £200million short: When do you need to worry about a deficit?
I have received a letter from an old employer’s final salary pension scheme which says it has a funding level of 95 per cent.
That doesn’t sound too bad, but the shortfall is still about £200million, which does sound like a lot.
The ‘actuarial valuation’ dates from spring 2018, which seems a long time ago. But the letter says the company put in £20million in summer 2018 and is paying in £40million-plus per year for the following four years.
My question is how can a layperson tell when to be worried about a final salary pension deficit? Do you need to be concerned at a 95 per cent funding level? What about 75 per cent? Or 55 per cent? Should you just relax unless a company is in financial trouble?
Pension concern: My old employer’s final salary scheme has a deficit of several hundred million pounds – should I be worried? (Stock image)
Tanya Jefferies, of This is Money, replies: After high profile business collapses like BHS, Carillion and now Thomas Cook, it is understandable to wonder about the financial health of an old employer which is meant to provide a final salary pension in retirement.
But as we explained in the case of Thomas Cook, final salary pension schemes are safeguarded even if a firm goes bust.
At worst they get rescued by a lifeboat scheme, and any reductions to payouts are relatively low except for those due a very large pension.
That said, it makes sense to stay alert to any warning signs. We asked a final salary pensions expert at a specialist financial consultancy to explain what funding levels are typical, and whether to be concerned about the size of this deficit.
Patrick Bloomfield, a partner at Hymans Robertson, replies: ‘Is my final salary pension safe?’ is a good question to ask, but it isn’t something most people should lose any sleep over.
Patrick Bloomfield: ‘The average funding level for all pension schemes’ valuations last year was 89 per cent’
As long as your old employer remains in business it is liable for your scheme paying your pension in full.
If the worst happens and your old employer goes out of business, your pension would normally be taken on by the Pension Protection Fund (the PPF).
You would get most of the pension you were expecting, but with some reductions.
For example, there’s a 10 per cent reduction for people under their scheme’s retirement age and the way pensions increase each year might be less generous than in your old scheme.
The PPF was set up in 2004 as a ‘lifeboat’ to protect final salary pension scheme members when a business becomes insolvent. This is paid for through the collection of a levy on companies with final salary pension schemes.
But, as I said at the start, this is the worst case scenario. Let’s hope that doesn’t happen and take a look at what you’ve been told about your scheme’s deficit.
Pension schemes hold assets in a trust, which is legally separate from the employer. This trust is run by trustees, who are also separate from your employer.
Every three years the trustees have to do a valuation, taking advice from a suitably qualified expert (an ‘actuary’). Trustees then have to tell members about the results of the valuation in an annual update. That’s why you got your letter.
These three yearly valuations estimate how much money needs to be invested today to pay all future pensions due from the scheme.
Actuaries call this estimate the ‘liabilities’ (or ‘Technical Provisions’, which is the term used in pensions legislation). This estimate involves making assumptions about lots of things that could happen in future.
If the assets are less than the liabilities then there is a ‘deficit’. If a scheme has a deficit, the employer must pay extra contributions into the scheme, to get it back on track.
A valuation is really a budgeting exercise to check if a scheme is broadly on track to pay out what it is due in pensions.
On track would be 100 per cent. Actuaries call this a ‘funding level’, but it’s simply the value of a scheme’s assets divided by its liabilities.
Ninety five per cent is quite close to being on track. The average funding level for all pension schemes’ valuations last year was 89 per cent. It’s reassuring that your old employer’s scheme is doing a bit better than most other schemes.
Your scheme’s deficit needs to be paid off with extra contributions from your old employer. These contributions are usually paid over a few years, to help make them affordable.
Looking at all of last year’s valuations, the average number of years being taken to pay off deficits was six and a half years.
The size of a deficit needs to be looked at relative to the size of your old employer. Big pension schemes usually relate to big companies.
So, although the deficit may be several hundred million pounds, it should be in proportion to your old employer and should be affordable.
All of this is regulated by The Pensions Regulator. The Pensions Regulator checks that the assumptions trustees are using for valuations are ok and that employers are paying off deficits as quickly as they can.
The Pensions Regulator has been getting tougher in recent years. For example, they are pushing employers to put paying off deficits ahead of paying dividends.
It’s impossible to guarantee your pension will be paid in full. Odd cases about final salary pension schemes make the headlines, but these are rare.
When they do happen, the PPF usually steps in to make sure people get most of the pension they were expecting.
I hope that helps ease your mind on how safe your pension is.