Relying on a 'defined benefit' pension? Don't...
How safe is your pension? If you have a "defined benefit" pension – based on your final salary, linked to inflation and paid for as long as you live – you probably think it is pretty safe. But the events at BHS should make you think again.
Its £571m pension fund deficit is big. But it is also the tip of a very nasty iceberg: the companies in the FTSE 350 alone have a total deficit of around £84bn, and of the 6,000-odd funds covered by the Pension Protection Fund (PPF), around 80% are currently running deficits (to a total of over £300bn). If the firms they are attached to stop paying in, they won't be able to meet the generous pension payments they owe.
And – just to be clear about the dangers – this isn't just about private firms. The PPF is also the last resort for schemes such as the University Superannuation Scheme, the pooled vehicle for all university pension schemes in the UK. As Philip Aldrick points out in The Times, this now has a deficit of £19.5bn (on assets of £49bn). That's up from a mere £8bn in 2013 and means that there is talk about how to slash both risk and pension benefits inside the scheme.
Pension deficits don't always matter to pensioners. Strong companies can manage them by increasing contributions in the short term; by creating realistic plans to do so over the long term; or by being able to wait out the interest-rate cycle (when rates rise, technical deficits will fall – see past posts here). Sensible pension trustees will shift their asset mix to get higher returns and use those projected higher returns when they calculate their deficit.
But they matter enormously when they are connected to weak or unwilling companies. Right now there are nearly 11 million people who count themselves members of defined benefit pension funds. Over four million of them are getting their pensions already (lucky, lucky them!) and nearly six million are in line to get them on retirement. Those six million should be keeping a very close eye on their companies. There are, as Jeff Prestridge says in the Mail on Sunday, "real concerns over the sustainability of defined benefit company pension schemes".
There may well be more trouble ahead. The Pensions Regulator – which is supposed to keep an eye on all schemes so that they don't end up with the PPF – doesn't seem to be doing the best of jobs: it did not, for example, know that Sir Philip Green had sold BHS until its staff read about it in the papers. Super-low interest rates will be with us for the foreseeable future. And young people might start to object to their wages being kept down because firms are paying all their surplus cash into pension funds,
Just because you have been promised a particular pension income in retirement doesn't mean you are going to get it.
PS This isn't just a problem in the UK. In Switzerland, economists have warned that negative interest rates may push domestic pension funds into bankruptcy. In the US, public pension fund deficits are killing state and city services. And in France, the chief executive of the country's largest public pension fund has said that the European Central Bank's determination to keep interest rates this low (-0.4% at the moment) will eventually mean that "many pension funds in Europe will implode". Buying French bonds today, he told the FT last week, leaves him "unable to fulfill my fiduciary duty".
