The pensions time bomb and the 12 questions you must ask
Published 19/11/2016 | 02:30
Should I stay, or should I go now? It is a question that thousands of people with company pensions are currently asking.
Specifically, they are wondering if they should cut their losses and take their fund and invest it elsewhere, or stick with the scheme in the hope that it will deliver on most of the pension promises.
The dilemma has been prompted by alarming research this week showing that deficits in the defined benefit schemes of the largest companies and semi-states have ballooned.
This means the pensions time bomb for up to 600,000 has started to go off. Here are the questions those with a company pension should ask.
Q: What is a defined benefit pension scheme?
A: A defined benefit scheme is where the pension paid to you at retirement is based on a formula, usually involving the number of years you were in the scheme and your salary at retirement.
Generally, someone who works 40 years would expect a pension of between half and two-thirds of their salary at retirement when combined with the State pension, according to Jerry Moriarty of the Irish Association of Pension Funds, which represents pension savers.
Q: Why is there talk of a pension fund crisis?
A: In order to ensure there is enough money put aside to pay the pension when a person comes to retire, employees and employers pay into the fund. The amount they pay in is calculated by an actuary and is based on assumptions on things like how long people live, investment returns, interest rates and future salary increases. When the investment markets crashed in 2008, many schemes had much lower assets than they had assumed for, and had to either put more money in or cut the pensions.
Asset values have recovered since, but low interest rates mean the cost of providing the pensions has risen significantly. This means schemes don't have enough assets should they have to meet all their liabilities now.
Q: Will it just get worse until there's nothing left?
A: Not necessarily, Mr Moriarty says. A rise in interest rates would improve the position of schemes.
Schemes are also regulated by the Pensions Authority. They set out a minimum level of assets schemes should have. When their assets fall below that the scheme has to submit a plan to the regulator, setting out how it will get back to having enough assets.
Q: What is a deficit?
A: A deficit means that if the scheme had to wind up today and pay out all the pensions it had promised, it wouldn't have the assets to do so. It is unlikely that the scheme will have to wind up as many expect to be around for the next 30 to 40 years while they continue to pay pensions.
Q: Should I ask my employer to switch me to a defined contribution scheme?
A: Some pensions advisers are suggesting that people pull their funds out of defined benefit scheme. The problem is that the value of what is called a transfer will be low. Many people prefer to stay where they are, as a defined benefit scheme should let you know what pension you can expect. The pension you get in a defined contribution scheme is completely dependent on the size of your fund at retirement and the cost of pensions at that time. Both of those are hard to predict.
Q: To quote the 1980s hit from the The Clash - should I stay or should I go now?
A: You don't often have a choice as it may be in your contract of employment that you have to be in the scheme. In any case, your employer will be paying more than you into the scheme and paying a lot of the costs. It is unlikely you'd do better on your own.
Q: Who's better off - younger or older employees?
A: People who are already being paid a pension have more protection if a scheme winds up in deficit as they have no opportunity to save further for retirement.
Q: What options will I have at retirement?
A: At retirement most schemes will pay your pension from the fund. Some might buy that pension so that an insurance company will then pay you the pension for the rest of your life. You will be able to give up some of your pension and receive a tax-free lump sum instead.
Q: Everyone in the UK is cashing in their pensions - should I do the same?
A: You can't cash in a defined benefit scheme here or in the UK.
Q: Is Brexit or Trump going to wreck my pension?
A: It may have an impact - but that could be positive. Since both events investment markets have been largely positive and bond yields have risen in the last week. Higher bond yields, or the interest paid on them, decreases the cost of pensions, which is good for those pension schemes.
Q: Should I increase my contributions?
A: You should work out what you need to attain the standard of living you desire in retirement.
Then look at what your defined benefit schemes is promising and what State pension you will get. If there is a gap you can consider paying more in.
This will go to a separate defined contribution scheme.
Q: Where can I get more information?
A: You should already get lots of information from your scheme including an annual benefits statement which will show how much pension you have built up and how much it is likely to be when you retire.
You can also get the trustee annual report which will give an overall summary of the scheme.
These will also detail who you can contact for any further information. Also check the Pensions Authority's website.
Read more: Pension bomb blows up for 600,000 people