Benefit Or burden? The Unseen Cost Of Pensions
14th September 2016 Liam Young, Senior Solicitor Burness Paull
People are often suspicious of proposed pension reform, which can be seen as an underhand attempt to swindle workers out of their hard-earned entitlements. Are they right to be cautious?
It is widely recognised that pensions are a good and necessary thing. After all, it’s difficult to take issue with the concept of setting aside a small portion of your pay (tax-free) and investing it, often with a matching contribution from your employer, so that you have adequate financial provision for retirement.
So what’s not to like?
When you get on to the subject of defined benefit pension schemes, things get a little bit more difficult for employers, and as it turns out, many of today’s employees too.
Traditional defined benefit pensions are based on a member’s final salary and length of service, with the benefits completely independent of contributions paid during the employee’s working life. When life expectancy was lower and fewer had long retirements, the fact that pensions weren’t pre-funded was less of an issue. However in recent years, increased longevity can leave an employer paying for as much as 30 or 40 years’ pension per employee.
On top of the inevitable increase in costs resulting from improved longevity, the government has introduced a number of protective measures which increase the financial obligations on employers with defined benefit pension schemes:
- In the 1970s preservation was introduced, requiring schemes to increase the pensions of members who left before retirement to protect against inflation.
- In response to the highly-publicised activities of Mr Maxwell, minimum funding requirements were introduced in the 1990s, to guard against employers making insufficient contributions to their pension schemes. Funding requirements have become increasingly onerous, with employers obliged to throw good money after bad in an attempt to close the funding gap.
- More recently, high profile failures of large companies with defined benefit pension schemes in the 2000s led to the creation of the Pension Protection Fund, paid for by risk-based levies imposed on all defined benefit schemes whether or not they are in trouble. Ironically, the burden of PPF levies can have the effect of moving schemes closer to the precipice.
The impact of these is that the number of open defined benefit schemes has been reducing drastically over the last decade.
The increased regulation of defined benefit pensions and introduction of PPF levies has been particularly difficult for family business, in particularly those that are structured as sole traders or unlimited partnerships. Aside from the obvious financial burden, such employers may not be able to demonstrate their ability to support their pension schemes long term, even if they have no intention of abandoning them. The PPF often classifies such employers as high risk, and imposes a disproportionately high levy.
Perhaps for some of the reasons outlined above, this issue has often been portrayed as one of employer verses employee. However, the reality is far less clear cut.
For younger employees, the drain on employer resources caused by ever-growing defined benefit liabilities is perhaps most keenly felt. With pension liabilities of such magnitude, only the most foolhardy employer would not maintain contingency plans to protect the business.
Such contingencies require cash reserves, cash that could be spent on expanding and improving the business, making new employment opportunities available and improving the benefit packages of current staff. It is difficult to make adequate provision for current employees when the majority of your profits still go to your former employees. Large pension liabilities can not only hinder growth, they may also put off investors and, in extreme cases, can lead to the collapse of the business.
People are often suspicious of proposed pension reform, which can be seen as an underhand attempt to swindle workers out of their hard-earned entitlements. Perhaps we need to start thinking about things a little differently, to re-balance the scales that are already weighted against the younger generation.