How secure is my defined benefit pension?

What is a defined benefit scheme?

Defined benefit pension schemes provide a guaranteed income when you retire. This is based on salary and length of service.

In this way, they provide members with some certainty about their retirement income.

They’re usually backed by a sponsoring employer. But sometimes the benefits have been secured by transferring to an insurance company.

To spread investment risk, schemes usually invest in a range of assets. This includes stocks and shares, property and long-term government bonds (called Gilts).

What safeguards are in place to look after my pension?

Defined Benefit pension schemes have to be governed by trustees. These trustees are appointed to act in the interests of the beneficiaries of the trust.

Defined benefit schemes must keep track of their funding position. This includes getting a full valuation every three years.

The funding position of a defined benefit scheme is measured by comparing the schemes assets with its liabilities.

Liabilities are a collection of ‘promises’ to pay an income to each member of the scheme.

The funding position provides information on the scheme’s ability to cover its liabilities using the scheme’s funds and assets held. Think of it as pension schemes having to check how much money they have available and compare that to how much money they need to pay to members that have already retired.

Although schemes only have to do a valuation every three years, the trustees will check the scheme’s financial state of health much more often. Especially during market turbulence and uncertainty.

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What happens if my scheme can’t afford its liabilities?

Schemes that are judged to not be funded well enough to cover their liabilities are known as schemes in deficit.

If a scheme is in deficit, it must prepare a recovery plan.

The plan has to set out what will be done to meet the funding goal – for example, deficit repair contributions. It must also set out how long this will take.

This recovery plan will need to be agreed with the employer and submitted to The Pensions Regulator.

What role does The Pensions Regulator have in monitoring defined benefit schemes?

The Pensions Regulator:

  • oversees how defined benefit schemes are funded
  • sets out rules and guidelines about the way funding deficits should be eliminated
  • sets out advice for trustees on how they should track the financial strength of the employer(s) who backs the scheme, and what they should do if this changes. This includes changes as a result of a company sale or takeover. 

What happens if my scheme can’t afford its future liabilities?

If your defined benefit scheme can’t meet its future liabilities, it will be assessed by the Pension Protection Fund (PPF). This will include a valuation of the scheme’s assets and liabilities to determine whether the scheme is overfunded or underfunded.

If the scheme is underfunded, it will transfer to the PPF. This process, called the Assessment Period, can take up to two years to complete.

If the scheme is overfunded, it will go through an insurance buyout. This will secure members compensation that is equal to or higher than the level of compensation the PPF would pay.

Who is the Pension Protection Fund and what do they do?

The Pension Protection Fund aims to protect members of workplace defined benefit pension schemes if their employer becomes insolvent and can no longer afford to deliver the pension benefits members have built up.

If my pension moves into the Pension Protection Fund, how will it affect my benefits?

This will depend on whether you’ve already reached your Normal Retirement Age or not:

  • If you’ve already reached your Normal Retirement Age, or retired through ill-health, the Pension Protection Fund (PPF) will usually pay 100% of the pension income that you were being paid when your employer became insolvent.
  • Those getting a deceased employee’s pension will also get 100% of the pension income that was in payment when the employer went bust.
  • If you haven’t yet reached Normal Retirement Age, or you are an early retiree, the PPF will usually pay 90% of what your employer promised. There is an upper cap on how much can be paid and this depends on your age. At age 65 for example, this is capped at £37,315 p.a. (90% of £41,461 p.a. as of 1 April 2020). 

Long Service Cap

From 6 April 2017, a Long Service Cap was introduced for members who have 21 or more years’ service in their original scheme. For these members, the cap is increased by 3% for each full year of pensionable service above 20 years – up to a maximum of double the standard cap.  

Minimum compensation levels from the PPF and Financial Assistance Scheme

In September 2018, the Court of Justice of the European Union ruled that individual PPF and Financial Assistance Scheme (FAS) members should receive at least 50% of the value of their accrued pension. This ruling only affected a few of these members – and their payments should have been increased by the end of March 2021. 

The FAS was set up to provide financial assistance to members of defined benefit pension schemes who lost all or part of their pension following their scheme coming to an end between 1 January 1997 and 5 April 2005.

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Additional Voluntary Contributions

Have you paid Additional Voluntary Contributions? Then these will usually be kept separate and not be picked up by the PPF. This is unless the contributions were used to buy additional years’ service in the scheme.

Transfers in

Did you transfer in benefits to your scheme and get extra pensionable service? Then these will be treated in the same way as your other scheme benefits – subject to same limits.

Did you transfer in benefits to your scheme and get a fixed amount of extra pension? Then your pension from the scheme and the fixed extra pension will be treated as two separate benefits in calculating how the PPF cap might apply.   

Can I still receive a tax-free lump sum when I start to draw a pension from a scheme taken over by the Pension Protection Fund?

Yes – and it usually works out around 25% of value of the pension, which the Pension Protection Fund (PPF) will pay.

The worst case scenario is where an employer goes into administration and the scheme remains underfunded. The PPF will then provide compensation to members. In some cases, the PPF might take over a scheme while the employer continues trading in some form. This is providing the PPF and The Pensions Regulator agree on this.

If my pension scheme is about to go into the Pension Protection Fund, can I retire early and secure a higher pension?

Before going into the Pension Protection Fund (PPF), your scheme will go through an ‘assessment period’. During this time, the scheme will usually pay out the pension on the same basis as the PPF.

Even if the trustees allow you to retire early on normal scheme rules, the PPF is likely to reduce your pension as soon as the assessment period starts. This is to make sure it follows the PPF’s rules.

What if the assessment period ends and your scheme isn’t taken on by the PPF?

If the scheme doesn't move in to the PPF it is likely that is has been judged to be sufficiently funded to provide higher pensions than the PPF compensation levels. In this case, your pension might revert to its earlier amount (before the assessment period) or an amount that is below what you would have been paid under the scheme, but, higher than the PPF compensation levels. You'd then normally be paid arrears for any underpayments during the assessment period. 

Will I receive any increases on my compensation payments from the Pension Protection Fund?

There will be increases, but these are often lower than those offered by your defined benefit pension scheme. It will depend on whether you’ve already reached your Normal Retirement Age or not, and the period you worked for your employer:

For compensation already being paid, increases on pensions accumulated after 5 April 1997 will be in line with inflation, subject to a maximum of 2.5%.

For compensation not yet in payment, increases on pensions accumulated before 6 April 2009 will be in line with inflation, subject to a maximum of 5%.

Increases on pensions accumulated after 5 April 2009 will be in line with inflation, subject to a maximum of 2.5%. 

Do my dependants get death benefits if my scheme goes into the Pension Protection Fund?

Yes – they’ll be proportionately reduced in line with the overall reduction in Pension Protection Fund benefits. For example, the 90% cap if you haven’t yet retired yet.

How is the Pension Protection Fund funded?

It’s funded by levies paid by eligible defined benefit pension schemes. It’s not funded by the government or taxpayers.   

How secure is the Pension Protection Fund?

The assets the Pension Protection Fund (PPF) holds cover around 121% of their liabilities. This is equivalent to a ‘surplus’ of £6.1 billion.

This can vary over time – but the PPF also has the powers to raise contributions or reduce the level of benefits paid if needed.

Since the PPF was set up ten years ago, there have been no changes to benefits paid. 

Should I transfer my pension out?

This is an important decision – especially if you’re worried about the security of your pension scheme.

If you’re considering transferring out of your defined benefit pension, you’ll usually need to get regulated financial advice.

A financial adviser who’s regulated by the Financial Conduct Authority will be able to tell you if transferring out of a scheme with guaranteed benefits is the right thing to do. They’ll also recommend what you should do next.

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If your scheme is in a PPF assessment period it won’t be possible to transfer out, unless:

  • you had got regulated financial advice, and
  • signed transfer discharge forms and returned them to the scheme’s trustees before the scheme entered the assessment period.
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MoneyHelper is the new, easy way to get clear, free,
impartial help for all your money and pension choices.
Whatever your circumstances or plans, move forward with MoneyHelper.

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