The provision of company defined pension schemes has been dwindling to extinction over the last 20 years. The main reasons are lack of company funds, employees not wishing to commit to long-term employment and uncertainty of long-term employment at the same company.
The professional employment landscape has also evolved. Employees no longer wish to remain in one company throughout their entire working life. Switching companies became the new norm and with that came the extinction of employee pension benefit offered to new employees.
An employee defined pension scheme became a norm after WWII and private pensions started gaining popularity in 1967. The pension tide has drastically changed since then. LCP, a leading international actuarial firm, reported that in 1993 “virtually all” FTSE 100 companies offered traditional pension schemes to new employees but by 2018 “not a single one does”. The defined benefits plans provide at retirement a guaranteed determined amount and are often inflation protected. This is no longer the case today.
Existing employees’ pension schemes are being hunted down as well. LCP shows that today less than 50% of the FTSE 100 companies provide “any form of ongoing defined benefit accrual to any of their existing UK employees”.
To make matters worse, in 1988 Margaret Thatcher’s chancellor imposed a tax on pension fund surplus. This led to companies stopping (or taking a “holiday” as they call it in the industry) from contributing into the pension fund reserves in order to avoid this tax. Then in 1997 Gordon Brown abolished substantial tax relief on dividends that pension funds received on their investments.
This had a monumental financial effect. It cost £118 billion in 2014 in tax for pension funds. If this lost income would have been reinvested, it would have added a total value of £230 billion to pension funds. This is all at the expense of the retirement future of the employees who not only pay tax on their income, but have a three-level taxation on their retirement income.
In 2018, the government introduced a compulsory Auto-Enrolment pension scheme. By law, an employee would have to make a minimum of 5% contribution of the annual salary and the employer only 3%.
Today, companies offer risky defined contribution schemes that are solely based on the performance of the underlying investments, which are managed by external fund managers. This takes the obligation off from the companies to make up for the “holes” in pension funds as with the defined benefit plan where employer and employee would identify the exact amount the employee would receive at retirement. With the defined contribution scheme – the retiree will receive what there is, based on the investment performance.
These pension funds are given to fund managers to invest with full discretion over the investment decisions. Therefore, the company pension schemes today are not risk-free and carry the same risk as if you would invest yourself (and cost-free as you would not be paying admin and management fees).
Employees and their pensions will increasingly be at the mercy of financial markets.
Savings and Retirement solutions:
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