Final-salary schemes continue to make the headlines. It is ironic that many scheme members will receive more information from employers and trustees when the schemes are coming to an end than when they were in force.
Many members are now finding out for the first time that the final-salary scheme does not guarantee a level of benefits. Even the “promise” to provide a level of pension at retirement is hedged around with conditions.
Unfortunately, employers and trustees have not explained the conditions clearly enough to members, the principal condition being that the future of the scheme depends on the employer's willingness and ability to continue contributions. Ultimately the employer could go out of business, so the member's job would be at stake as well as his or her pension.
If employers and trustees are prepared to spell out these conditions to the members of the final-salary schemes that remain in force, for now, then perhaps members will recognise that they have to prepare for the worst and start to top up their savings.
Relying on the state to provide for your retirement or trusting that future governments will not change the rules before you retire was always a dangerous game. Depending on your employer is also becoming increasingly risky, as many large companies have made radical changes to their pensions in recent years.
The recently published CBI/Mercer survey on employment trends shows that 24 per cent of firms closed their final-salary schemes to new entrants in the past five years and 12 per cent are considering doing so.
According to the survey, the reasons for this are the increasing cost and complexity of final-salary schemes, the abolition of the repayment of dividend tax credits, poor investment returns and new regulations such as the MFR and the accounting standard FRS 17. However, 64 per cent of firms said that currently they are not planning to close their schemes to new entrants, despite increased financial risks.
The survey also contains interesting information on the way in which employee remuneration is changing. Pay was most often linked to individual or company performance, with 58 per cent of employers using formal assessment of individual performance to determine employees' pay. Employers have shifted towards nonconsolidated payments, with 22 per cent increasing the proportion of pay that was not consolidated into basic pay.
This could have an adverse impact on members' pensions – earnings not consolidated into basic pay are unlikely to be pensioned under the pension scheme unless the definition of pensionable salary includes elements of pay not classified as “basic pay”.
Traditionally, such elements have comprised bonuses, P11D benefits such as the taxable amount of fringe benefits, and, controversially, an amount that equates to the basic state pension (sometimes known as a “state scheme disregard”).
Employers will need to decide whether they intend that the practice of paying nonconsolidated payments should feed through to pensions too. If so, then they are effectively reducing scheme benefits. This will give the employer a welcome degree of cost control. It may also give the employer room to continue with the final-salary scheme rather than having to switch to a defined-contribution scheme.
Pickering argued that pension schemes have to change as the working environment changes. He recommended that employers should have greater flexibility over the pension benefits they provide, such as dependants' pensions and postretirement indexation.
We may find that if legislation is not changed in the way that Pickering recommends and employers are not given the flexibility to drop these benefits if they choose, they will restrict the definition of pensionable salary through greater use of “non-consolidated” pay.
Communication is essential on changes like this. Members must appreciate what is happening, however unpalatable, so that they can take remedial action to protect their retirement income, for example, by increasing their savings either inside the scheme through AVCs or, for example, outside the scheme by paying concurrent stakeholder contributions.
Unfortunately, communication on pensions has never been a strong point for employers. Perhaps in the days of positive investment returns and contribution holidays it was never a priority. But now is the time to ensure that employers, trustees and scheme members scheme are clear about their responsibilities.