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The final countdown

I am the managing director of a family-owned business with some 25 employees. The business has been going for many years and in the early 1980s we set up a final-salary pension scheme for long-standing staff, including some family members. But the directors have become increasingly concerned about the burden on the company of maintaining the scheme. What are our options?

It was once the case that final-salary schemes were the automatic scheme of choice for employers looking to reward staff with pension benefits. This was particularly true in the mid-1980s when high investment returns were allowing many employers to reduce or even suspend company contributions to such schemes.

The economic environment has shifted substantially since then and many employers are finding themselves in a position where the ongoing financial commitments of a final-salary scheme are rising sharply. This has led some of the biggest employers in the UK, such as BT and ICI, to conclude that future pension provision would be better made through an alternative framework.

Looking at the choices available to you, the simplest option is to maintain the scheme but scale back the benefit structure. This could be done easily by reducing the rate at which benefits accrue in the future. This would have the direct consequence of reducing the ongoing contribution rate. It would not, however, affect any deficit in the scheme, which would still need to be addressed in the short term.

Moreover, your ongoing commitment would still be volatile and the next actuarial report could well recommend an increased contribution rate.

There are other risks associated with a final-salary scheme. New accounting standards have been introduced and will have the effect of making the pension cost figures in the company accounts far more volatile. One potential consequence is that the company may have to restrict dividends.

Further, as you should already be aware, unless the pension scheme fulfils certain criteria, you will need to set up a separate stakeholder scheme for staff not currently in that scheme. Having two separate schemes running for a workforce of this size is not necessarily the most cost-effective route of pension provision.

An option you may wish to consider is closing off the scheme and making future contributions to a stakeholder-style arrangement. This would control your ongoing costs and alleviate part of the uncertainty over what goes in the company accounts. However, it is still quite possible that poor investment markets and/or increasing annuity costs will mean that the company will have to pay further money into the old scheme in the future. Finally, it will still mean having two separate schemes.

The most radical option is to wind up the scheme completely. This will eliminate entirely the risk of fluctuating future contributions as well as the possibility that pension costs could distort company accounts in the future. It would also mean having only one pension scheme in the future, as long as it is stakeholder-compliant.

There are some drawbacks to winding up the scheme which will need to be considered carefully before taking any such step. First, any funding deficit (measured against the statutory minimum funding requirement) would have to be rectified before the scheme could be wound up. This might involve a big injection of cash into the scheme.

Second, winding up the scheme would force members to make a difficult decision. They can either:

Have their benefits secured on guaranteed terms, in which case the value of their accrued pension rights would almost certainly fall, or Transfer to the new stakeholder scheme or any other suitable arrangement, where eventual benefits will depend on future investment performance and annuity rates.

Either way, scheme members will be concerned about such a significant amendment to their pension expectations and will require advice in making the appropriate decision.

Winding up the scheme will mean surrendering scheme investments. If an insurance company administers the scheme, there is a possibility of a substantial surrender penalty in such circumstances. This could produce or increase a deficit on winding up the scheme, which would need to be plugged by the company before winding up could proceed.

This is an area which will need to be explored extensively before any decision is made. In such circumstances, the option of freezing the scheme and making future provision through a stakeholder arrangement may be preferable.

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