Pressure mounting on companies with defined benefit pensions
09 August 2012
Irish Independent
New statutory requirements relating to funding defined benefit pension schemes became law on May 1 with the Social Welfare and Pensions Act.
The new rules will inevitably lead to an increase in the wind-up of defined benefit pension structures.
This is due, among other things, to the new requirement for a "risk reserve" to be set aside to act as a buffer against further economic turmoil.
These new measures are going to add further pressure on company balance sheets and, indeed, in the past month companies such as AIB have announced their intention to shut down their company defined benefit schemes.
Defined benefit schemes have long been considered the Rolls Royce of pension structures. They offered a guaranteed pension for life based on an employee's final salary.
However, in recent years these pension schemes have been under severe pressure due to volatile asset values and increasing liabilities which have been caused by bad investment performance, low German bond yields and increasing life expectancy.
These issues, coupled with a difficult business environment, increasing taxation and regulation, and a poor economic outlook have caused employers to consider restructuring their company pension arrangements.
The new funding rules introduced by the Social Welfare and Pensions Act 2012 will now force employers to make decisions they had been hoping to avoid with such decisions having an immediate impact on company employees.
Take an employee who has been a member of her company's defined benefit pension for the past 14 years. She has been contributing 6pc of her gross salary every year of her employment with a matching contribution by the employer.
But she is still 16 years from her retirement age. Unbeknownst to her, the contributions she has being paying in to the scheme haven't been ring-fenced in an account for her.
They've been used to pay the monthly pensions of the employees already retired. Her company has now decided to wind up the defined benefit scheme and transfer her benefits to a defined contribution arrangement.
It is at this point she realises that that she has far less in her pension than she originally thought.
Allowing for her own contribution and that of her employer, she thought she would have about €84,000 plus a bit of growth.
But she will see less than €30,000 transferred to her new pension, as the entitlements of the retired employees have to be honoured first and in full according to the law.
She is pretty shocked as she had assumed that she had been saving for herself, not one of her older colleagues.
So what are her options now and what can she expect from her employer?
All employers are required by law to ensure their company employees have some access to a pension arrangement, so it cannot be a case of walking away from responsibilities.
Companies will have to consider restructuring their pension offering. That will involve establishing some type of defined contribution structure.
Employers and employees are increasingly looking at other pension arrangement options such as one-member pension trusts or Personal Retirement Saving Accounts (PRSAs) to avoid the risks of underfunding and to bring some sense of equity, fairness and transparency to their pension provision which they do not perceive as being possible under the defined benefit structure.
These structures also allow an individual and employer to control the cost of pension provision.
The financial implications of changes to pension arrangements will be specific to each employee.
Some of the differences include different methods of calculating tax-free cash lump sums, making individual investment decisions if the employee wants to and decisions on what can be done with their retirement fund at retirement, such as reinvesting in an Approved Retirement Fund (ARF) or deciding when or what type of pension to buy.
The realisation that defined benefit is not a guarantee of benefits at retirement will be an unwelcome message for most employees, but it is better they know now rather than at the point of retirement when their options are restricted.
Paul Gilmer - Irish Independent
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