Here in Wales final salary pension schemes have been hot news as Tata steel workers voted to give up their final salary pension scheme in return for job security (1).
Tata workers aren’t alone in having to make this decision; with final salary schemes facing huge deficits (2) many private sector workers have had to make the same difficult choice as employers sought to curtail the escalating costs of pension schemes (3).
Across the public sector reports show that final salary schemes have been largely replaced by less generous average earning schemes (5). In the private sector too many workers have accepted lower pension entitlements. However while pension benefits may be reducing record numbers are now part of occupational pension schemes thanks to the auto-enrolment initiative.
If you have been involved in discussions about workplace pensions you’ll undoubtedly have heard mention of defined benefit (DB) and defined contribution (DC) schemes; but do you know what they mean?
DB pension schemes are those that specify how much an employee will get in pension payments when they retire. Traditionally this amount was linked to your final salary, as it used to be at Tata Steel. However DB schemes today are more likely to be linked to your average earning over the course of your time with an employer, a figure that will inevitable by less. Since 2008 the number of employees paying into DB schemes has shrunk from 2.6 million to 1.6 million (5).
DC schemes are far cheaper for employers to run and are the most common occupational scheme with 3.9 million members compared to 1 million in 2008 (5). They specify how much will be paid into the scheme and not what you can expect at the end. Employers prefer DC schemes because they are cheaper to run. In career average schemes average employer contributions are 12.9%, and in DC schemes just 2.5%.
Another advantage for the employer is that their liability is limited to making a specified contribution rather than making up any shortfall in the fund. The responsibility for ensuring their savings are sufficient lies squarely with the employee concerned (4), and as employee contributions into DC schemes are typically around 65% less than into DB schemes, this is a major shift (5).
The value of pensions and the income they produce can fall as well as rise. You may get back less than you invested.