Most people have a defined contribution (also known as money purchase) pension scheme where the saver will contribute to a pot of money that will be used to provide an income in retirement. However, there are other schemes which can be referred to as defined benefit or final salary schemes.
This form of scheme is almost always an occupational pension scheme, funded through employer and employee contributions. However the pension saver does not have their own, allocated account.
Rather, there is a formula which states what their pension is likely to be on retirement, normally linked to a percentage of the last salary they’ll earn, combined with how long they’ve worked for their company. Traditionally, these schemes were seen as very safe.
But new research suggests that one such final salary scheme, that of FTSE 100 retailer J Sainsbury, may be dangerously underfunded to the point where it may harm the supermarket’s long term performance in Britain’s grocery price war.
A spokesman for the supermarket chain said, “Sainsbury’s should in no way be listed as high-risk compared to others. It is meaningless to look at pension liabilities alone; rather it is about the overall pension deficit – ie the assets less liabilities.
“Our pension deficit has been reduced by about £40m since 2009, and last year we also closed our defined benefit scheme to future accrual, further mitigating any pension risk.”
However, their pension liability still measures a massive £6.9 billion, even greater than the company’s entire market value which slipped to £6 billion in 2014.
Sainsbury’s is not alone in the industry in having this problem, with Tesco’s pension deficit increasing a staggering 34% in just the last year to £3.2 billion before tax.
The truth is that many final salary pension schemes, in both the public and private sector, are underfunded. This casts into doubt their ability to meet funding obligations for the scheme’s members as they enter retirement.
It is this frightening reality that has led ever increasing numbers of people with these sorts of schemes who are now living outside of the UK to look at transferring these pensions into Qualifying Recognised Overseas Pension Schemes (QROPS).
Even if transferring a final salary pension scheme into a QROPS is the right move, many who would like to take advantage may soon be blocked. There is a lot of talk that the UK authorities will prevent transfers from certain public sector defined benefit schemes as they fear a huge exodus will undermine the affordability of these schemes.
Transferring out of final salary schemes can often be highly beneficial and getting a Transfer Value Analysis System (TVAS) will show a comparison between the income the scheme should generate in retirement and what might be possible after a transfer.