Singing Carpenter pt.2...oh, and Final Salary Pensions

Thursday, 29th January 2009 20:55 - by Resident IFA

If you use the Blog calendar to look at my Blog of 2nd July 2008, you will read about the ‘Singing Carpenter’ (SC). The ‘Naked Cowboy’ who entertains people in and around Times Square, New York is well known, but I am holding up the SC as the UK equivalent! In a business networking meeting at 7.45 yesterday morning, the SC launched into another excellent and slumber-banishing ditty. In my opinion, a man who can rhyme ‘Civil Engineering’ with ‘God-fearing’ is a borderline genius! But I digress. I chose for my ’60-second’ speech at this meeting a topic which has garnered a few headlines over recent days - namely the impending closure of many ‘Final Salary’ company pension schemes. Put simply, a Final Salary pension scheme is of a ‘Defined Benefits’ type i.e. you, as an employee, know what benefit you will derive in terms of retirement income. The income is worked out in ‘th’s (aka fractions) based on the number of years service, whereby you can receive a maximum income of 2/3rd’s of your final pensionable salary, or perhaps an average over, say, the last three working years before retirement. So, for example, if you work at a company for 40 years, you may receive 40/60th’s or 2/3rd’s your pensionable salary. If you were to work for that company for 30 years, you get 50% as a retirement income…and so on. Right, that short crash course done with, what is the reason these Final Salary schemes are on their way out? Surprise, surprise, it is money worries again. These schemes are expensive to run. Think of the amount of money that needs to be in the fund to cater for all those scheme pensioners that are running amok with all that extra life expectancy we are promised nowadays! Let’s say that a Final Salary scheme asks an employee (always) earning £10,000 over a 40-year service period to contribute 6% per year of their salary and the employer contributes 8% themselves. This 14% total contribution amounts to £56,000 over that time-frame. Then, if that employee retires on the 2/3rd’s pension they are allowed and lives for another 25 years, that is a total of £166,650 (£6,666 x 25 years). You can see from this the inequity of the calculation, especially if we have a horrendous period in the stockmarkets - where a lot of companies’ pension funds are invested - as experienced over the last 15 months. Slap bang at the start of a global recession, you can see why, if not necessarily empathise with them, a lot of companies are trying to close their Final Salary pension schemes and lose this (now) potentially crippling overhead. The move to ‘Defined Contribution’ (where the employee knows their contribution, but the employer does not guarantee the income outcome, it being wholly reliant on investment performance instead) schemes is well and truly on… Until next time…