Concern is mounting that thousands of employees are being ‘bribed’ to give up valuable benefits in final salary schemes for less generous cash payments.
A report from accountants KPMG has shown that more than 90,000 people have been offered cash incentives to transfer out of final salary pension schemes.
The figures also show that around 25% of people have accepted the cash offer, which could potentially leave them worse off than if they had retained their membership of the final salary scheme.
Final salary pensions
Final salary pensions are widely regarded as the most attractive form of pension as not only do they provide a guaranteed income in retirement, which rises annually, the liability for providing this guarantee rests with the employer and scheme trustee. Indeed they are seen as so attractive the government’s proposed changes to public sector final salary schemes caused widespread strikes earlier in the year.
In these difficult economic times many employers still need to reduce costs, one option is to offer cash incentives to employees, who have often left the company, to switch out of the final salary scheme into “defined contribution” arrangements.
In a defined contribution, which is also known as a money purchase scheme, the member bears the risk and growth is linked to the returns achieved on the investment chosen, which often means exposure to the stock market. Furthermore when the member retires the pension need to be converted into an income, often via an Annuity. Any pension Annuity calculator will show that buying an index linked Annuity can be costly.
Experts are concerned that the financial packages offered to members to transfer out of final salary schemes do not adequately compensate the member for the pension they are giving up. Earlier in the year Steve Webb, the government’s pensions minister warned that these cash offers have the potential to leave people worse off and he wanted to see the Pensions Regulator stamp out bad practice.
The Pensions Regulator has already issued guidance stating that pension trustees must assume that for the majority of workers moving out of a final salary scheme is a bad idea. However, the regulator is clearly concerned that members are not getting accurate information and that because of the limited nature of some of these offers in terms of time that they are available, members are coming under undue pressure to accept them and are consequently making poor decisions.
Chief executive of the Pensions Regulator, Bill Gavin, said: “Pension transfers are an extremely difficult financial equation, most members find it impossible to understand their options unaided. The offer might look attractive, particularly with cash as an incentive. But poorly informed decisions are likely to be regretted years later.”
He continued: “We believe such offers won’t be in most members’ best interests, and have pointed out that employers run significant risks in offering incentives to members to transfer out of these [final salary] schemes.”
The incentives offered to members to leave the scheme can include an upfront cash payment, the option to take benefits early or an enhanced transfer value.
The exact incentive offered depends on the company in question, for example InterContinental Hotels recently offered its former employees a 25% cash lump sum, on top of their transfer value, to buy them out of their final salary pension scheme. Although the company would not say how many members took up the offer it did confirm that it paid out more than £10 million from the scheme in transfer values.
In these financially difficult times experts are concerned that cash strapped employees may see a short term benefit in a lump sum of money, which could be used for example to repay debts, rather than the long term effect that moving from a final salary pension will have on their retirement income.