How safe is your pension cash if your employer goes under?
Sections
Defined benefit pension schemes
The Kodak pension scheme was a defined benefit scheme. That means that you have some certainty about the pension you can expect when you come to retire. Typically you will be paid something between 1/40th and 1/60th of your salary for every year you worked at the firm. So if you worked there for 30 years and the scheme offers 1/60th of your annual salary for each year of service, you’ll retire with an annual income of half of your salary.
These schemes are dying out rapidly as employers increasingly find them too expensive to run. With a defined benefit scheme, the risk is all on the employers’ shoulders – they need to find the cash to meet the promised pension payments. And the fact that Kodak’s scheme was so severely in deficit shows you that Kodak was struggling to do just that.
Many employers now only offer defined contribution schemes, which is where your employer will match your contributions up to a certain level, but the money is invested in a pension via an insurance firm. In this instance, there’s no certainty about the money you’ll end up receiving in retirement.
For a great guide to how these two forms of pension compare, check out Where you can still find a final salary pension.
So what happens to your defined benefit pension if your employer goes under?
The Pension Protection Fund steps in
Back in 2005, the Pension Protection Fund (PPF) was set up to offer a safety net should an employer that offered a defined benefit pension scheme go bust, leaving the scheme underfunded.
When the employer has an ‘insolvency event’, the PPF is informed. A number of different things qualify as an insolvency event, including entering administration and being on the receiving end of a winding up order. For a full list of events, check out the Insolvency Events section of the PPF website.
The PPF will then perform an assessment on the scheme, to see whether it meets certain criteria before it will assume control of the scheme. Essentially the main criteria are that the scheme must have no chance of rescue, and have insufficient assets to pay out benefits at least equal to any compensation the PPF could pay.
Don’t expect this assessment to be a swift process though – the PPF aims to complete assessment for most schemes within two years!
A limited level of compensation
The compensation you then receive courtesy of the PPF is capped for some people.
If you have not yet reached retirement age when the assessment takes place, then your compensation will be no more than 90% of what you were due to be paid had the pension scheme survived. This is capped at £29,897.42 per year and that figure will increase in line with inflation (as measured by the Consumer Prices Index) up to a maximum of 2.5%.
If you’ve already reached the normal retirement age when the assessment process begins, or if you receive ill health or survivors’ pensions, then you’ll be entitled to 100% of what you would have been paid.
The PPF has put together a really nice leaflet outlining the ‘journey to becoming a member of the Pension Protection Fund’ which is worth a read, and can be found here.
The important thing to remember is that even if your employer goes bust, the bulk of your pension is protected.
What about defined contribution schemes?
If your employer offers a pension scheme, chances are it’s a defined contribution scheme. So what happens if they go bust?
With a defined contribution scheme, it’s you the employee who shoulders all of the risk. All that the employer has promised to do is match your contributions up to a certain level. Your retirement income is determined by how your investments perform, and nothing else.
In this respect, there’s no central pension ‘fund’ that would be threatened by your employer’s demise. That doesn’t mean your pension won’t be affected though. For starters, you’ll obviously no longer enjoy your employers’ contributions, which will cut the size of your pot. What’s more, your employer may have been paying the administration costs for the pension, so you’ll have to start paying those too.
On the plus side, the cash you have paid in will still be there (well, depending on your investment performance!) should your employer hit the skids.
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