The Decline And Fall Of Pensions!

Work-based pension schemes are often fairly generous, so why is membership of these plans dropping -- and who's to blame?

Membership of work-based pension schemes has dropped in recent years. Research from The Office of National Statistics (ONS) has revealed that 9.6 million workers were active members of (that is, current contributors to) employer pension schemes in 2006, compared with 9.8 million in 2004. In other words, the total membership of occupational pension plans has fallen by around 200,000 workers over two years.

In 2006, 4.4 million people in the private sector were active members of work-based final-salary and money-purchase pension schemes, down 400,000 on the figure for 2004. In contrast, things look much rosier in the public sector, where employees enjoy copper-bottomed pensions which are guaranteed by the taxpayer. Indeed, active membership of public-sector pension schemes has actually risen slightly, from 5 million to 5.1 million people between 2004 and 2006.

Final salary or money purchase?

With a final-salary, or defined-benefit, pension, your retirement income depends on your length of service and your final salary (or, in some cases, on your average earnings during your service). These plans are considered the 'gold standard' of pension schemes, because your pension is largely guaranteed if the scheme is fully funded.

On the other hand, in a money-purchase (or defined-contribution) plan, your retirement income depends on how much you and your employer contribute and on your fund's future investment returns. Hence, final-salary schemes are almost always superior to money-purchase plans. However, this is part creates problem for businesses, because final-salary schemes are more costly to maintain and, therefore, are riskier for firms.

To put things into context, combined contributions from employer and employee to a typical final-salary scheme will total roughly a fifth (20%) of wages. Elsewhere, in money-purchase schemes, contributions total around an eleventh (9%) of salary. In other words, funding a final-salary scheme costs, on average, at least twice as much as a money-purchase plan.

Thus, firms have been closing final-salary schemes left, right and centre. In most cases, schemes are still open to existing members, but bar new employees from joining. However, some companies (such as Rentokil Initial) have gone the whole hog and completely closed their final-salary schemes to both new and existing members. In contrast, around three-quarters (75%) of the members of private-sector pension schemes enjoy final-salary guarantees.

Alas, according to a report by the Association of Consulting Actuaries (ACA), more than eight out of ten -- over 80% of -- final-salary schemes in the private sector are now closed to new members. In addition, one in seven schemes (14%) no longer accepts new contributions from existing members, and has transferred workers to inferior schemes. Indeed, final-salary schemes that are closed to new employees now have more active members (1.73 million) than those that are open to all workers (1.63 million).

In order to cut back on the cost of providing employee pensions, companies have tried switching members into replacement money-purchase schemes, raising retirement ages, lowering employer contributions or hiking employee contributions, switching to career-average earnings, or trying a combination of these.

Therefore, although the public sector has firmly seized the nettle by tackling the ever-rising cost of company pensions, the State has yet to follow suit. Estimates of the government's liability for public-sector pensions vary, but most fall between £750 billion and £1 trillion. In other words, guaranteeing pensions for public-sector workers comes to around £30,000 and £40,000 per household, which is a crippling (and ultimately, unsustainable) burden.

One fear is that if the government does not take action by raising taxes or reducing the generous benefits paid by public-sector pensions, then this enormous cost (which is not yet counted as part of the national debt) will damage the UK's credit rating and ability to borrow cheaply.

In summary, although we're living longer, and therefore need larger pension pots, our company pensions are in decline. However, one piece of good news is that companies have been paying in higher contributions and lump sums in order to improve the solvency of their pension schemes. As a consequence, many final-salary schemes are in a much better financial state as shortfalls are reduced or eliminated.

Finally, if you're an employee and have yet to become a member of your company pension scheme, then what's stopping you from doing so? Not joining your work scheme could mean losing out on a benefit worth, say, an extra 10%+ of your wage, so start looking into it today. Otherwise, you may well end up joining the millions of workers who face financial misery in their post-work years!

More: Learn more in The Fool's Retirement and Pensions centre