How to cope with pension cutbacks

As a large insurance broker takes a knife to its company pension scheme, we come up with five ways to enhance your pension.

In his first Budget in 1997, the then Chancellor, Gordon Brown, introduced a tax change which deprived UK pension funds of an estimated £5 billion a year of income. Thanks to this loss, plus falling investment returns and longer lifespans, organisations have been making radical changes to their occupational pension schemes.

Companies cut back on pensions

Over the past twelve years, thousands of companies and organisations have reduced the benefits available to members of work-based pension schemes. First to go were final-salary (or defined-benefit) schemes, which provided workers with a guaranteed pension based on their salary at retirement. Providing such quality pension promises can add a quarter (25%) to salary costs, so firms started closing these schemes to new members.

Later, some firms went further by shutting down final-salary schemes completely and shifting all employees into inferior money-purchase schemes. With a money-purchase scheme, your pension at retirement depends on the contributions made, investment returns earned, charges deducted and annuity (pension income) rates when you retire. Thus, in these plans, you take the risk, rather than the company -- by far the cheaper option for the firm.

Aon prunes its pension payments

The latest big employer to take a knife to its company pension is US insurance broker Aon, which employs five thousand workers in the UK. Aon closed its final-salary scheme in 1999, replacing it with a money-purchase plan for new workers. In 2007, the firm closed down the scheme completely, forcing all existing members into the money-purchase scheme.

Until now, Aon has paid at least 6% into employees' pension pots, rising on a sliding scale to 12% for older workers. Workers contribute 2% of salary. Alas, Aon is ending the age-related extra contributions and will pay in only 6% of base salary, regardless of an employee's age. Thus, older employees of Aon face a big cut in their pension contributions. For the oldest workers, Aon's pension contribution will halve just when they need it most.

Personally, I think that Aon's move is disgraceful, as it is abandoning its UK workers in order to enrich its US shareholders. However, there is one saving grace: Aon has agreed to match extra pension contributions paid by its employees. So, employees worried about losing Aon's age-related contributions can reclaim these by putting in the same additional amount themselves.

Here's how it works for Aon's oldest workers:

Contributions before and after Aon's cut

As you can see, before the cutback, this employee received 2 + 12 = 14% of salary into his pension. In order to keep his 12% contribution from Aon, he must quadruple his own contribution from 2% to 8%. This increases the total contribution to 20%, or a fifth of salary, which will help to build a bigger pension. In effect, in order to get the same contribution level from Aon, employees will have to raise their own contributions by between 1% and 6% of salary.

What if something similar happens to you?

If you're not a member of your work-based pension plan, then you should be, especially if your employer contributes to it on your behalf. Unfortunately, if you've been forced out of a final-salary scheme, then it's seriously expensive to earn a similar pension from a money-purchase scheme. Indeed, depending on your age, securing a comparable pension to that on offer from a final-salary scheme can cost up to a third (33%) of salary!

Given that few of us can afford to pay such massive sums into pensions, what are the alternatives? Here are five ideas to set you thinking:

1.    Grab your employer's contributions

If your employer contributes to its own pension scheme, then join it. Not doing so could cost you, say, up to 15% of your salary. Why lose this future pay when most of your colleagues are eagerly grabbing it?

2.    Pay the basic contributions

If it costs, say, 5% of your salary to be a member of a standard or enhanced occupational pension scheme, then join it and pay in at least this proportion of your pay. Usually, your employer's contributions are higher than yours, which means that you more than double your money on day one.

3.    Pay in matched contributions

If your employer offers to match your contributions pound for pound, then pay in as much extra as you can. For example, paying in an additional 5% of salary a year could put an extra 10% of your salary into your pension pot, thanks to one-for-one matching.

4.    Sacrifice some of your bonus

If you receive a yearly or quarterly bonus, then consider paying some of this windfall into your pension. For example, my wife's pension has swelled enormously in recent years, thanks to her paying her entire annual bonus into her company pension fund. Even better, by doing this, Mrs D has dodged taxes of up to 41% on her yearly performance-related bonus.

5.    Set up a low-cost alternative

If you don't have access to a decent company pension scheme, you're self-employed, or you don't want to pay any more into your occupational pension, then it's up to you to arrange your own retirement planning. I'd recommend looking around for a low-cost private pension, such as a Stakeholder personal pension or a Self-Invested Personal Pension (SIPP).

As I work for my own private limited company, there is no-one else willing to contribute to my pension. Hence, I've become a huge fan of my do-it-yourself Hargreaves Lansdown Vantage SIPP, which allows me to invest in a wide range of shares and funds at low cost.

More: Twenty years of DIY pensions | The death of guaranteed pensions?