High Pension Poverty Trap

The basic premise of The Pensions Institute's report 'The Greatest Good For The Greatest Number' is that many defined benefit pension schemes are unlikely to get to a position where they can provide full benefits due to the weakness of the sponsoring employer.

There is a strong argument in favour of reaching a compromise whereby members receive benefits that are scaled back, but greater than they would receive if the employer became insolvent and the scheme entered the Pension Protection Fund (PPF).

This is particularly relevant for members who receive a scheme pension in excess of the PPF compensation cap of £36,401.19 pa (this equates to £32,761.07 when the 90 per cent level is applied).

Particularly hard hit are those who retired early but have not yet reached the scheme's normal retirement age; have benefits in excess of the cap; and who took a lump sum. The earlier you retired, the lower the annual cap is set, and the lump sum payment will be added back into the calculation.

This can result in some members having their pension benefits savagely cut back if their benefits exceed that to which they are entitled under the PPF 'lifeboat'.

I ought to state for the record that I am great fan of the PPF in principle. Having been an independent trustee for over 20 years I have had too many conversations with members who were robbed of their pension scheme when their employer became insolvent. Trying to explain winding up priority orders and MFR funding principles is never easy when a member is still reeling from the shock of redundancy.

The compensation cap, however, creates a new form of poverty trap, and I believe that trustees faced with a weak employer covenant ought to consider some form of compromise deal so that the interests of the membership as a whole are optimised.

This is likely to be unchartered territory for many trustees, and the Regulator would expect to see an independent trustee in place. This need not be as expensive as a strapped-for-cash employer might imagine, and, if it results in a more equitable outcome for the members, and the possibility of a future life for the company, then it would be money well spent.

If you would like to discuss any issue covered in this piece, please get in touch.

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