The UK Defined Benefit Pension Deficit: Definition, Causes, and How to Deal With It
A pension deficit is where the company that offers employees a Defined Benefit pension scheme doesn’t have enough money to meet retirement needs. Shortage of pension funds usually occurs because the investment chosen by the pension manager does not meet expectations.
The condition of pension shortages is caused by many things, such as investment losses, poor planning, demographic changes, or geopolitical situations. Such negative situations can be risky for the company, as pension benefits for former and current employees are often legally binding.
Watch an explanation by our CEO and Independent Financial Advisor, Dominic James Murray through a video below for a better understanding of Defined Benefit Pension deficit.
Understanding The Risks of Defined Benefit Pension Plans: Pension Deficit
In the United Kingdom Defined Benefit (DB) pension scheme, a clause states that a guaranteed payment will be received during the employee’s retirement. The company/employer will provide a large pension fund for various investment assets. The objective is clear; generate investment income to meet the company’s obligations for retirement now and in the future.
The most considerable risk of the Defined Benefit schemes is that the investment assets, including the income, are smaller than the total pension payment obligations. Thus, the company/employer fails to fulfil its obligation to pay pensions to retirees.
The pension deficit situation can be seen in the scheme’s funding position. The scheme describes the condition of the value of assets and liabilities expressed in a comparison ratio and is known as the funding levels.
Defined Benefit Pension plans are very likely to experience such vulnerabilities for many reasons. For example, Russia’s aggression against Ukraine could trigger the UK’s economy. Like causing a financial crisis, changes in interest rates, falling stock market conditions, and a drastic decline in asset values. Thus, making various investment instruments suffer losses, either directly or indirectly.
The pension deficit has become a kind of trend in the UK. This deficit condition will not be far from factors influencing it, such as:
- The equity market crash
- Increased life expectancy of retirees
- Miscalculation of future investment income
- Companies cannot simply renege on the pension scheme contract
How Do Companies Deal with It?
The pension deficit condition requires companies/employers to take planned mitigation actions. There are several types of mitigation actions that companies can take. When a deficit occurs, there are two main types of actions that companies often take, namely:
- Trying to generate high income from existing investment instruments
- Inject funds into investment instruments from company profits
Action number 2 is the practice companies often carry out to make up for the pension fund deficit. This practice does seem safe and does not harm the company or retirees. However, injecting funds into investment instruments from the company’s profits will harm or reduce shareholder profits.
Suppose the practise of injecting funds is carried out every year. In that case, the confidence of investors or shareholders will begin to erode, which will harm the company. Another option is to apply the strategy proposed by Fisher Black in 1981. The principles of the idea are:
- No change in the financial position of the combined entity (firm plus pension fund)
- But there are tax advantages
- And some cost savings
- There are some conditions needed for this to work
How You Can Deal with Pension Deficit
Your first reference when the company is in a pension deficit situation is the guidelines issued by The Pensions Regulator (TPR). This guideline covers various actions that retirees need to take to get their financial rights from the company. However, how can you know whether the company will be in a pension payment deficit situation or not?
Retirees need to consider many factors when dealing with pension deficit conditions. These factors are usually directly related to the state of the company, whether the level of profit, growth, the country’s economic conditions, world political conditions, equity market conditions in other parts of the world, etc.
Therefore, getting advice from an Independent Financial Advisor is the safest path to take. At least, you will not be bothered by yourself reading various variables that are criss-crossing each other. An Independent Financial Advisor should have been your first step of decision-making in your retirement. At least, before retiring, you already have a decision-making who will give you a tailored advice and will guide you through the intricacies of every step of your pension decision.
A qualified and experienced Independent Financial Advisor have the best knowledge, preparation, and calculations when the company/employer faces a pension deficit situation. An Independent Financial Advisor will help you communicate with your employer, the TPR, pension trustees, pension protection fund, and other relevant parties.
You can get advice and free initial consultation regarding your retirement condition amid the company’s pension deficit vortex to us. Qualified Independent Financial Advisors at Cameron James have the right experience in terms of pension transfer and pension deficit. Book yourself for your free initial consultation through the button below and talk to one of our qualified Independent Financial Advisor.