How will the current climate impact defined benefit pensions?
The outbreak of Coronavirus has caused turmoil in global markets as uncertainty and panic spreads around the globe, but what does this mean for people with final salary pensions?
As coronavirus has spread markets around the world have tumbled, prompting central banks, including the Bank of England, to cut interest rates. The move is designed to make the cost of borrowing cheaper and encourage companies and individuals to spend in order to keep the economy moving.
Lower interest rates lead to lower gilt yields. This is significant because it is gilt yields that are typically used to calculate the liability of final salary pension schemes. With gilt yields at all-time lows, the cash value of future pension liabilities is at an all-time high.
This has two significant consequences.
Firstly, for individuals with defined benefit (final salary) pensions it means that the capital value (or cash equivalent transfer value) of their future income will likely be the highest it has ever been. In the current climate this could mean that individuals would be offered a sum significantly more than the annual income on offer in later life. The benefit of this can be compounded by the ability to then buy into a heavily discounted market which has been so heavily sold in recent weeks. The ability to cash in at such significant valuations and then invest into a market so far below recent highs is unique in financial history.
Additionally, the decline in gilt yields means a significant increase in the deficits for occupational pension schemes. The Pension Protection Fund (PPF) estimated that shortfalls in Britain’s defined benefit schemes rose from £75 billion to £125 billion in February and with the low interest rate environment set to continue this is only likely to rise. To compound the issue, the current economic climate means there is unlikely to be the sort of significant revenues generated this year to address the shortfall. For example, can British Airways reasonably be expected to fund a pension deficit while flights are grounded and staff are being laid off?
Ultimately with companies struggling to afford to fund legacy pension schemes, with values at record highs and markets so subdued, there has never been a better time to assess your pension options. Those with defined benefit pension schemes would be wise to take the time to assess their options with a qualified financial adviser.