What to do about the UK's workplace pension mess

The appalling state of some of the UK's workplace pensions has been brought onto the front pages of the national press in recent months thanks to the BHS mess.

The high street retailer went into administration back in April leaving with a £571m hole in its pension scheme, which might now have risen to £700m. It was terrible news for BHS employees but the retailer is not alone.

Britain's final salary pension schemes in particular are in a dire state, with many of the country's blue chip companies unable to meet their future pension commitments.

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Most of the schemes are already closed to new employees or contributions, but even less generous money purchase equivalents are likely to leave people short on retirement provision because of persistently poor investment returns.

Former Pensions Minister Steve Webb has said he believes that there are hundreds of defined benefit (final salary) schemes that are so-called 'zombie schemes', meaning they have no chance of ever being able to meet their commitments.

What has gone wrong?

"The UK’s collective pension deficit has transformed from negligible in 2006 to Britain’s biggest liability, eclipsing government and corporate debt," says Oscar Williams-Grut in Business Insider.

The pension deficit in Britain's final salary schemes now sits at an astronomical £935bn by some estimates - and it's not all because people are living longer.

"A combination of lax regulation, low interest rates and frugal employers has allowed deficits on defined benefit work schemes to build to frightening proportions," says Jeff Prestridge in the Mail on Sunday.

The first problem has been low interest rates. Almost a decade of meagre rates has affected pensions.

Most pension schemes are invested in long-term, stable investment products such as government debts, known as gilts. “But the yield on gilts has collapsed in the wake of the financial crisis, due to demand from other risk-averse investors,” says Williams-Grut.

Pension schemes forecast how much they expect to make based on gilts. "But if gilts are falling, their expected returns are falling, meaning they need to invest more money. That is money they don’t have, meaning deficits rise," he adds.

Of course, this also means that if and when rates rise again, deficits will automatically shorten at least to some degree.

The other problem is that there hasn’t been enough regulation of pension schemes. Last year, 35 FTSE 100 companies paid out more in dividends to shareholders than to fill their pension deficits.

"Workers should be given a fairer deal," says Prestridge.

Is the government doing anything about it?

"Beefing up The Pensions Regulator’s powers has been mooted – giving it the right, for example, to veto takeovers that involve businesses with substantial pension deficits (BHS)," says Prestridge.

"But this seems like shutting the gate after the horse (Sir Philip Green) has long bolted." What is really need is laws that require companies to "fund their schemes adequately," he adds.

Other suggestions involve injecting some "realism" into the market by allowing firms who would face potential oblivion as a result of their deficit to reduce future payouts, perhaps by limiting the inflation link from the higher Retail Prices Index to the Consumer Prices Index.

That has been mooted in relation to the pension scheme of Tata Steel, but is controversial and would require a change in the law.

What else could be done?

Longer term - and of particular relevance for those who aren't even entitled to more generous final schemes and looking at a meagre retirement - there are some suggestions for radical reforms.

We need to find a half-way house between generous defined benefit schemes that employers can’t afford and defined contribution, where all the risk lies with the employee, says Patrick Collinson in The Guardian.

"How about sharing some of the risk? How about saying: 'We can’t afford to guarantee pensions of up to two-thirds of final salary – but we could underwrite a promise that your stock-market based scheme will at least give you, say, 25 per cent of your final salary," says Collinson.

"We’re between a rock and a hard place on pensions. Until now it is workers who have given up all their rights. It’s now time employers began to show a bit of flexibility – and rather a lot more long-term responsibility."

What to do with your pension?

If you are part of a defined benefit scheme and you are worried about whether your employer will actually be able to pay you what you expect then don’t panic. Find out what state your scheme is in.

Understand that if your pension scheme or employer went bust your final salary pension would be covered by the Pension Protection Fund. This means if you are already retired your payouts are fully covered, and if you have yet to retire you should receive 90 per cent of what you expected up to a cap of around £30,000 a year.

You also have the option to transfer your benefits out of the scheme, but this is "not easy given the reluctance of financial advisers to sanction such a move for fear of being found guilty of pension mis-selling," says Prestridge.