Don't let pension scares put you off

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The Independent Online

Pensions made the headlines for all the wrong reasons once again last week, as new research revealed that schemes run by some of the biggest companies are facing severe cash shortfalls.

Pensions made the headlines for all the wrong reasons once again last week, as new research revealed that schemes run by some of the biggest companies are facing severe cash shortfalls.

The survey, by actuary Bacon & Woodrow, reveals that FTSE 100 companies BT, Marks & Spencer, Tesco, Scottish & Newcastle and Vodafone all have underfunded schemes. All in all, a total of 17 major occupational pension schemes at 14 companies are underfunded by millions of pounds. The problem has been caused by falling stock markets, low inflation and low interest rates, combined with people living longer and retiring earlier.

While many companies will make up the shortfall, all this is bad news for the future of final salary pension schemes. These are by far the best type of pension because they guarantee a certain level of income and benefits on retirement – usually a set percentage of a worker's final salary, depending on his or her length of service.

Some companies, such as BT, ICI, Barclays and Lloyds, have already announced that they will no longer be offering final salary schemes because they are so expensive. And finance directors who are now being forced to top up pension funds may well be persuaded to replace final salary schemes with cheaper defined contribution schemes in the future.

With defined contribution, or money purchase, schemes, the employee shoulders the risk as the size of the final pension is not guaranteed. It is based on the size of the individual investment pot – created by the money the employee has paid in and the growth of the stock market. It also depends on annuity rates, which at the moment are poor.

Talk of underfunding provides more ammunition for critics who argue that pensions are not the best investment for retirement. But pensions are useful because of the tax breaks that come with them. And because you can't get your hands on your money before the age of 50, you are not going to fritter it away on holidays, weddings or cars. What's more, the fact that we have to buy an annuity with three-quarters of our fund by the time we reach 75 means we get a guaranteed income for life – even if rates are poor.

Of course, there are problems with pensions: they are inflexible investments and most of us don't know how to choose investment managers who are going to invest our money wisely. Some advisers recommend a mix of pensions and other investments such as individual savings accounts. But the important point is that we should be saving more for our retirement, not less – so don't let talk of underperforming schemes scare you off.

m.bien@independent.co.uk

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