Pensions: a roller-coaster ride

Money-purchase schemes are good news for employers - but employees might feel differently.

If your employer runs a pension scheme, you are one of the lucky ones. Occupational pension schemes give you a far better deal than personal pensions, mainly because your boss tops up your contributions. However, another great advantage of workplace pension schemes is slowly disappearing. Final-salary schemes, which give members the security of knowing exactly how much their pension will amount to, are giving way to money purchase pensions. With these, everything hangs on the fortunes of the stockmarket.

If your employer runs a pension scheme, you are one of the lucky ones. Occupational pension schemes give you a far better deal than personal pensions, mainly because your boss tops up your contributions. However, another great advantage of workplace pension schemes is slowly disappearing. Final-salary schemes, which give members the security of knowing exactly how much their pension will amount to, are giving way to money purchase pensions. With these, everything hangs on the fortunes of the stockmarket.

About 90 per cent of UK employees in workplace pension schemes are now in final salary schemes. But already, big employers such as the Post Office, many high-street banks and pharmaceutical companies Glaxo-Wellcome and SmithKline Beecham have switched their pension schemes from final-salary to money-purchase. And research from pension consultants Towers Perrin has revealed that about a third of major employers intend to make the change.

"Five years ago, nearly every large employer would provide a final-salary scheme for their employees, but an increasing number are now moving away from final-salary towards money-purchase," says Lee Jagger, associate at pensions consultancy Bacon & Woodrow.

What is the difference between the two types of scheme? With a final-salary - or defined-benefit - scheme the size of income you get when you retire is a proportion of your earnings at or near retirement. For each year you pay into the scheme, you receive a guaranteed amount of pension. With a money-purchase -or defined-contribution - scheme, contributions from you and your employer are invested, and when you retire the fund that has built up is used to buy an annuity, or pension income. This type of scheme works in a similar way to a personal pension plan, except that usually there are additional benefits. These benefits include life insurance and, most importantly, the fact that the company itself makes contributions.

However, unlike final-salary schemes, there are no guarantees with a money-purchase scheme - the income you end up with depends on how the investment performs.

So, why are employers turning their backs on final-salary schemes? The main factor is that, under this type of scheme, it is the company which shoulders the risk. However stocks and shares perform, however high inflation rises and however long the company's staff live during retirement, the pre-determined pensions must be paid.

"There is lots of uncertainty for companies in terms of how much it is going to cost them, though there is certainty for the members," says Mr Jagger.

The collapse of annuity rates in the last few years has shown employers just how uncertain their pension liabilities can be. Shanti Duggal, head of stakeholder pensions at Friends Provident, says that, in some cases, funding an employee's pension is costing £150,000, though the same level of income would have cost just £100,000 two years ago.

The 1995 Pensions Act - legislation largely prompted by the Maxwell scandal - required companies to ensure that their pension schemes were adequately funded.

And new accounting rules could make pension liabilities a much less predictable - and therefore less welcome - item on corporate balance sheets. The Accounting Standards Board proposes that, under a new standard called FRED 20, pension funds should reflect the volatility of their market value. At the moment, smoothed actuarial projections are used which fluctuate less from year to year.

"Surveys we have done indicate that, for finance directors, volatility of cost is just as important as the absolute cost," says Mr Jagger. "He would much rather know what he's got to deal with."

Many companies are now cutting their costs, becoming smaller and, in some cases, splitting apart from larger parent companies. "Downsizing is also having an effect," says Mr Duggal. "Companies that are downsizing are finding that final-salary schemes are no longer viable."

Others in the pensions industry say that final-salary schemes no longer suit the times. The jobs-for-life culture has changed, and people are now taking a greater responsibility for their own financial welfare. One pensions consultant says that money-purchase schemes are easier for employees to understand and that they give a greater sense of ownership.

Obviously there is a bright side to every-thing, but the bottom line is that, with a money-purchase scheme, it is the employee who takes the risk.

There is little employees can do about the change in pension terms. New members will simply have to take the terms offered, since these are bound to be preferable to a personal pension plan. In a few cases, members of existing final-salary schemes may be given the option of switching to a money-purchase scheme. But they should be clear about the advantages of a final-salary scheme.

"Money-purchase schemes are not second-rate, but the very best would be final-salary schemes," says Philip Telford, of the Consumers' Association.

The change from final-salary to money-purchase has been at a snail's pace up to now. But things could be about to hot up. Companies are putting decisions about pension schemes on ice because of the many Government proposals in the air, but once new legislation takes effect, the move could be rapid, pension consultants say.

"When the landscape clears, we will see more companies changing their arrangements," says Mr Jagger. "Our surveys show that 20 per cent of companies would change their pension arrangements simply because of the accounting changes."