Why Are Defined Benefits Pension Schemes Winding Up

As you all know, Pension Schemes are a unique type of saving plan that helps you save money which will be usually be used later in life often in retirement. It is also known that Pension Schemes have advantageous tax treatment when you compare it to other forms of savings. We can divide Pension Schemes into to main schemes and they are:

  • Defined Benefits Pension Scheme
  • Defined Contribution Scheme

Defined Benefits Pension Scheme

Defined benefits pensions pay out so-called secure income for life which will increase each year. The scheme is contributed by your employer and is he is responsible that there is enough money when you decide to retire.

A lot of these schemes have a normal retirement age of 65. At that time your employer often stops to contribute to scheme and your pension will start to be paid.

When you die, it might continue to be paid to your spouse, civil partner or dependents. This is usually a fixed percentage (for example 50%) of your pension income at the date of your death.

Defined Contribution Scheme

Defined contribution scheme is based on building up a pot, also called pension pot. This scheme is composed of employers contribution plus return on investments and tax reliefs.  Defined contribution scheme usually consists of two steps.

First step

In this step, it is often that funds are invested in stocks and shares thus allowing it to grow over the years. You can also choose from a range of stocks and shares, but also remember that you can value of the investment can drop.

Second step

You can access and use your pension pot in any way you wish but only if you are 55 years old. You can:

  • Take your whole pot in one go. One-quarter of funds will be tax-free and the rest will be taxed the usual way.
  • Take funds as and when you need them, but remember that one-quarter of each withdrawal will be tax-free while the rest will be taxed.

The size of contribution benefits pension pot and the amount of income you get when you retire will depend on:

  • How long you save for
  • How much you pay into your pot
  • The choices you make when you retire
  • How much you take as a cash lump sum
  • How well your investments have performed
  • How much your employer pays in (if a workplace pension
  • Annuity rates at the time you retire – if you choose the annuity route
  • What charges have been taken out of your pot by your pension provider

When you retire, your pension contributor an employer will usually offer you a retirement income based on your pot size, but you don no have to take this.

Defined Benefits Pension Schemes Winding Up

Defined benefit schemes have been all over media in recent months. The great majority of this scheme are low funded which means that they do not have enough money to cover all its members.

Because of this many of defined benefit schemes are being closed, also known as winding up. Low or poor funding can be caused if the company operates bad, but the majority of employers are closing these schemes because of rising costs that are associated with paying defined benefits schemes and they are not guaranteed to employees.

Previously, it was believed that defined benefit pensions were guaranteed, but they are not because they can only be paid if there is enough money in the scheme to meet liabilities of all its members.

Following reasons are the most cause why the great majority of employers or trustees deciding to close or wind up benefit pension scheme, of course, there can be some other reasoning, but these are most common:

  • Agreement with between employer and employee. The contributing employer is not willing any longer to support or to contribute to defined benefit scheme but is willing to support a defined contribution pension scheme. This is usually happening when costs of defined benefits scheme are too greater that of a defined contribution scheme, so employer and employee agree to close defined benefit scheme.
  • If the employer operates poor and because of that employer may be in financial difficulties unable to fulfill all obligations that come with a pension scheme.
  • If defined benefit pension scheme is reducing in size it can become too small to operate. This is usually happening if the scheme is closed for new members and existing members are dying or retiring. In this case most common is that employer and existing members decide that it is in the best interest to wind up the scheme.

As a result of above mentioned many are transferring from defined benefit pension scheme to defined contribution scheme. But this is not without risks.

Risks of transferring to a defined contribution scheme

Any potential advantages of transferring from a defined benefit pension scheme to a defined contribution pension scheme can be outweighed by the costs, risks, and loss of benefits involved. Your future pension income can not be predicted precisely no matter are your employer is contributing or it is a personal or stakeholder pension. With a personal or stakeholder pension, you will give up any benefits you had in the former employer’s scheme.

Risks of staying in your defined benefit scheme

Staying in a defined benefit pension scheme can also be very risky. If your employer is operating well he still needs to secure that defined benefit scheme has enough funds to fulfill all obligation to scheme members. Some of these employers sponsoring these schemes have gone out of business, not leaving enough money to pay promised pension.

If an employer is going out of business without enough funds in its pension scheme, the Pension Protection Fund might be able to provide compensation, but this will not be the full amount of the pension you have accumulated.

Whatever you decide always consult with specialized financial advisors to avoid any unwanted risks.

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