FOOL'S EYE VIEW
The Hidden Dangers Of Pensions

By Stuart Watson (TMFTiger)
August 15, 2002

Chatting idly over a plateful of barbequed food last weekend, I was told a very distressing tale. It concerned someone who recently lost their job at age 60 when the company they worked for went bust. It was a relatively small company with a few dozen employees and it had its own defined benefit company pension scheme. However, with the company going bust, all the money in the pension scheme is likely to go towards funding the payments to existing pensioners. Not only has the person concerned lost their job, they've (almost certainly) lost most, if not all, of their pension too.

The conventional wisdom is that company pension schemes are a good thing. And for the most part, they are. According to the National Association of Pension Funds, companies contributed an average of 9% of employees' salaries in 2001 in the case of defined benefit schemes. The contributions for defined contribution schemes were 6% -- less generous, but still a very significant contribution. (The average amount that we as employees put into both these types of pension is around 5% of our salary). The employer payments are usually more than enough to offset the inherent inflexibility and high charges that most pension schemes suffer from.

Although there has been a lot of fuss about the closure of defined benefit schemes in recent months, this does illustrate one of their major shortcomings. Particularly where the company concerned is small, or perhaps in a highly competitive industry, you have to consider the possibility that it may longer be around when you retire. A more likely scenario is perhaps the pension fund itself has to close down at some stage and you may not get as much pension as you were anticipating.

Defined contribution schemes, despite the fact that they shift more responsibility onto us as individuals, are more robust in such situations. Although you'd lose the benefit of any future contributions from the company, the amount you've saved already is effectively ring-fenced.

Of course, such problems apply to any sort of retirement or investing plan. Those who entrusted their money to Equitable Life can attest to that. Putting your eggs in one basket is a risky approach to take, especially if you don't keep a close watch on the basket in question. A spread of funds or different investment vehicles is a better approach to take, provided it doesn't mean you are paying significantly more in fees and charges.

When it comes to company pensions, particularly defined benefit schemes, we all have a tendency to assume that everything will turn out peachy with little intervention on our part. As we're slowly finding out though, this is a dangerous assumption to make. There are very few people who can afford not to have a contingency plan in place if they want to have a comfortable retirement. It doesn't have to be anything fancy -- a steady monthly contribution into something as simple as an index tracker will do the trick for most people.

More: Pension centre | Pensions discussion board