What Is the Pension Protection Fund?
The Pension Protection Fund protects employees’ pension pots if their employer goes bankrupt or ceases trading. Read on to learn how the Pension Protection Fund works and what is covered.
The Pension Protection Fund (PPF) can provide vital peace of mind to members of certain pension schemes. Should their employer go bust – and the pension fund sinks with it – the PPF safeguards their retirement income.
Read on to find out more about the scheme and how it works.
Who is covered by the Pension Protection Fund?
The PPF covers members of certain defined benefit pensions.
Defined benefit pensions are schemes that pay members a guaranteed income in retirement based on the size of their salary and the number of years they were a member. The PPF pays compensation when there is a qualifying insolvency event in relation to the employer and where there are insufficient assets in the pension scheme to cover Pension Protection Fund levels of compensation.
The PPF exists to protect the retirement incomes of current and former employees who are still working, as well as those who have already retired and are receiving their pension. It currently protects around 10 million workers and has 275,000 members.
Not all defined benefit scheme members are protected by the PPF. If you are in a public sector scheme – for example, the NHS or Teachers’ Pension – you won’t be protected. This is because these schemes are already safeguarded by the government, so additional protection isn’t necessary.
What about members of defined contribution pension schemes?
If you are in a defined contribution workplace pension, you will also not be covered by the PPF. These are the most common workplace schemes and rather than offering a guaranteed income in retirement, the size of your eventual pension is based on the amount of money you pay in and the performance of the investments you select.
Although employers will contribute to these schemes too, they are not responsible for making sure there is enough money to pay you an income for life at the time of your retirement. As such an employer going bust shouldn’t affect your pension benefits.
How does the Pension Protection Fund work?
The PPF works by paying ‘compensation’ to members of eligible pension schemes. How much you get will depend on whether you had already reached pension age when the scheme collapsed.
If you had already reached pension age, or had taken early retirement due to ill health when the scheme collapsed, the PPF will pay 100% of your retirement income. Anybody receiving a survivor’s pension, for example a widow or widower’s pension, or a child’s pension, would also be able to claim 100% of that income from the PPF.
If you were yet to reach your pension age, the PPF would cover 90% of the amount you had saved up until the point the business went bust. This amount is subject to a cap based on your age. The older you are, the higher the cap.
The cap for a 65-year-old – who has more to lose and little time left to boost their pension – is currently £41,461.07. However, a 40-year-old, who will have accrued less and is still only mid-career, would see their maximum compensation capped at £22,491.67.
In reality, the vast majority of claimants are not impacted by the cap. According to the PPF, it only affects 0.5% of its members.
Will my compensation increase with inflation?
Usually income from a defined benefit pension will increase each year at a level set by the scheme. However, once the PPF has taken on a pension different rules will apply.
Currently, payments increase in line with inflation up to a maximum of 2.5% each year. But this only applies to benefits accrued since 6 April 1997. Any benefits built up prior to this date won’t increase.
How is the PPF funded?
Compensation paid by the PPF doesn’t come from the government or the taxpayer. Rather, the scheme is funded by the pension schemes it protects. Each member scheme pays a levy – a bit like an insurance premium – into the compensation pot.
The PPF may also be able to claim any assets of schemes that transfer into it and recover some funds from insolvent businesses.
What happens when eligible schemes become insolvent?
If an employer with a defined benefit pension goes bust, the scheme will be passed to the PPF to check whether its members will be eligible for compensation.
The PPF will also need to investigate the assets in the scheme and explore whether it could be passed to a specialist insurance company, which would pay benefits to members at the same level as the PPF. If there isn’t enough money left in the pot for an insurer to take it on, compensation would be paid by the PPF.
Unfortunately, it is not a quick process and this ‘assessment period’ can take as long as two years.
During this time, the pension scheme is effectively frozen – no more contributions can be made and members are not able to transfer out, unless an application had been made before the assessment period started and the scheme’s trustees are willing to sign it off.
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Rachel Lacey is freelance journalist with 20 years experience. She specialises in personal finance and retirement planning and is passionate about simplifying money matters for all. Read more