• The pensions deficit in the charity sector was recently estimated at £1.9bn
• As the ‘black hole’ grows, many defined benefit schemes have been closed to new entrants
• From 6 April, a new deferred debt arrangement will help charities avoid having to pay off outstanding pension liabilities in one go when closing a final salary scheme
• Good communication with trustees and pension members can help charities manage a deficit effectively

The UK’s pensions deficit stood at just over £17bn in 2017. The UK Civil Society Almanac and the Office for National Statistics estimate that pensions run by charities accounted for £1.9bn of the total figure. This represents the gap between the amount available and the amount needed to pay people in a final salary pension scheme.

Final salary, or defined benefit, schemes guarantee to pay a percentage of someone’s salary on retirement. Until a decade ago they were considered a popular perk and were enjoyed by many charity employees, as well as those in the private and public sectors.

Andrew O’Brien, director of policy and engagement at the Charity Finance Group, says that up until 2008 many schemes had healthy surpluses. But after the recession, many dipped into deficit. This resulted in the so-called UK ‘pensions black hole’.

Defined benefit schemes need to pay out to current retirees as well as setting aside money for those who are enrolled in the scheme but have not yet retired. An ageing population, combined with stagnant investment returns, meant the guarantee offered by the schemes became unaffordable. This has led many charities, as well as private and public companies, to shut their defined benefit pension schemes to new entrants.

O’Brien says the deficit among the charity sector will continue to grow. While most schemes have stopped taking on new members, there are still many current pensioners drawing on them and many people who have yet to retire. These are all people who have been promised a guaranteed pension.

Because of uncertainty over Brexit, along with low yields on the many investment vehicles pension funds rely on to deliver returns, schemes are likely to continue to struggle to make up the funds they need. O’Brien says at least a third of average charity running costs relate to pension schemes.

But does a large pension deficit spell disaster? Not necessarily. O’Brien explains that while the top figure may look insurmountable, charities will not have to pay off the whole deficit at once.

Insolvency is more likely if its current pension contributions become unaffordable and the deficit figure includes the amount yet to be paid to people who have not yet retired.

Staying on the right side of The Pensions Regulator (TPR), which is responsible for making sure all workplace pensions are properly funded, should be the priority for charity directors and board members.

“Those charities which are being run well, pension deficit or not, have little to fear from TPR,” says Anne-Marie Winton, a partner at pensions law firm ARC. “But they do have to keep an eye on their pension fund.”

So what should the boards and directors of charities be doing?

Smaller charities can take some comfort from government reforms affecting the financial status of multi-employer pension schemes.

While larger charities will often have their own schemes which only their members pay into, smaller charities tend to be part of multi-employer schemes such as The Pensions Trust, which runs schemes on behalf of many charities.

Until relatively recently, there had been fears that a charity in a multi-employer scheme that closed its final salary scheme in order to cut its deficit would trigger the end of a ‘deferred debt arrangement’ – meaning they would have to pay off all their pension liabilities in one go. For some charities, this could have led to insolvency and closure of the organisation.

But a campaign run by, among others, the Charity Finance Group has been successful in seeing the creation of a new deferred debt arrangement, thereby avoiding the issue of repayment of the entire liability.

The result is part of the Occupational Pension Schemes (Employer Debt and Miscellaneous Amendments) Regulations 2018, and comes into force on 6 April 2018.

O’Brien says the most important thing any charity can do is obtain regular updates from the pension trustees. Trustees are independently appointed individuals who hold the assets on behalf of the charity. Their powers are written in trust deeds.

Many pension trustees work across several schemes, which means charities will need to be proactive.

O’Brien says “keeping a line open with the pension trustees” is of high importance. “Whether you’re in a large charity with its own scheme or a smaller charity in a multi-employer scheme, you need to be able to speak frankly.”

Worryingly, O’Brien adds: “We are finding that not all charities are taking the deficit issue seriously. Instead they are leaving it till the last minute.”

“Remember, a successful investment strategy can help to bring down a deficit,” says Winton. “So they need to explain what the fund is doing and how it can improve its performance if possible.”

Keeping members of a final salary scheme informed is also key, explaining that while the scheme may be in deficit, it’s not in any danger of failing to meet its current obligations. This needs to be communicated to current employees in the scheme who are not yet retired and also to those who are already taking their pension benefits.

Winton points out that good communication benefits the reputation of the charity. Reputation needs to be handled well if the charity is to be considered a going concern and worthy of donations from members of the public, or being awarded grants.

The introduction of pension freedoms in April 2015, which allow pension investors to take cash withdrawals from their pension fund at age 55, only applies to members of defined contribution schemes.

However, under some circumstances, members of defined benefit schemes can ask to close their final salary scheme and transfer their pension to a defined contribution scheme.

If the employee transfers out, the advantage for the charity is that they are no longer in the scheme and that liability is removed.

O’Brien says pension freedoms are still not understood well enough within the charity sector and scheme members who wish to take advantage of them will need to be directed towards the government-backed Pensions Advisory Service.