Why do we treat charitable pension schemes as if they were for profit?

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Charities are charitable and  different – it should go without saying but it seems that many pensions people haven’t worked this out,

Why are they different?

Firstly they are not for profit and typically view their work as infinitely valuable in terms of meeting a demand- I suppose Cancer Research might consider there a world without cancer, Age UK might dream of immortality and Oxfam might aspire to eradicating hunger; but Cancer, Ageing and Famine don’t look like going away any time soon.

 

They think longer term

So charities think long-term and those who work for them set their eyes on distant goals. They wold like to think about pensions the same way.

Secondly they are taxed differently, because they do not make a profit, they do not think of corporation tax.

In thinking about their pension obligations, charities have a different agenda. The funding of defined benefit pension arrangements for staff who work for them is eminently sensible, these staff are dedicated to the cause they work for, tend to work for the Charity for long periods, do not see huge earnings progression and are highly dependent on the paternalism of the organisation to which they typically have devoted themselves. So many charities choose to reward staff through good quality pension schemes because it suits the culture of the charity and the needs of its staff.

But advice given to charities on how to fund for these long-term obligations is too often aimed at emphasising how “charities should come into the real world”, a world where pension liabilities sit ill on a corporate balance-sheet and the aims of trustee and sponsor alike is to get treat pensions as Japanese Knotweed.

The trouble with Japanese Knotweed, is that it is extremely expensive to get out of the ground and organisations that try to eradicate it, often find it becomes an obsession. Getting  defined pension guarantees out of an organisation can also take over the normal priorities and STOP CHARITIES BEING CHARITABLE!

Rather than be ashamed to have long-term pension liabilities, many charities are extremely proud that they do the right thing by staff who – do the right thing!

There is a second and more technical point that can be made while I am about it.

They don’t pay corporation tax

Because charities are not for profit, they do not pay corporation tax and do not need to mitigate tax by making pension contributions. The contributions they make to pension schemes, are made simply as a reserve and not part of a tax mitigation exercise.

But by contributing money into a pension scheme, the money is being committed for all time. For much of the past five years, money has been pouring into charitable pension schemes to plug deficits created by low interest rates (theoretically increasing liabilities) and low returns on assets. As the yield curve bends back, liabilities are being shown as less expensive and as growth returns to the economy, assets are increasing in value.

Many charities are finding themselves with decreasing deficits but with the same demands being made on them to lose revenue to the pension scheme.

This is where treating charities as corporate pensions is so dumb. Demanding , as many actuaries do that charities fully fund their pensions is crazy. The cash flows diverted to build up these huge reserves reduce a charity’s capacity to be charitable to no great purpose.

Charities can get smarter about pension funding

Charities should be advised to get smarter on funding, the use of contingent assets, escrow accounts and other side pocket arrangements can provide just as great short-term security as the long-term  investment of such reserves. And whereas a corporate might regard the consignment of these cash flows as beneficial as they offset tax, the CFO of the charity can take no such comfort.

Without getting out of my depth in the technicalities of escrow or contingent assets, I think this blog has made its point.

Too much pensions advice is based on treating charities as uncharitable and as much the same as for-profit corporations. Whether in view of strategy – “what’s the scheme?” or in terms of tactics “how do we run this without impairing our charitable works?”, charities must be treated differently.

Many asset management and advisory  firms have seperate divisions to market to charities, but from the conversations I am having with charities and their advisers, the marketing differentiation is not extending to product innovation!

A blatant plug

This can and should change and if for once I can plug  my company, if this is ringing bells and you have defined benefit pension liabilities within your charity, you might want to ping an email to my good friend peter.shellswell@firstactuarial.co.uk .

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About henry tapper

Founder of the Pension PlayPen,, partner of Stella, father of Olly . I am the Pension Plowman
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4 Responses to Why do we treat charitable pension schemes as if they were for profit?

  1. As an adviser to charities, I am puzzled by Henry Tapper’s blog on charity pension funds. He’s right that many charities have a very long term horizon – far longer than most closed DB pension schemes. But why should this mean that charities don’t need to fund their pension promises adequately? Ultimately, a charity’s DB pensioners have to be paid in hard cash. Other than leaving the liabilities unfunded and paying pensions out of cash flow at the time, this can only be done through funding the scheme with cash (and possibly some contingent assets, though as Henry implies this is rarely a good solution for a charity). Is his point simply that funding requirements are unnecessarily onerous because of very low gilt yields, and that pension promises can be met with a smaller “pot” than is currently being required by the actuaries? Maybe so, but it is a slippery slope to lose sight of the very real cost of providing good pensions, especially if, as Henry suggests, those organisations are particularly keen to look after their employees.

    • henry tapper says:

      Thanks Nicola. I’m not suggesting that charities are let off the funding hook, I’m simply saying that there’s no good reason for them to superfund their schemes to a point that they lose the working capital needed to be charitable.

      Funding an escrow account is a simple alternative to funding the scheme but has the advantage that when the scheme moves back to surplus, this money is not “lost to the scheme” and the scheme does not go super funded!

      I’m all for solvent schemes but in the overall scheme of things, a better balance can and should be found which allows Charities to get smarter with their pension funding.

  2. Ted Belmont says:

    Two comments if I may. First, the Regulator’s new ‘sustainable growth’ objective is hard to interpret in the case of a charity (TPR has sort of recognised this but it’s far from clear what they are going to do about it). Secondly, there are many admirable charities, including the ones Henry has named, but a lot of other bodies are registered as charities too – including schools and universities, as well as many smaller charities whose aims are much narrower and may only benefit a very small section of society. My point is that it is not a homogeneous sector and that makes it more difficult to justify giving it a blanket exemption.

  3. henry tapper says:

    Excellent points Ted. I will hope to return to this theme soon

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