As one of the last final salary pension schemes in the city is overhauled, Jon Robins looks at how law firms propose to fund pensions for partners and staff in the future

As Freshfields Bruckhaus Deringer overhauls what is believed to be one of the last final salary pension schemes in the City, there was a timely reminder this month of the perils of such arrangements. The Law Lords ruled that the 560 partners of KPMG, Britain’s third-largest accounting firm, would have to dig deep to find £88 million to plug a hole in its final salary scheme.


‘It doesn’t matter whether the case was about a law firm or an accounting firm, it highlights the fact that final salary schemes that have a deficit have to be made good by partners,’ comments George Bull, head of the professional practices group at accountants Baker Tilly.


‘This is the issue that law firm partners will have to consider if they have a final salary pension scheme, and it will be an issue that affects partners leaving or joining firms as well.’


It has been reported that the pensions regulator wants the deficit to be cleared within a decade, which would mean KPMG increasing its annual pension contributions from £6 million to £26 million. There will be further cost in the form of the levy that has to be paid to the pension protection fund, designed to be a central pot of money to meet defined benefit (or final salary) pension scheme liabilities in the event of the company’s failure.


Over the years, law firms have shut down their final salary schemes, which provide pensions based on a member’s salary and pensionable service. For example, City firm Nabarro Nathanson took, as the firm described it, ‘the prudent decision’ to close down its scheme in 2004. Have law firms been too hasty in seeing off the risk of such arrangements? Many firms take ‘quite a benevolent or altruistic view of their employees’, reports Mr Bull, and ‘may be trying to keep final salary schemes going for longer’.


He says: ‘Just as many other organisations have over the years replaced final salary schemes with money purchase arrangements, law firms have followed the same trend. Some firms have been quick to do that because they want to take advantage of certainty over costs, or others just wanted to reduce costs, or, in some cases, they simply have not been able to afford the contributions.’


Defined benefit schemes are very much a minority practice, while the traditional view has been that partners look after themselves. ‘Pensions are primarily an issue for the partners as individuals and, until recently, firms haven’t been particularly concerned about broader pension issues,’ comments Roger Zair, head of the professional partnerships group at accountants Grant Thornton.


The majority of firms have defined contribution schemes, not defined benefit schemes. The former build up a fund that is converted into income upon retirement. Ian Greenstreet, pensions partner at Nabarro Nathanson, points out that law firm arrangements are no different to any other business. ‘The only difference is that the partners of law firms are self-employed, and if you’re self-employed you can’t be a member of an occupational pension scheme,’ he says. ‘Even if the firm provides an occupational scheme for those who are assistants, when they make partner they have to cease. The expectation is that the self-employed partners will make their own arrangements.’


Caroline Wilson is human resources director at national firm Eversheds. One of her tasks was to review pension arrangements when she joined in July 2001. At the time, due to the firm’s merger history, there were 14 different pension schemes including a final salary scheme with 25 members. That was already closed down and now has only 12 members. ‘Over the last five years, we’ve been trying to contact the providers to get better arrangements in place for our people,’ she says. The firm runs its own Eversheds personal pension – provided by Investment Solutions, an offshoot of insurance broker Alexander Forbes – which covers 1,500 of the 4,000 staff. Staff can provide up to 5% of the salaries and the firm matches that. She is currently running an Eversheds ‘roadshow’ to raise awareness about ‘A-Day’ on 6 April, the biggest shake-up of the tax regime surrounding pensions in decades.


Ms Wilson reckons that the majority of employees who become partners are with the Eversheds plan when they are made up to partner, and stick with it. ‘Other than that, we do not do anything for the partners because they are essentially self-employed,’ she says. The firm takes the view that the people who own the firm should stand on their own two feet. ‘We are very cautious about giving financial advice or even paying somebody to offer financial advice, because it can come back to haunt us,’ she says. ‘I am a strong believer in people having to grow up and find their own financial advice.’


While there is constant bad news about pensions, A-Day could represent some rare good news. ‘There are huge tax-planning opportunities after 6 April,’ reckons Mr Greenstreet. ‘We are sweeping away the eight existing tax regimes and replacing them with one integrated regime.’ From 6 April, people will be able to invest up to £215,000 a year – and up to £1.5 million in total – in their pension, above which they will be taxed. ‘And not very many retiring solicitors have a pension pot of £1.5 million,’ notes Roger Zair. By scrapping current limits on contributions, people will be able to build up their maximum lifetime allowance much more quickly, he explains.


In terms of law firm management, Mr Zair says that A-Day provides ‘an incentive to encourage partners to make retirement savings as they go through their career’. He says: ‘So the firm is not faced with difficult issues when people go into retirement and begin to wonder, “What have I got to live on?”,’ he says. ‘If the firm makes it clear that lawyers can make these larger contributions, there should be no difficulties when they get to the end of the practice.’


At the other end of the law firm spectrum – high street firms performing large amounts of publicly funded work – pension arrangements are largely informal. According to David Gilmore, a management consultant at DG Legal who advises firms doing legal aid work: ‘Most of my clients do offer a scheme, but it’s a pretty pointless exercise. The firms tend to be more of a post-box for a pension company rather than actually setting up and monitoring a scheme.’


‘Firms for quite some time have been getting meaner and meaner about what they give to retiring partners,’ notes Tony Williams, founder of the legal consultancy Jomati and former managing partner of City firms Clifford Chance and Andersen Legal. He describes the Freshfields scheme as ‘one of the last credible partner pension provisions’. He explains: ‘The difficulty is that [law firm schemes] tend to be unfunded – they are paid as they go along. While traditionally this involved small amounts, those amounts have now increased as law firm profits have shot up dramatically.’ Nabarro Nathanson closed down its scheme to avoid pension liabilities becoming a ‘headline-grabbing deficit’, as senior partner Simon Johnston put it.


‘If you go back 20 years, it was quite common to have annuities for retired partners, which was almost the equivalent of them getting the benefit of the goodwill that they had built up in the business,’ explains Mr Williams. ‘We have now moved to the stage where people are desperately trying to avoid that.’


As he points out, firms might have a limit on the amount that they will pay out by annuity. Freshfields is still working on its revised scheme. A partner hitting retirement age would get one-fifth of the amount a working partner receives in that year, subject to a 10% cap on total annual profit. The idea is to ‘rebalance the distribution to avoid a situation where the current generation of retired partners do well, but the next generation gets nothing’, as one Freshfields source puts it. It has been reported that retired partners receive a pension on a point system with a maximum payout of £153,000 a year.


Peter Rowley, national head of pensions assurance at Grant Thornton, reckons there is further pressure on final salary arrangements. The risk-based element of the levy for the pension protection fund for defined benefit schemes has just been finalised. ‘That is focusing minds on the status of funding and the ability of the employer to meet obligations to the scheme,’ he says. ‘Some very large bills are likely to be falling on some pension schemes trustees’ desks right now.’


Grant Thornton recently issued a warning that partnerships and limited liability partnerships (LLPs) might be unfairly disadvantaged if that risk assessment process was based on inaccurate information, such as the assumption that the business was a start-up because of recent conversion to LLP status (see [2006] Gazette, 2 February, 3). That difficulty could arise because only one year’s accounts would have been filed at Companies House. ‘LLPs with defined benefit schemes should check that their pension assessment is based on the firm’s historical financial record,’ advises Roger Zair.

Mr Williams points out that the rush to converting to LLP, with its requirements to publish accounts, can be an incentive for dealing with final salary schemes. ‘It is a balance sheet item,’ he says. ‘You have to put a value on it – and potentially it can look like a horrendous figure.’ He notes that Freshfields had not gone down the LLP route. ‘Maybe that is what put them off,’ he suggests.


Jon Robins is a freelance journalist