Like all employers, charities are faced with the difficult task of providing pensions for their workers, and one of the trickiest elements of pension planning is assessing the strength of the employer covenant – working out whether there is enough money to meet defined-benefit pension commitments now and in the future.
The Pensions Regulator has recently issued guidance for companies on how to negotiate their employer covenant, with a section entirely devoted to the not-for-profit sector. The guide is a useful tool, says David Davison, director of the financial consultants Spence & Partners.
"There are a number of specific issues that relate to charities," he says. "Their income is basically divided into two different streams – donations and commercial activity - and the guidance is very clear that these should be looked at separately."
When trustees of charity pensions are assessing their covenants, he says, the key is flexibility. "You need to look at the flexibility of your income, of your expenditure and of the benefits you're offering," he says.
Commercial income from contracts can be stable, but potentially inflexible. "If a charity, for example, has a contract with local government to provide particular services, it can't very easily reduce those services to reduce its expenditure without the local authority withdrawing the contract," Davison says.
Conversely, income derived from donations can be unstable but might offer more room for manoeuvre. "You might be successful in fundraising one year and not much the next, so you have to very carefully assess what the level of expected income is," says Davison. "But at the same time, you can scale back activities paid for by donations in order to put more into the pension pot."
Charities might be able to make up any shortfalls through a drive to increase donations but, Davison warns, this approach could be challenging. "To say to donors 'look, we need to raise additional money to pay our pension deficit' – that's a difficult job to manage," he says.
And, crucially, there might be limits to how flexible some donations can be: for example, money from bequests might be tied to particular purposes and be restricted from counting towards the pension scheme.
The guidance from the Pensions Regulator advises trustees and employers to seek legal advice about legacy donations to find out what can and cannot be used – for example, it might be possible to put part of a bequest earmarked for a particular project towards pension provisions for staff working on that project.
Trustees who are becoming concerned about the strength of the charity's covenant might need to look to the flexibility of the benefits it offers to reduce their costs – particularly if they are contractually unable to withdraw from the pension scheme.
"The difficulty with pensions is that it's a legacy issue – costs build up over time, for which you have to find the money," says Davison. "If you find yourself on that slippery slope and you can't get out – for example, if you're in a multi-employer pension scheme - you can start reducing the number of people with access to that, limiting your liabilities to what is affordable."
Davison recommends that charity leaders and pension trustees look at the Pension Regulator's guidance. "When it comes to pensions, preparation is everything," he says.
"It's about looking at your individual pension fund, because every charity is different, and working out how much flexibility you have from your income to come up with something that's affordable for your charity."