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Hi, I'm Ros Altmann. My blog aims to help people understand financial issues. I'll cover pensions, savings, annuities, care, retirement and economics. I'm an independent expert and have advised consumer groups, Government, corporations, trustees and the pension industry.

Guidance Guarantee could be a golden opportunity for IFAs

25 July 2014

The Guidance Guarantee - a whole new industry of impartial guides?

Important for customers to understand that ‘Guidance’ is not ‘Advice’

Great opportunity for the advice sector

This week, the Treasury released more details of its plans for every DC pension saver coming up to pension age is offered free, impartial financial guidance on their pension options.  The Service will be funded by a levy on financial firms, who have an interest in its aims of ensuring customers are better informed about their retirement finance options before committing to buy any product. The Guidance will be entirely separate from any provider of at retirement financial products or services and focussed on financial education and financial planning.  Guidance will be available for each pension pot, so people with more than one pension fund will be entitled to more than one guidance session.

Guidance is not ‘Advice’:  Guidance can help people consider the important questions they need to ask before making decisions at retirement – something that should have been in place long ago.  However, it will not provide the answers - customers will be left to make their own decisions - so many may need expert independent financial advice to help them.  It is really important to understand that this Guidance is not the same as regulated advice. If the Guidance Session is run properly, customers will realise the complexity of the decisions they face and may be more likely to consult a regulated independent financial adviser for individual help to ensure they are making the right choices.

Is MAS up to the task?:  The officially approved guides will be required to operate to consistent, robust, well-enforced standards, overseen by the FCA.  An expert team at the Treasury will work with TPAS (The Pensions Advisory Service), MAS (Money Advice Service) and an advisory board of experts to decide how best to provide the information and guidance.  However, I agree with Andrew Tyrie of the Treasury Select Committee that there are big question marks over the ability of the Money ‘Advice’ Service – which does not actually give ‘Advice’, only Guidance – to deliver a sufficiently high-quality service for customers.  Certainly, the MAS annuity engine and information system has fallen woefully short of even the most basic standards of adequacy for customer needs.  MAS took weeks to update its information after the Budget, its annuity quote system contains only a very few providers and the system does not contain any warnings on its single life quotes that partners will be left with no pension.

Guides will not FCA-authorised – will customers be sufficiently protected?: The Guides will not be authorised by the FCA.  For the initial phase, the Treasury will control the approval of firms or organisations to carry out the work.  In order to ensure this Guidance is useful, the FCA is consulting on what the guidance should cover.  It needs to be comprehensive enough to equip people to make decisions and also to help them understand the benefits of paying for professional advice if they are not sure what best to do.

Government wants this new National Retirement Guidance Service to become a strong trusted brand:  The intention is to build up a new, national brand of ‘Retirement Pension Guides’ who consumers will trust and be happy to go to before making retirement decisions.  Building trust is vital.

A range of channels will be offered including phone, on-line and face-to-face:  The Treasury suggests everyone reaching pension age will be signposted by their pension provider to a centrally-run telephone number and on-line service.  Providers must inform their customers about the guidance 4 to 6 months before pension age and again 6 weeks before.  Individuals will call or register on-line and can choose whether they want to just use web-based, telephone-based or face-to-face sessions.  Many will not want to actually meet a Guide in person, so offering a range of different channels is sensible.

What will the guidance cover?  The guidance will be tailored to the individual’s specific circumstances and will cover their options at retirement.  Individuals will be asked to come to a guidance session with essential information on their pension fund and personal circumstances, in order to ensure the session can be tailored to their own needs.  Pension providers will have to give all customers standardised information about their pension savings - any guarantees, the value of the funds and any special features.  The Guidance should explain the tax implications of any choices they may make, take account of their other income and dependants’ needs and also consider whether they are still working and therefore help them realise that they may not need to touch their pension at all.

What will the guidance not cover?  The guidance will not tell anyone what products to buy, which providers to use or which adviser to go to.  For individual product recommendations, people will be told they may need to consult an independent financial adviser.

Could be great for financial advice industry:  The new Guidance sessions could be a fantastic opportunity for the financial advice sector.  At last, individuals may start to understand the difference between a free guidance session, which tells you the important questions but doesn’t give you any answers, and professional, expert advice which you need to pay for, but which then ensures you make good choices.  With a decision as important as retirement, people may increasingly want the reassurance that they have used their pension savings wisely.  In the past, too many people believed financial advice is ‘free’.  Why should experts be expected to work for nothing?  Having clarity on the difference between guidance and advice could hand advisers a golden opportunity to demonstrate their value.

 

July 25, 2014   2 Comments

Quick Guide to the New Pensions Landscape

The table below summarises the changes confirmed today, what the system was like before the Budget, how it

works in the interim period up to April 2015 and what is planned when the full flexibility starts next April:

Policy Before Budget Interim changes up to April 2015 Full flexibility from April 2015
AGE: when you can access your pension fund Age 55 Age 55 Age 55 – rising to age 57 from 2028
WITHDRAWING SOME MONEY: The rules on taking some money out of your pension fund from age 55 If you took any money at all out of your fund, you had to ‘secure an income’ within 6 months i.e. buy an annuity or drawdown policy, otherwise you faced 55% tax You only need to ‘secure an income’ within 18 months, so technically don’t need to annuitise (though providers aren’t allowing it!) No requirement to secure an income

i.e. nobody forced to buy an annuity, can choose how much to take each year

CAPPED DRAWDOWN RULES Annual income taken out of your fund cannot be more than 120% of standard annuity (GAD) rate.  Any income above that is taxed at 55% Annual income withdrawn cannot be more than 150% of standard annuity (GAD) rate.  Any income above that is taxed at 55% No cap on income, all withdrawals taxed at marginal rate.  Existing capped drawdown policies protected and if withdrawals don’t exceed 150% of GAD rate, retain full £40,000 Annual Allowance for future contributions
TAX ON DRAWDOWN FUNDS INHERITED: 55% tax deducted from drawdown funds passing on to beneficiaries unless taken as a pension No interim changes Tax rate will be lower than 55%. Exact details to be announced in Autumn Statement 2014
CASHING-IN SMALL FUNDS: The rules on cashing in small pension funds as a lump sum from age 55 ( ‘trivial commutation’) Can only cash in and take small funds as a lump sum if:

- your total pensions are worth <£18,000

- or you can cash 2 funds worth up to £2,000.

Can cash in and take small funds as a lump sum if:

-  your total pension savings are worth  <£30,000

- 3 funds up to £10,000 each

Any size pension fund can be taken as cash flexibly, whenever you want after age 55 subject to marginal tax rates
CASHING-IN LARGE FUNDS FLEXIBLY: Rules on cashing-in large pension funds as a lump sum from age 55 (‘flexible drawdown’) Those with large pension funds can access their money flexibly in flexible drawdown and cash in if they wish as long you already have minimum lifelong pension income of £20,000

 

You can cash in your fund if:

- you already have minimum lifelong pension income of £12,000

 

Any size pension fund can be taken as cash flexibly, whenever you want after age 55 subject to marginal tax rates
TAX AVOIDANCE PROTECTION: The rules on contributing to future pensions once you have taken as much money as you want from your pension fund Once you have used flexible drawdown to access your pension savings, no further pension contributions are allowed (£0 annual allowance) – in order to prevent tax avoidance of large ongoing pension contributions Minimum lifetime pension £12,000pa

No further pension contributions (£0 annual allowance)

No minimum pension income required – all drawdown is flexible.

Allow extra pension contributions – £10,000 annual allowance [BUT can retain full Annual Allowance if cash in 3 pots up to £10,000 each or unlimited small occupational pots]

ANNUITY DESIGN: The rules for annuities – what limits on product design? Inflexible.  Income must remain same or increase every year, never fall. Maximum 10-year guarantee for ongoing income after death.  Money-back guarantee (value protection) is available but funds inherited on death are taxed at 55%.  Can’t take lump sums if need to pay for care. No interim changes Will allow variable income stream.  Will allow lump sum payments up to £30,000 (if specified at time of purchase). 10-year maximum guarantee removed, unlimited guarantees to allow more fund to pass on at death. Funds up to £30,000 can be paid as lump sum rather than ongoing income
ANNUITY SALES: Rules governing sale of annuities and information given to customers before pension fund converted to income No requirement for suitability checks before annuity sales.  No control on value for money or commission deducted at sale.  Pension providers must send information on pension fund (‘wake up pack’) around 4-6 months before pension age and again 6 weeks before and must offer an annuity.  Must inform of ‘open market option’ but no requirement to check suitability or warn of risks. Still no requirements for suitability checks, providers must inform of open market option Providers will have to provide standard information for customers to use in Guidance session.  Will have to inform customers of how to access the free Guidance – this applies to each pension pot.  May lead to ‘Pensions I.D.’ card or ‘Passport’ and eventually hope to have commonality for multiple funds all in same format
GUIDANCE AT RETIREMENT: No actual personalised guidance offered at retirement. No personal information taken into account when communicating with customers other than age and pension fund size.  Relevant questions on health, other options not asked Still no guidance Guidance Guarantee starts April 2015.  Free, impartial, tailored guidance to go through options, warn of tax implications, signpost to more information or professional advice.  Guides must not have connection with products or providers.  Will not be FCA regulated but will be authorised and approved by Treasury.  Funded by levy on all financial providers
TRANSFERRING DC PENSION FUNDS: You have the right to transfer to another provider up to one year before pension age No interim changes You can transfer at any time, including at pension age if desired (to ensure everyone can take advantage of flexible access)
DB TO DC TRANSFERS: Transfer from DB (final salary-type) schemes to DC schemes Transfers permitted for non-pensioner members.  Taking advice before transfer is only an actual requirement if transfer instigated by the employer.  Trustees have power to delay timing of transfer and to reduce value to reflect scheme under-funding but many may not be fully aware of this power No interim change All funded DB scheme non-pensioner members will be allowed to transfer to DC.  Safeguards strengthened so every member must have independent advice from an FCA-regulated adviser before transfer a pension worth over £30,000.  Guidance for trustees strengthened to ensure they know they can delay timing and reduce transfer values to reflect scheme funding level.  Unfunded public sector schemes (e.g. NHS, teachers, civil servants) will not allow transfers except in exceptional circumstances but funded public schemes (i.e. local authorities and MPs)will allow transfers
FUNDING SOCIAL CARE: No incentives to save for social care.  Capital in pension funds or drawdown  ignored for purposes of means-test, use a notional income, but no encouragement to set aside pensions or other savings for care No interim change No new incentives to save for social care, however money that remains in pension fund without being annuitized could be used if required.  The Guidance must explain issues of social care funding to increase awareness and discourage withdrawals

 

July 21, 2014   1 Comment

Why working longer is the way of the future

People will increasingly realise the benefits of redefining retirement

In the past, retirement was not an active decision – it just happened to you, dictated by your employer, a pension scheme or society:  Traditional UK retirement was not an active choice, but an event that happened, dictated by outside forces rather than being a positive and considered decision.  For example most people automatically stopped work at their pension age or were offered the chance to retire early with a good pension funded by their employer, or believed they must stop when reaching state pension age. Workers were not encouraged to make pro-active decisions about how or when to retire, unless they were in poor health.

Most people retiring now are still fit and healthy – what a waste of resources.  Decisions about how, when – and even whether – to retire can increasingly become the choice of the individual.  The old days of standard lifestyles that shoehorn everyone into the same mould are outdated.  In the 21st Century, retirement no longer needs to be standardised.  As people are living longer and are healthier, they do not need to leave the labour force just because they reach a ‘standard’ pension age. The skills and talents of the over 50s are too often wasted, due to outdated stereotypes of poor health and disability.  Medical advances enable most of us to recover and live well with illnesses which would have disabled previous generations.

The recent pension changes make flexible working in later life easier:  The UK has a tremendous opportunity to revolutionise its retirement and pensions system over the next few years as the restrictions and inflexibilities that have hampered UK pensions are being swept away.  This can transform the way we think about retirement and pensions. This pensions revolution is an important part of the social revolution being driven by issues such as increased longevity, improved health in retirement and economic reality.

Pensions and retirement are out of step with people’s lives:  As the proportion of people’s lives spent working has fallen so much, the failure to move retirement thinking to match developments in health and life expectancy has left many living on much lower incomes for longer than they need to.  In the 1950s, when the current pension system was designed, the average worker would start working at age 15, work for about 50 years and then live for five or 10 years in retirement.  That meant most people would be working for around two thirds of their lifespan (50 years out of 75).  10 years of retirement might follow their 50 years of work.  In other words, each 1 year of retirement was funded by 5 years of work.  Nowadays, people are working for perhaps 45 years and living in retirement for around 23 years, so each 1 year of retirement is funded by less than 2 years of work.

Record numbers already working past pension age:  According to the Office for National Statistics, the number of pensioners in work nearly doubled from 753,000 (7.6% of pensioners) in 1993, to 1.4million (12% of pensioners) in 2011.  Two thirds of older workers are working part-time, the majority with their previous employer.  The longer people can stay economically active, the more chance they have to protect their spending power and increase their future income prospects. Those who work longer will not only have more money immediately, but they will also have more chance to build up savings.  Setting money aside for future income needs, even after age 60, can help meet the challenges of longer periods in retirement.

Survey evidence confirms this is already happening:  MetLife Survey results, from a nationwide Survey of 2000 adults highlight how attitudes are already changing:

  • 71% of workers said they would consider working past state pension age, in order to achieve a higher retirement income
  •  Only 8% of workers said they would not be willing to work on, even if that meant they had to struggle financially
  • Only around 20% of workers believe they are saving enough for retirement.

TABLE 1: Most people expect to be fit enough to work beyond their mid-60s.

Do you think you will be physically fit enough to work in your current job beyond your mid-60s?

   

Age 60+ Age 50-59
Yes 76% 60%
No 10% 17%
Don’t know 14% 23%

TABLE 2:  The majority of people will consider working longer, particularly part-time, in order to achieve a much higher retirement income

Would you consider working longer to have much higher retirement income?

 Age 60+ Age 50-59

Yes

66% 71%
I would consider working full-time past state pension age to have much higher retirement income 24% 27%
I would consider working part-time past state pension age to have much higher retirement income 42% 42%

TABLE 3: There are other reasons for staying on at work, apart from financial, such as giving a sense of purpose in life and social interaction.

Why would you want to keep working past state pension age?

   

Age 60+ Age 50-59
I can’t afford to retire 32% 44%
I enjoy working and don’t feel ready to retire 47% 21%
Work gives me a sense of purpose in life 34% 29%
I would miss the social interaction of work 20% 31%
I want to save more for my retirement 20% 19%

Working longer brings significant income and capital benefits.  Every extra pay cheque means higher lifetime income, larger potential pension fund and pension savings have to last for fewer years.  Staying at work can also keep people healthier – both physically and mentally.

Many people find retirement disappointing: Retiring while fit and healthy has been disappointing for many, who find they are bored or miss their work colleagues, do not have enough money and little structure to their lives.  Some may have sufficient income to travel the world, participate in their hobbies and do voluntary work without any financial concerns, but they are a minority.  The ideal is to work part-time for a while, before retiring altogether. This would give them a better work-life balance, help provide more income and enable a more gentle transition to full retirement.  The retirement of the future will be one where people cut down work gradually and work part-time before finally stopping altogether.

 

 

July 15, 2014   3 Comments

I am delighted to be Government’s Champion for Older Workers

Older workers can be the key to economic growth

Over 700,000 people may retire each year – helping them stay at work means more income to businesses and individuals

Working just one year longer would add 1% to economic growth  for the nation

I am delighted to have been appointed as the Government’s Older Workers Champion.  Having worked on the issues surrounding rethinking retirement and extending working lives for many years, I am delighted to be able to play a more direct role in this social revolution that is already underway.  I believe passionately in the value of staying in the labour market, ideally part-time in later life, and see this as an all-round positive development for society.

Individuals will have higher incomes and will therefore be able to afford better pensions.  A continuing income stream also means that their pensions won’t need to fund as lengthy a period of non-earning in later life.  Instead, those who go on working – whether full-time or part-time – will increase the potential growth of the economy as well as continue to be, and feel, valued. Too many people retire when they are still capable of making a strong contribution to society and to the workforce. The talents and experience accumulated throughout working life don’t suddenly stop being valuable at the age of 60 or 65.

Nobody should be forced to keep working, but equally, those who can benefit from staying economically active should be encouraged and enabled to do so. At each age from 50 and older there are at least 700,000 people who may stop working every year.  To put this in context, less than 200,000 immigrants come in to the UK each year.  Retirement means mean lost income to many individuals, both now and in future, and lost output to the economy.  As well as the financial implications, though, those who have already retired often miss working, not just because they have such reduced incomes, but also because they miss the social interaction, daily structure and positive feelings that derive from work.

Employers often have ageist attitudes which mean they fail to make the most of the knowledge and skills of their workforce, and challenging these attitudes will benefit businesses as well as employees. The number of over 50s will be soaring in the coming years, and it is vital that we ensure they have opportunities to earn and save more, as well as continuing to contribute to the growth of the economy as a whole.

For many years, I have been highlighting the need to consider retirement as a ‘process’ rather than an ‘event’ and to enable people to leave the labour market more gradually, by enjoying a period of part-time work before stopping altogether. Until now, retirement has often been an irrevocable step; a more gradual move will make the transition easier to manage both financially and personally. But most people are no longer ‘old’ in their 60s.  Societal attitudes are changing and staying at work for longer needs to reflect those changes and become the norm.  Just as we have redefined work for mothers with young children over the past 30 years or so, we can now redefine work for older people.

This will bring benefits to the individual and also to businesses who retain experienced staff for longer.  In addition, all of society will benefit from the additional production and income generated in the economy as well as from the health and wellbeing benefits that working longer can bring. If everyone works just one year longer, this would boost UK economic growth by at least one per cent – which is at least an extra £16billion a year.  That can offer a permanent boost to economic activity and will help both older and younger generations.  It’s a win-win, let’s help make it a reality.

ENDS

July 14, 2014   1 Comment

Tomorrow could be the start of a whole new retirement

29 June 2014

  • Right to request flexible working for all starts tomorrow
  • Government giving green light to redefine retirement – encouraging flexible working in later life
  • A win-win-win – better for older people’s health and wealth and better for the economy

All workers can request flexible working:  From 30th June, the Government is giving all workers the right to request flexible working.  So far, parents and carers can ask their employer to allow them to work flexibly, but now all workers will be able to.  Employers have been agreeing to over 70% of such requests, so it is likely that increasing numbers of older people will be able to work part-time in future.

Older workers can benefit from easing into retirement more gently:  This will help to redefine retirement.  Rather than retirement meaning stopping work completely, it can increasingly mean cutting working hours first, before stopping altogether.  Already, more than 1 million people in the UK are working past age 65, the majority part-time, and this is likely to extend to many more in future.

Rethinking retirement is better for the nation’s health, wealth and growth:  Retirement will become more of a process than an event, and longer working lives is a win-win-win for all of us, especially as the population is rapidly aging.  Most people in their 60s nowadays are still fit and strong and capable of working, although they may prefer to work less than full-time.  Having the chance to stay in work offers the opportunity to earn more money and also to build up a bigger pension.  But working longer does not just increase wealth, it will also improve health.  Studies show that people who retire suffer a deterioration in their health, often become more lonely and miss the social interaction of working life.  With increasing numbers of baby boomers reaching their sixties, keeping more of them in work will improve the economy and create more growth for all of us.

Older workers are a precious national resource:  Helping older people stay in work allows the whole economy to benefit from the huge range of skills, talent and experience that they have gained during their working years.  If too many suddenly stop work and have low pension income, the outlook for growth will deteriorate, whereas keeping them in work on a part-time basis will increase their income, should increase their eventual pension and also contribute to economic output.

Flexible working can improve the lives of millions in future:  The right to flexible working marks another advance for older people who can benefit from a better work-life balance as they get older, without having to stop working altogether when they are still in good health and have twenty or thirty years ahead of them.

June 29, 2014   Leave a comment

Use pension reforms to help social care crisis

23 June 2014

  • Budget pension reforms could help kick-start saving for social care
  • New tax breaks will help savers build up care savings funds - could be with pensions or ISAs
  •  My Budget consultation response highlights urgency of addressing social care funding crisis

In my response to the Chancellor’s 2014 Budget on pension reforms, I have included a section explaining how the pension freedoms could be used to help kick-start a culture of care saving.  This probably needs to be incentivised with further tax breaks. However the cost to society of failing to ensure money is set aside for future social care needs could be unaffordable and there are already signs that the pressure is proving damaging to the NHS.  The real crisis is still some years away, but as baby boomers reach later life, the numbers needing care will soar.  Something must urgently happen to head off a disaster that is clearly on the horizon.

The new pension fund freedoms introduced by the 2014 Budget could pave the way for exciting new approaches to solve the crisis in social care funding - which will inevitably follow the pensions crisis.  Official estimates suggest that perhaps 80% of the population over age 65 will need some care and support in later life.  Half are likely to need to spend around £20,000 and one in ten will spend over £100,000.

But there is no money set aside for care:  Even though the demographics and medical advances obviously point to a dramatic rise in the numbers of older people needing long-term care, as the millions of baby boomers currently reaching their 60s will be likely to need care in the coming twenty years or so, there is almost no money set aside to pay for the care they will require.  The Government has not set aside any money for this huge looming cost, so no one has actually prepared for this.

Government needs to urgently design new tax rules to encourage saving for social care

People need to plan to meet such costs - guidance could help:  It will be important to ensure that guidance or advice on retirement planning includes consideration of having to pay for care.  Materials that help people understand the risks of facing very high costs if they or a loved one needs care, can help educate people who are currently totally unaware of this issue.

Current products to help people cover care costs are expensive and poorly understood:  There are various products on offer to help people pay for care, each of which has advantages and disadvantages.  These include Immediate Needs Annuities, Equity Release and local authority deferred payment plans (which are often unavailable in most cases nowadays), other savings such as ISAs or insurance bonds and perhaps some health or illness insurance.  New products and approaches, together with new Government incentives, are likely to be required.

Possible new approaches to paying for care - with proposed new tax incentives:

Potential new products for care funding

Using pensions for care

Tax free pension withdrawal - allow pensions to be withdrawn tax free if used for care

Care ISAs -  incentivised by allowing them to pass on free of Inheritance Tax

Family Care Saving Plans - incentivised by allowing them to pass on free of Inheritance Tax

Workplace care savings plans in auto-enrolment


Using pensions for care: 
Until the latest Budget changes, pension savings could not be easily accessed to help pay for care.  Many people reaching retirement will have some tens of thousands of pounds in their pension funds but once they buy an annuity, this capital could not be directed to pay for care.  Now that the annuity requirement is removed, pension funds could potentially be used for care.    Those who do not require extra income from all of their pension savings, might be interested in a savings or investment product that would be specifically earmarked to pay for care - perhaps for themselves or for a member of the family.  Each couple may have a one in two chance of needing long-term care, although they do not know which one of them or when, the Government could use the new pension reforms to kick-start a culture of saving for long-term care.  Even without new incentives, people may benefit from the opportunity to use their pension savings to pay for care.  However, if any money withdrawn is taxed, the amount available will be reduced by 20-45%.

Tax free pension withdrawal:  Given the social importance of funding social care, it makes sense for the Government to consider tax-exempting pension withdrawals that are used to pay for care needs.  A specified sum of money might be allowed to be taken out of a pension fund tax-free if spent on care.  This might encourage people to leave money in their pension funds for later life, closer to the point when they might need it, in the knowledge that there are tax advantages if they do spend it on care.  While the money stays in a pension wrapper, it does not incur tax on investment returns, and then allowing it to be withdrawn tax-free if paying for care, might encourage more people to leave it there unless they really have an important reason to spend it.

Care ISAs - IHT free:  Another possibility is for the Government to introduce a specific annual allowance for any ISAs that are earmarked to pay for care.  This could be to pay for care for oneself, or for another family member, but as long as the money is used for care, people might be offered a special tax concession.  This could allow ISAs to be used as a care saving plan.  Investment returns would be tax free and if the fund was not needed for care it could be exempt from inheritance tax as long as the funds passed on are themselves set aside for future care funding.  These special ‘Care ISAs’ would help signal the need for people to save for care.  Even if only those with larger amounts of saving will benefit most at first, introducing special  tax allowances to encourage care saving, could help more people realise the need for this kind of saving, which is important because most are currently unaware of the issue.

Family Care Savings Plans - IHT free:  Another possibility is for families to save collectively for the care needs of their loved ones.  For example, parents, siblings or children might join together to put in money each year, to build up a fund in case one of them needs care.  The probability is that one in four people will need care, but nobody knows in advance which one.  Again, the Government could offer tax breaks to incentivise this kind of saving.  People could perhaps use the tax free lump sum from their pension, with these plans being free of all inheritance tax as long as they stay earmarked for care spending.  These savings plans might also include some ‘catastrophe insurance’ that would pay out if more than the expected number in the group actually need care.

Workplace benefits for care saving:  Alongside auto-enrolment, it might also be helpful to ensure that employers consider offering the option for people to save in a workplace savings plan that is set aside specifically for care.  This could be set up by the employer, and perhaps offered as part of a flexible benefits package, or offered to older workers who have some pension savings, but have not yet saved for care.  These could be tax advantaged savings products, offered as a workplace benefit, or ordinary savings accounts which receive an employer contribution.

Why Dilnot reforms will not solve the care crisis: The £72,000 cap, based on Dilnot’s proposals, is not a solution to the problem of inadequate social care funding.  It is not an actual maximum and represents only part of the amount people may need to actually spend on their care.

  • £72,000 cap excludes £12,000 a year board and lodging costs which must still be paid
  • Cap only covers spending when care needs assessed as ‘substantial’, ignores moderate need care spend
  • Cap only covers spending up to local authority basic rate
  • Only starts from 2016, any spending before that won’t count towards the cap
  • Even after cap is reached, people must still pay £12,000pa for care home accommodation

The cap is much too high to allow an insurance solution to care funding:  The £72,000 cap is too high to allow insurance companies to offer insurance solutions for care funding.  Because of the exclusions, someone would probably have needed care for about 5 years before they reach the cap, and even then they will need to spend thousands more.  The average care home stay is 2-3 years, so most people will simply not reach the cap and never be able to claim on the insurance.  Thus, insurers will be reluctant to offer such a product and the bottom line is that people will have to find money to pay for care.  As there are no savings currently set aside to pay for the huge looming costs of social care for an aging population, a new source of money must be found which will need to be based on savings, not just insurance.  The sooner we can start to help people save for later life care needs - for themselves or their loved ones - the better.

Pension reforms are a start, but more tax incentives are required:  The Chancellor’s pension reforms could help to raise awareness of the issue and, if coupled with further tax incentives, could form the basis for starting care saving that is so urgently needed.

Here is a link to my response to the Budget Consultation questions on social care funding
http://www.genesysdownload.co.uk/rosaltmann/140623_social_care.pdf

June 23, 2014   Leave a comment

Response to Budget consultation on transfers from DB to DC schemes

10 June 2014

Here is my response to the Treasury’s consultation on the issues relating to transfers from Defined Benefit to Defined Contribution pension schemes.  Members of unfunded public sector schemes will no longer be allowed to transfer, however members of funded schemes should be able to take their money out.  Here are my thoughts

  • Transfers should be permitted from funded DB schemes to DC schemes
  • Some schemes could benefit from members transferring small entitlements due to the savings in administration and ongoing liabilities
  • Government should allow any funds transferred to be withdrawn flexibly from DC after age 55, without restriction
  • It might be necessary to control transfers if demand is too high, for example if too many members try to transfer or one or two very large entitlements want to leave which account for the majority of liabilities
  • Trustees should be given powers to restrict or refuse transfers, which should only be permitted with trustee approval
  • There may be times when market conditions prevent transfers, or trustees may be unable to realise illiquid investments quickly so might need to restrict or impose timing constraints on transfers – like ‘gated redemptions’ or lock-up periods
  • The amount transferred could be capped or reduced to reflect underfunding of a scheme, in order to protect the integrity of the scheme and the future pensions of other members – rather like ‘Market Value Reductions’ imposed on with-profits funds
  • The situation in future will be different from that which prevailed in the past.  Until now, employers tried to encourage workers to leave, however with the new pension freedoms it could be that members themselves will want to transfer
  • Past concerns about transfers were based on fears that members might be enticed to give up guaranteed benefits and end up in inflexible and insecure DC schemes instead.  Now that members themselves may wish to transfer in order to cash their pension rights in, consideration could be given to requiring those who request to transfer (whether it is the employer or member) to pay for independent financial advice before doing so
  • Government might consider the possibility of permitting members to request that their GMP rights are transferred back to the state pension system, this could help scheme funding and also ensure a faster move to ensuring more people do receive the full flat rate state pension

Detailed response of DB-DC transfers

Question:  What are your views on the following options for DB scheme transfers?

  • No transfers allowed, as per public sector unfunded schemes

I would not be in favour of preventing transfers.  In some cases, members do need to transfer, for example if they are ill, or if they have urgent need for some funds and transfers can be in the interest of both members and the scheme itself.  It would seem unwise to allow full freedom to DC members without permitting at least some private sector transfers from DB to DC.  The funding of many defined benefit schemes could benefit from transfers especially of very small entitlements which are expensive to administer, although some controls on timing or amounts may be required.

  • Allow DB-DC transfers but then impose restrictions on the funds transferred to DC as now

I am not in favour of this option, it is difficult to see the point of permitting this.  It would not be consistent with the desire for freedom and flexibility in pensions and is unlikely to be taken up.  It seems to leave defined benefit members in a much worse position.  If they do transfer, it may well be because they need the funds or are seriously ill.  Thus, preventing them from withdrawing that money would be particularly unfair when those in DC are permitted to do so.

  • Cap the amount of DB to DC transfers allowed each year

It might be necessary to cap the amount of pension benefit members are permitted to transfer each year.  Controls could be placed on the maximum amount of pension entitlement that can be transferred out (a little like the small pots or trivial commutation rules under the previous DC regime).  The purpose of this would be to protect the integrity of DB schemes which could be compromised if too many members try to transfer out of schemes all at once.  I would be in favour of allowing trustees to limit transfers, if they feel they need to in order to mitigate risks to other members of the scheme and to the scheme’s survival.

  • Transfers have to be approved by the trustees

I would be in favour of requiring trustees to approve transfers, so that trustees can carry out their duties to protect the scheme and its members.  Trustees may need to take advice on the impact of transfers, but they should have the power to stop transfers, or to encourage transfers, albeit ensuring they can justify any decisions.  Members should have the right to apply to transfer benefits from DB to DC, but the trustees need the right to refuse such a request, or to cap the amount of the transfer, or to adjust the timing of the transfer.  It is not possible to establish a one-size-fits-all rule that would cater for requirements of all DB schemes.  Therefore, the principle of freedom and choice in pensions can be offered, but it should not be imposed on schemes which would be damaged as a result – and whose remaining members could be negatively impacted.

  • Full flexibility with no controls on the transfers from DB to DC

I would be concerned that full flexibility could be too risky.  I do think that powers to impose controls in the interest of financial stability may be required – either because of risks to markets, or to the scheme itself.  These could be triggered by trustees of schemes and their advisers, or imposed by the Regulator if considered necessary.  Providing full flexibility runs the risk of mass transfers of large entitlements which could compromise the future survival of some schemes with large deficits.  It might be necessary to only permit transfers at reduced values – below the actuarial equivalent of full benefits – if schemes have large deficits.  This would be rather like the market value reductions in with profits fund.  It might be necessary to delay transfers if investments cannot be sold to raise funds for the transfer.  It might be necessary to limit the size of transfers each year.

I also have some suggestions for further options relating to DB to DC transfers:

Pay for an IFA – I would suggest requiring members to pay for full financial advice before requesting to transfer, to ensure they understand the risks of doing so.  If members take advice and then decide to transfer, that is their fully informed choice.  Up till now, the issue of pension transfers has been from a very different perspective under the previous regime.  Until now, the issue stemmed from employers trying to entice members to leave, offering them enhanced values to transfer out of the scheme.  Under those circumstances, it was important to protect members from transferring out and then losing guaranteed benefits, in exchange for DC benefits with annuity restrictions.  The fact that employers were willing to enhance the transfer value is a clear indication that permitting transfers could improve scheme funding.  Under the new rules, however, it is quite possible that members themselves will want to transfer, due to the ability to take cash, rather than having to annuitise or use capped drawdown.  In future, therefore, permitting transfers could be in the interests of both members and schemes, however it will still be vital to ensure members’ interests are protected.  This could include requiring any member who applies to transfer out to have proved they have taken independent financial advice.  At the very least, they need to sign and confirm that they understand the risks of transferring and the guaranteed benefits they are relinquishing.

Capping the maximum percentage of scheme assets that can be transferred each year without regulatory approval – this would be designed to protect the scheme and possibly the PPF if there were some large transfers that jeopardised future scheme funding

Only allow those near scheme pension age to transfer out – for example only from age 55, the same as is allowed in DC.  This would limit the amount of people transferring, although over time as schemes mature, increasing numbers of members will fall into this category

Transferring the GMP element to the state – this could be a significant radical reform that would have a number of benefits for schemes and possibly for members.  Firstly, by transferring GMP rights back to the state, the new flat-rate state pension would be received in full by far more citizens, since there would no longer be a contracted out deduction.  The Government could consider allowing members the option of transferring their GMP rights back to the state pension system if they want to receive the full flat-rate state pension.  The assets transferred from the schemes would be a cash boost to the Treasury and removing GMP rights from the schemes could result in higher pensions if schemes would otherwise end up in the Pension Protection Fund.

Requiring the funding level of the scheme to be considered when assessing the permission for scheme transfers – It might be necessary to only permit transfers from DB to DC for schemes which have funding above a prescribed level.  The aim would be to encourage improved scheme funding, with employers increasing funding and then the scheme being able to transfer members out as funding levels increased. On the other hand, it might be helpful to permit transfers from very underfunded schemes, but with an allowance for the underfunding, so that transfers are at less than actuarial equivalence of full scheme benefits, if such transfers would actually help the funding position and prevent entry into the PPF.

Restricting transfers if there is too much demand –  ‘gated’ redemptions – It might be necessary to introduce powers for either Government, the Pensions Regulator, or scheme trustees to impose restrictions on transfers if markets become disorderly or too many members want to transfer all at once.  There could also be a case for considering whether there is a risk to scheme funding and investments, or a risk to the Pension Protection Fund, for example if large entitlements are transferred out which exceed the PPF cap.

Allowing the value of a transfer to reflect the underfunding of each scheme – like market value reductions – If a scheme is perceived to be in trouble and the employer covenant is in doubt, it might be necessary to allow transfer values to reflect the underfunding of each scheme.  Again, if members are required to receive full financial advice before transferring out, they would have someone to explain the risks to them and if they still choose to leave that is their fully informed decision.

Question 9.  Should the government continue to allow private sector defined benefit to defined contribution transfers and, if so, in which circumstances?

If the member has paid for full independent financial advice and has still chosen to transfer their benefits out, then the government should not need to specify particular circumstances or restrictions from the member’s perspective.  There may be legitimate reasons why a transfer is considered advisable for that member.  For example, if they are in very poor health, if they do not have a partner, if the scheme is very poorly funded and the employer is in danger of bankruptcy, (fears of large benefit reductions in the PPF) or indeed perhaps if they need the money very urgently and there is no other source.  There will also be circumstances in which the transfer could be detrimental to the scheme, rather than the member, so the scheme integrity needs to be considered when deciding whether to permit DB to DC transfers.  If a scheme is very poorly funded, has illiquid investments that will not generate sufficient funds in the near term to meet the redemptions, or if the scheme has cash-flow constraints that may already be hampering ability to meet pensions in payment, then members’ rights to transfer out should be curtailed.

Question 10.  How should the government assess the risks associated with allowing members of private sector defined benefit schemes to transfer to defined contribution under the proposed tax system?

The risks are relatively easy to identify but very difficult to quantify.  There are risks to scheme members – if they give up rights to a guaranteed, inflation-linked lifetime pension they could end up poorer in retirement.  The member needs to understand what is being given up when transferring, preferably after receiving independent advice to explain the risks.

There are risks to the schemes themselves, if too many members try to transfer out all of a sudden, the pension fund’s investment allocation could be compromised and some schemes are struggling with cash flow requirements as liabilities for pensions in payment increase, so sudden demands for pension transfers could be problematic.  Schemes often have illiquid investments, whether small cap stocks, infrastructure funds, private equity, hedge funds or real estate, which can all be difficult to sell quickly.

There are also, therefore, potential risks for financial assets, if schemes were to have to liquidate investments rapidly and force the asset prices down in order to sell, at times when market circumstances proved unfavourable.  Each scheme will be in a different position and the impact on the schemes themselves and the impact for the financial markets will depend on which members do transfer, when, how much is moved and what investment position the pension fund itself is in, as well as which assets the funds are moved to – or whether they are simply taken as cash.  On balance, allowing transfers is likely to be favourable for scheme funding, especially if smaller deferred entitlements are transferred.  Small accrued rights are costly both to administer and to pay, so if many of those with very low pension accruals decide to take their funds out, rather than waiting to receive just a few pounds a week in pension, the scheme funding position should improve.  The terms on which transfers are made will also be important when assessing the impact on the scheme.  If members are allowed to transfer to DC from under-funded schemes with sums equivalent to less than their full entitlements – in order to reflect the scheme underfunding in some way – then there would be a benefit to the scheme overall in the long-term.  However, if members have to transfer out only with full value, then the position of underfunded schemes could worsen.

To assess the risks, it would be important to survey schemes and their funding levels, as well as surveying members to try to gauge attitudes to transferring small entitlements.  Ultimately, there is probably an argument that transfers should only be permitted after taking independent advice, to ensure that the decision to transfer out has been understood by the member.

There could possibly even be risks to the Exchequer if people use defined benefit funds to generate extra tax relief in recycling.  This could be a significant issue.

As regards defined benefit schemes, the flows into gilts and bonds are likely to depend partly on how many schemes are considering or undertaking bulk annuity purchase, either in the form of buy-ins or buy-outs.  It is likely that increasing numbers of bulk deals will be done in coming years and either pension funds themselves or the insurance companies will increase demand for bonds as a result.  If transfers out of DB schemes are permitted freely, then the impact will depend on size of assets transferred, age of those transferring (the older those transferring, the more likely their liabilities were backed by bonds anyway) and what those who transfer actually do with their assets.

June 10, 2014   Leave a comment

Guidance Guarantee must be impartial – providers will not protect customer interest

9 June 2014

  • Providers cannot be trusted to offer the Government’s Guidance Guarantee
  •  Some may look after customers but too many do not - and they cannot be impartial
  •  As FCA continues its study of the Retirement Income Market customers need reassurance that past failings will not be sanctioned again

Providers do not know their customers:  Pension providers cannot be relied upon to offer the Government’s promised free, ‘impartial’ at retirement guidance service.  The Association of British Insurers has suggested that its members, the ones who presided over the annuities market and regularly sold unsuitable annuities to their long-standing customers without even bothering to ask any relevant questions, should be allowed to offer this impartial service.  Astonishingly, the ABI spokesperson said at a conference today “providers are in the best place to know the individual customer circumstances and be able to adapt their existing pre-retirement communications.”  If they really did know their customers’ circumstances, then many of the failings of the annuities market could have been avoided.

Past promises did not work for customers and cannot be relied on:  If the providers’ existing pre-retirement communications were up to the job, then far more people would have actually shopped around and found better annuity outcomes for themselves.  The fact is that the providers - not all, but too many - have failed to look after customers properly in the past.  Commendably, many providers have said they do not wish to deliver the guidance anyway.  They are no doubt aware that too many companies have put the interests of their business above those of their customers, which is of course understandable, but it is not acceptable when trying to reassure the public.  There is scant reason to sanction provider delivery of this new guidance. 

FCA Thematic Review uncovered poor provider practices:  An important reason for the reforms was that providers were not treating their customers fairly.  Having the results of the FCAs thematic review of the annuities market, which exposed practices that were clearly not in customers’ best interests, it is important that lessons are learned that self-regulation of at-retirement products is not sufficient to protect consumers.

Providers cannot be relied on to meet the Government’s requirements: The Consultation on the Guidance Guarantee says that the Government needs to ensure customers ‘can be confident in the impartiality of the guidance they receive’ and the aim is to focus on ‘helping consumers understand the choices open to them’ and ‘how to engage with products and providers confidently and knowledgably’.  On each of these criteria it is simply not credible that providers will all be impartial.  Yes, there may be some firms who will try to be truly impartial, but the FCA has seen with the annuity process how inconsistent standards are among providers.  All the pension companies signed up to a Code of Conduct and various ‘Raising Standards’ initiatives, yet annuity customers were not given clear information and providers had ‘retention teams’ to ensure customers were enticed into buying their own - often very poor value and unsuitable - products. 

FCA broadens scope of its ongoing retirement income market investigation:  The FCA has today announced that it will be broadening the scope of its study of the retirement income market, which is welcome, but it once again suggests the guidance guarantee should not be left to providers.  That does mean that all providers have to be excluded from offering guidance, even if some of them might truly believe they can perform the required guidance impartially, because the FCA simply cannot pick and choose which providers should be allowed to offer the guidance and which would not meet any required impartiality tests. 

Providers will not offer all the options so would be tempted to bias customers in some way:  In the new pensions world from April 2015, customers will have a wider array of options and not all providers will offer all the options.  Indeed some options could be offered by companies that have no existing pension customers.  Therefore, members of the public must be given properly unbiased information, that is standardised and ensures all the options and materials provided to them are presented in a clear and comprehensive manner.  It is inevitable that providers offering the guidance will be tempted to include extra materials extolling the virtues of their own products, perhaps de-emphasising the products they do not cover and if there is no other source of guidance, customers will be misled into buying poor products, which may be irreversible.

Figures of 400,000 needing guidance straight away is a significant over-estimate:  Many commentators are suggesting that the huge numbers of people who will need guidance will make it impossible for any third party source to have the capacity to deliver.  This seems somewhat unlikely, but is clearly an issue that must be considered.  Many people have more than one pension fund, so are likely to only take the guidance once.  Not everyone will actually want the face to face guidance - but it must be offered - and they may prefer on-line information, Skype calls, webinars or group meetings organised by their employer.  Many large companies already have retirement advisers working with them and if they are independent firms of advisers or educators, these can deliver the guidance guarantee to the required standards.  This should cover a significant part of the demand.  It will also be possible to gauge the level of interest with pilot studies and pension providers can include a questionnaire in their pre-retirement packs which asks people to register their interest in having a face to face session, or whether they would prefer other media.

Worries about those who do not get guidance:  Some are concerned that many of those reaching scheme pension age will choose not to have the guidance at all.  That need not necessarily be a significant cause for concern, since many of those who reach scheme pension age in future will not actually be retiring - and many may have other pensions as well - so they may simply delay taking the guidance.  Until now, customers did not realise they could decide not to annuitise because their pension providers either led them to believe they had to, or they were sent to an annuity broker who had a vested interest in selling them an annuity.  Others who wanted to just take their tax free cash but either had other pensions or were still working, were forced to annuitise but will now not need to do so.   If they are going to buy an annuity, their provider should be required to make sure they have been sent to an independent, impartial guidance service that can help them find the right type of annuity and how to shop around for good rates. This would help the open market option work in customers’ interests and offer them far better protection than relying on providers who may be biased towards annuitisation.

Default should be ‘do nothing’ option:  If people do not want to take the guidance, that could mean that they may not need to take any money out of their fund for the moment.  The fact that people reach pension age does not mean they need to get any guidance, since they may be continuing to work, may have already had advice or be covered by provision elsewhere.  If the default option moves to not buying any product until later in their retirement, that has many advantages.  Someone who takes tax free cash and then waits before making any further decisions until they have more time to consider things carefully when they are retired may well make better choices in the long-run than having to commit to a product at the same time as making the life-changing adjustments to retirement.

Whole new industry of financial guides could be established:  My overall conclusion is that the guidance guarantee can be delivered by impartial third party bodies that combine all different media channels, including face to face.  These would be funded by the providers, in a similar manner to the funding of the Regulator.  With common standards, organisations such as The Pensions Advisory Service and financial advice or education companies, should be able to deliver a good service.  Even if TPAS alone does not have the capacity to deliver at scale, this guidance could form the basis of a whole new industry, encouraged and overseen by the FCA and operating in the customer interest.

June 9, 2014   1 Comment

CDC New Style Pensions – What does it mean?

1 June 2014

  • Government is right to legislate to permit Collective Defined Contribution pensions but beware over-optimistic claims
  • In theory, they are better for employers than traditional final salary and better for workers than traditional defined contribution
  • In practice, they still suffer from market and actuarial risks and new pension freedoms may mean they are less attractive for members
  • Lower earners may subsidise higher earners -Younger members may subsidise older members

The Government is set to unveil another Pensions Bill in this week’s Queen’s Speech.  This Bill will be the third major piece of pensions legislation launched by the Coalition.  Today’s headlines claim that one of the centrepieces of the Bill will be introduction of new-style pensions that will have the potential to increase member’s pension income by 30% or so. 

It is claimed that by allowing employers to contribute to so-called ‘Collective Defined Contribution’ (CDC) schemes, members will achieve much better outcomes, without imposing unacceptable risks on employers.  These new schemes are commonplace in other countries, such as the Netherlands, while Canada and Scandinavia are also increasingly looking at these plans.  It is important, however, to recognise that there are both advantages and disadvantages to these types of pension scheme.

Summary:

Possible advantages of CDC:

  • Employers pay fixed levels of contributions (typically being 10-12% of salary)
  • No balance sheet risk for employers
  • Members are offered a ‘target’ level of pension, related to average salary
  • Members are offered the chance of inflation protection to their pensions
  • Less risk for employers than DB and less risk for members than pure DC
  • Pooling investments allows lower management costs and higher pension fund
  • Pooling investments in large funds offers chance for better spread of assets to deliver higher returns - current DC pensions usually just equities and fixed income, whereas CDC could include many other assets such as infrastructure, forestry etc.
  • Government estimates CDC pensions could be up to 30% higher than pure DC.

Possible Disadvantages of CDC

  • Pensions in payment could fall
  • Pensions are at the mercy of market forecasts - and actuarial accuracy
  • If pensions are too generous due to forecast errors, they will have to be cut
  • Younger members may end up with lower pensions than older members
  • On average, lower earners live less long than high earners, so low earners may subsidise the pensions of the high earners in the scheme
  • Relies on trust between generations and requires ongoing pool of new members coming in and contributing through time
  • Sounds rather like previous with-profits investment approaches which did not always work out well due to unexpected market movements.

On balance

  • Government is right to legislate to permit CDC but it should not over-hype the benefits
  • The new Budget pension freedoms may mean people prefer pure DC that they can access in retirement if they wish to, as CDC usually means they cannot just take cash.

So how does CDC work?  The theory is that an employer will contribute a fixed level of contributions (the ‘Defined Contribution’ or ‘DC’ part), with members also paying contributions at a specified level.  These contributions will go into a giant pool of assets (the ‘Collective’ part of ‘CDC’) where a fund is built up over time and pays out pensions when members reach the scheme’s pension age.  So this is not like individual DC, where each member has their own fund and then buys a pension income (usually with an annuity) when they reach pension age.  The pension assets build up in a collective pool and those assets pay the pensions each year.  This saves paying profit margins to insurers when buying annuities which should generate higher pensions and it also saves significant sums on managing the assets, because of economies of scale, again enabling higher pensions because less money is taken out in fees.

Usually promises a pension related to average salary plus inflation protection – but this is only an aspiration not a guarantee:  The pensions paid will be determined usually as a proportion of career average salary, with an actuarial calculation determining how much can be afforded.  The aim will usually be to pay pensioners a proportion of their average salary during their career, and also to increase that pension over time in line with inflation.  However, the inflation linking may or may not be paid, depending on how the assets in the scheme perform and, indeed, the level of pension itself could also be reduced over time if scheme assets perform much worse than expected.

‘Target Pension’ not guaranteed:  These schemes are sometimes called ‘Target Pension Plans’ since members are told to expect a pension which is a proportion of their average salary and also some inflation uplift over time.  However this is the ‘target pension’ and may not actually be delivered if investment or actuarial assumptions are not achieved.  These plans are a form of ‘adjustable Defined Benefit’ schemes.  The benefit is defined for members, but may not actually be delivered.

Government plans to legalise such schemes, currently benefits cannot be reduced: Such schemes are illegal at the moment and the Queen’s Speech will introduce plans to legislate for these kinds of pension arrangements to be permitted by law.  Currently, if an employer promises a ‘Defined Benefit’ pension, specifying a particular pension level, or starts paying a pension out to pensioners, the law says these benefits can never be reduced under any circumstances.  That means employers take on an open-ended commitment which has proved too risky for them to underwrite in recent years - as markets have performed less strongly than expected and life expectancy has continued to rise.  By allowing CDC schemes, the Government is offering employers a less onerous system of promising pensions to their staff.  The employer will no longer have to carry balance sheet risk from the pension plan, because the contributions are defined and the benefits can be adjusted if necessary.  The Government hopes that employers who might otherwise simply close their current Defined Benefit scheme and move to pure Defined Contribution, will instead be persuaded to introduce CDC schemes, which are potentially better for members and less risky for members than pure DC.

All this sounds good in theory.  What are the downsides?

Pensions in payment might have to be cut:  There are, unfortunately, some serious concerns about CDC.  Firstly, it is clear that pensions could fall if markets do poorly.  This has already happened in the Netherlands.  For example, some CDC members have had no inflation increases on their pensions for nearly 10 years and then had their pensions cut by about 5% in the past couple of years.  Members need to understand that there are no ‘guarantees’ on their pensions in these schemes.

Relies on trust, inter-generational risk-sharing and reliability of actuarial forecasts:  Second, CDC relies on trust and willingness to share risks between generations.   As the scheme pays out the pension, the ultimate payments are determined by actuaries who make forecasts of future returns and life expectancy of members.  If those forecasts are wrong, the solvency of the scheme could be jeopardised and benefit cuts would be inevitable.  However, there are risks that actuaries will not recognise the need to reduce benefits in time and continue to pay out more than is justified because they fail to foresee the future problems.  In such cases, the older members will have had a more than fair share of the scheme assets, leaving younger members with less pensions than their own contributions would have generated.

Low earners may subsidise higher earners:  Another issue is that CDC could see lower earners subsidising pensions for higher earners, because low earners typically have lower life expectancy than the better off.  For similar percentages of salary, the assets in the CDC scheme may end up being used more than proportionately to pay pensions to the higher income members who live longer than their lower earning colleagues.

Budget changes would allow people to cash-in pensions if they need to but CDC usually would not:  Finally, it is not clear that CDC is in every members’ interests following the introduction of the other measures unveiled in the Queen’s Speech.  As DC members will in future have freedom to take their pensions as cash if they wish, and nobody will be effectively forced to buy an annuity or secure an income any more, workers may prefer to be in control of their own pension outcomes, rather than relying on being part of a collective scheme that promises them a target level of pension which may or may not materialise.  It is unlikely that CDC schemes would allow members to transfer their benefits out as cash, because the ongoing success of CDC relies on a constant inflow of new members’ contributions to build up the fund.

Government right to legislate to allow CDC - lower management fees, better investment approaches can mean higher pension:  Overall, it is absolutely right that the Government should legislate to permit CDC schemes and to end the draconian restrictions that employers currently face in UK Defined Benefit pension provision.  However, it is important not to over-hype the potential benefits of such pension arrangements.  They can, indeed, offer better pension outcomes than pure DC and also are much more likely to be acceptable to employers than traditional DB, however with the new pension freedoms introduced in the recent Budget, many people may prefer to have their own pension arrangement.  The challenge, then, is to ensure pension providers can offer individuals a much more cost-effective investment solution to accumulating their own pension fund than has hitherto been the case.  Being part of large collective asset pools with lower management fees and a broader spread of investments, should generate larger pension funds.  One of the biggest drawbacks of the current DC schemes is the high costs of management and administration and the poor range of investments offered.  The industry should come up with more diversified investment options at lower cost to deliver better value over time. 

Mastertrusts such as NEST could deliver more effective pooled funds for pure DC too:  I hope that perhaps Mastertrusts such as NEST can come up with such solutions or other pension companies might enter the market to offer these options.  With auto-enrolment bringing millions more workers and billions more assets into pensions, there is a tremendous opportunity to revolutionise pension delivery in the UK.

June 1, 2014   Leave a comment

Auto-enrolment is now a no-brainer

20 May 2014

  • New Budget flexibilities dramatically increase appeal of pensions auto-enrolment
  • Opt out rates should fall significantly
  • ‘Buy-one-get-one-free’ deal too good to miss for most

The Pensions Policy Institute has today published new research highlighting that auto-enrolment is now far more attractive than previously expected.

Opting out of auto-enrolment is turning down free money:  Even for older workers, who were the group least likely to benefit from staying in their employer’s scheme, the flexibilities introduced to pension savings in the 2014 Budget will mean those who do opt out will be turning away free money.  As the PPI says, unless they are really in dire straits, it is hard to see why they would want to refuse their employer’s pension contribution and the tax relief.

Pensions are far more attractive now so opt-out rates should be much lower than expected:  The new flexibilities in the UK pension regime will dramatically increase the appeal of pension savings and employers should be prepared for much lower opt-out rates than they might previously have budgeted for.

Older workers will be first to benefit:  As workers will all be entitled to take their pension funds as cash from April 2015, if they want to, the pension savings under auto-enrolment have become significantly more attractive, especially for older workers who could be the first to benefit from the pension reforms.

Taking the funds as cash removes the previous risks to older workers:  The new rules remove the problems of pension saving for older workers, who might previously have been at risk of either just tipping over the old limits for cash withdrawals.  These ‘trivial commutation’ and ‘small pots’ limits will be swept away in 2015, so pension savers will be able to take their auto-enrolment pension fund and spend it if they wish.  In addition, there were previous concerns that older workers would find their pension income resulting in lower means-tested benefits, but now that they will be able to take their fund as cash and spend it, it will not need to count against their  means-tested benefits.  In any event, fewer pensioners will be subject to mass means-testing, as the new state pension rolls out after 2016, so the amount of money built up in an auto-enrolment pension fund will be more likely to improve people’s retirement finances.

Auto-enrolment offers a ‘buy-one-get-one-free’ deal:  Therefore, any workers who do opt out will be turning down free money from their employer.  The auto-enrolment regime offers a ‘buy one get one free’ deal on pension contributions.  For each £1 the worker puts into their workplace pension scheme, another £1 goes in (75p from their employer and 25p from the tax relief).  Unless they have huge debts, it will normally make financial sense to remain in the scheme, even at older ages – or perhaps especially at older ages – because they will be closer to the point at which they can access the money if they need to.  If they do not put that £1 into their workplace pension, they will not get the extra 75p from their employer, nor the 25p tax relief. Indeed, even non-taxpayers can benefit from the tax relief and can request to join their employer’s scheme.

Employers should be prepared for majority of workers to stay in:  The new rules will be a gamechanger for future pension contributions under auto-enrolment and employers will need to be prepared for the vast majority of their employees to decide to stay in.

May 20, 2014   Leave a comment