Pensions but not as we know them
30th January 2013
Expert advice from Jillian Thomas DipPFS, Managing Director of Future Life Wealth Management Ltd Gone are the days when the daily newspaper headlines were about Katie Price aka Jordan's latest beau; now, an equally boring subject dominates the media, pensions.
With the backdrop that we are living longer, income in retirement has never been more important and all aspects of pension provision are seeing changes. State Pension Provision The state pension was established in 1909 with a maximum payment of five shillings (25 pence) a week the equivalent of about £20.00 today. Since then successive governments have tampered and tinkered so that now we have a basic pension, graduated pension State Earnings Related Pension Scheme (SERPS), state second pension and pension credit. It's fiendishly complicated with nobody having a clue what the state is going to pay them. State pension age is currently being equalised, with women shortly getting state pension provision from 65. In 2020 the state pension will increase to 66 and eight years later will further increase to 67. The state pension will then be linked to longevity. That means that every Parliament will consider if and by how much the pension age needs to be raised with just 10 years' notice being given of any change. The Pensions Minister, Steve Webb, announced in January 2013 that there would be an overhaul of the state pension provision in an attempt to make it simpler. Currently the full state pension is £107.45 a week but it can be topped up to at least £142.70 with pension credit and by the state second pension. A new flat-rate state pension is to start in April 2017; the weekly payment will be £144, plus inflation rises between now and 2017. Anyone who has not paid at least 10 years' National Insurance contributions will not qualify for the enhanced state pension and those who have paid for less than 35 years will see their pension reduced - the current threshold is 30 years introduced a few years ago. Some prospective state pensioners on the current basis will accrue a higher level of state pension than £144 a week, via a combination of their basic and state second pensions. The government has promised that all accrued pension rights will be recognised, with the new system paying a top-up to the new, merged, flat-rate payment. The introduction of the increased state pension and the removal of means testing means that individuals can be confident that it is worth saving for retirement. Along with the changes to the state pension the government has introduced National Employment Savings Trust (NEST). What is NEST? The British population is living longer and whilst this is very good news, the government is concerned that people save more for their retirement. But at the same time there's a requirement to reduce reliance on the state for pension provision and thus reduce the deficit. In order to encourage personal saving for retirement, the government is introducing the National Employment Savings Trust, known as NEST. All employers with eligible staff will have to: Automatically enroll staff into a Qualifying Workplace Pension arrangement (QWP). Together, employee and employer must pay a minimum contribution of 8% of salary annually within a specified band of earnings, of which a minimum of 3% must be made by the employer. Employees are eligible for auto-enrolment if: They are aged between 22 and state pensions age (SPA). Their earnings exceed a qualifying threshold of £8,105 per annum. Employers will have one month from the day an employee becomes eligible to auto-enroll him or her into a QWP. The legal requirement to comply rests with the employer and those who do not comply may face considerable fines. If employers already offers a workplace pension scheme, then they may auto-enroll their staff into this provided it meets the NEST conditions or they may auto-enroll their employees into a national savings plan called NEST1. Transfers into and out of NEST will be prohibited. Employees may opt out within a month of being auto enrolled. If they opt out they must be auto-enrolled again 3 years later. What employers should do Employers will face additional costs not only in the pensions premiums themselves, but also for the administration of the scheme. This cost needs to be quantified and built into cashflow forecasts and future contract costs. Many companies see the introduction of these requirements as a further tax on jobs and might mean their plans for future expansion are not currently viable. But, however employers view this, it is a legal requirement and it is absolutely essential they establish a plan. Once they have established the date by which they need to comply, they will need at least nine months to make all the arrangements and get the administration and scheme platforms in place. For those companies who already have a company pension scheme, there will be the same lead-in period to make it Auto Enrolment compliant. The changes can be complicated in that not all the current pension scheme providers have invested in back office systems to make their schemes Auto Enrolment and NEST user-friendly. Final Salary Pensions and Quantitative Easing The introduction of quantitative easing by the Bank of England was aimed to introduce more money into the financial system to aid economic activity. Opinion is divided as to whether it has achieved its intended aim but a side effect of quantitative easing has been the dramatic effect on final salary pensions. On the negative side the artificially low interest rates have affected the valuations of final salary pensions pushing many schemes into an under-funded position. On the positive side quantitative easing has artificially inflated equity values, which means that for schemes with a high percentage of equity investments, quantitative easing has improved their financial position. Just as important and forgotten by most pension scheme trustees is the investment management of the scheme's assets. Too often the investments do not reflect the needs of the pension fund; for example, they may not be structured to target a return to reduce the scheme deficit, nor might the investments reflect the demographic profile of the members as they should. Furthermore, there may not be sufficient profit taking or rebalancing and there might not be a proper objective review process. Trustees forget that their duties require them to use the utmost diligence to avoid any loss and if they depart from this standard of care the law will hold them personally liable for any loss caused by a breach of this duty. These are difficult times for final salary schemes but for those who need to find solutions, to enable a sale of the business, to fund retirement or to place the business on a more secure financial footing, there are thankfully some solutions. Annuities' decline in popularity Annuities are no longer the obvious choice for taking retirement income and there are good reasons for this but the result is that there is now less choice of investment vehicles. Annuity rates are based on average life expectancy so people that die early effectively subsidize the annuity rates for people that live longer than anticipated. But now, the introduction of -impaired life annuities means that people that have a disability or illness can negotiate their own lower individual annuity rate which reduces the so-called -mortality gain for the many healthy annuitants. The Bank of England's financial intervention through quantitative easing has reduced annuity rates even further. Additionally, on 21st December 2012 the Gender Directive, imposed on the UK by the EU, meant that providers were no longer able to provide differing annuity rates for men and women, thus reducing the annuity rates further. In January 2014 Solvency 11, yet another imposition from Europe, will come into force with potentially equally devastating effects on the emerging income from pensions taken as an annuity. All these changes over the last few years have been dramatic and have added to the decline in popularity of annuities which not that long ago were the automatic choice for most people reaching retirement. In Summary It is fair to say that the reasons that pensions have been treated with suspicion by many people for so long is that they are too complex and the rules are constantly changing. In addition outside factors can have a dramatic effect on their values and viability for the individual and employers that want to provide this important benefit to their staff. There are many ways to provide an income in retirement but pension saving is still the most popular choice and for good reasons; there are employer sponsored tax breaks and flexibility. The key to any long term financial plan is to take the correct advice and have regular reviews.