An article in the Times today (20 Jun 2011) has raised the issue of the development of a two tier occupational pension being provided by companies. Those of us well versed in the machinations of the UK pension industry would probably say ’so what else is new’ but maybe for some readers of this blog, it needs a bit more explanation. So here goes:

As we all hopefully know, starting from 2012, employers will be required to auto enrol qualifying employees into some sort of pension arrangement and pay contributions into it. For many particularly smaller employers, this will be something of a shock if they have never had to contribute to a pension scheme in the past. For the very smallest companies, there will be a default option called the National Employment Savings Trust or NEST. For others, they may wish to simply use their existing arrangements (if they have one) as long as it qualifies by providing a certain minimum standard of provision especially contribution rates. But many of the medium to larger companies particularly in those industries that have a high turnover of staff may suddenly be facing a vastly increased bill as more employees who may not have been ‘eligible’ to join schemes in the past (or indeed may not have wanted to) suddenly do.

So, what’s the answer? For some, it would seem to be to establish a type of ‘feeder’ arrangement whereby a scheme is established providing only the bare minimum that it needs to in order to qualify. Only if an employee stays for a given period of time will they then be able to join the main scheme that provides a far greater level of benefit and contribution. Or they may be offered NEST for perhaps the first couple of years – again providing a fairly meagre level of pension savings but better than nothing at all.

For those with a work history of low paying peripatetic employment, the reality of retirement will still be pretty poor. But it will still be better than reliance on the State. And for the employer, perhaps a more manageable cost. There are a few other ideas being bandied about too including setting up industry wide schemes akin to the Dutch model.

But more worrying of all is the lack of engagement and communication at the moment together with a certain amount of ostrich like behaviour!! 2012 is getting closer all the time and while for some, the staging date process will mean a formal start date of 2015, it can take well over a year and maybe closer to two to get things up and running. The time to start planning is now.

After a bit of a break to recharge my pension batteries (lounging on a beach works wonders!!) normal service is resumed with a report of recent happenings in the pensionsphere.

I have just got back from a fantastic conference organised by Mallowstreet which was frankly unlike any pension conference I’ve ever been to. I loved the motivational speakers and the drumming session (yes really!!) was amazing once one got over the slightly cultish feel to the rhythmic beat.

But there was serious stuff there too. Worthy of particular mention was James Cameron on Climate Change Capital. His premise essentially was that pension schemes would do well not to underestimate the effect of growing scarce resources such as water, food and energy on the investment potential of asset allocation. Indeed, CCC should be considered a separate and valuable asset class of its own. People will kill over lack of water supply and being aware of the need to support new ways of doing things is vital if we are to avoid social and economic meltdown in the future. Now I am no ‘green goddess’ far from it – I am frankly a cynic when it comes to the causes of climate change – but much of what was said made sense to me, if not from a green perspective then certainly as another investment opportunity for growth.

Then of course there was the Pension Minister Steve Webb. A very good speaker it has to be said, and on the day when Age UK organised a march on Parliament to demonstrate against the rapid rise in womens’ State Pension Age, he again mentioned that the Government would ‘reflect’ on what for many women will mean an extra 2 year wait for their pension – a wait they can ill afford and for which they have had insufficient time to plan. Sadly I suspect the Treasury computer will say ‘No’ to any real change in the current proposal but we can but hope as the Pension Bill is delayed on its passage giving a potential opportunity for revision if the pressure for change is accepted. I’m not holding my breath though…

He also had words to say on Auto Enrolment and NEST – nothing we don’t franly already know but it was nice to actually hear an acknowledgment from a Minister that what we have at the moment is too complex, provided inadequate pension provision, and was a turn off to most people to save for their retirement. We know the problem Minister, now let’s find the solution.

Which brings me to the Debate section – will Defined Contribution ever be as good or better than Defined Benefit? Accepting as most of us do that DB is flapping about like a dying swan, DC remains the ’standard’ alternative. At the outset, the audience were pretty firmly in the No camp, but after some great discussion, at the end and with significant support for a collective DC solution, a small majority win for the Yes camp ensued. It was a ‘first past the post’ vote. We decided that adopting AV was just too difficult…!!

I also had the pleasure of doing another radio interview with Danny Pike at BBC Radio Surrey/Sussex yesterday. Here it is http://www.silverman-sherliker.co.uk/mp3/jkradio4.html and most of my other interviews with Danny can be heard from our main Silverman Sherliker website

Today’s big story of course is the Government green paper on the future of the basic state pension. Currently one of the lowest in the developed world it stands at a paltry £97.65 a week (assuming you have a full National Insurance record) rising to a minimum income guraranteed top up figure of £132.60 if you have no other income from other sources such as a company pension scheme.

But this minimum figure top up is means tested and it led to some of the neediest of our society failing to claim what they were entitled to. Many older people especially older women with incomplete NI records due to home care breaks, were of a generation too proud to go cap in hand as they saw it to some bureaucrat in the social security office asking intrusive and personal questions.

What is now being proposed is a flat rate simple £155 per week basic state pension, available to all new pensioners from 2015 irrespective of child care breaks. (Of course, another proposal mentioned in the Budget was the merging of income tax and National Insurance too so that all dovetails nicely if they can ever get the system to work!!).

There will be additional positives for the Government too in a subtle boost to the NEST scheme. Why? Simply this. NEST, while giving a pretty minimal outcome for an inadequate 8% contribution overall, would have been sufficient to remove people from qualifying for the means tested M.I.G. Consequently the view went, why bother to save for one’s old age when the government would provide anyway. Some pundits were predicting a significant opt out from NEST as a result. Of course, the best answer is adequate work place pensions but that’s another story!!

This Green Paper for once seems a very sensible simplification and is to be welcomed by all (though no doubt some will not). Iain Duncan Smith conceded what those of us in the pension industry have been saying for years. That the State pension system (in fact ALL pension systems in the UK) are just far too complicated and frankly are a turn off to saving. Yes it is unfair to existing pensioners who will not benefit from the change but as we know, the coffers are not bottomless. As Steve Webb said on BBC Radio 4

“Tomorrow’s pensioners do face a very different world. They will, on average, be working for a lot longer, they will be retired for longer, they won’t on the whole have final salary guaranteed pensions in the way that perhaps their parents did. We therefore need a simpler, clearer foundation because more of them will now be asked to save for their retirement.”

A further reform announced today concerns linking the increase in State pension age to increasing longevity. We already know that State Pension Age is to rise to 65 by 2020 And then gradually to 68 by 2040.

By providing automatic rises this will depoliticise the argument as it’s pretty tough to argue with science and the science tells us we’re all living longer. It’s a price we have to pay…get over it.

We have now had the full report which did not fundamentally differ from the Interim Report issued at the back end of last year. Workers will now have to work to 65, pay higher contributions and the final salary scheme will become a career average scheme, meaning that rather than a final salary figure being used in the pension calculation instead, a salary will be averaged over the working life so generally this will be a lower figure but actually fairer to most workers. The losers will be those who would expect rapid promotion over their working lives.

Why? Although this is not the main rationale set out in the Report, the reality is that simply the traditional FS scheme is unaffordable. We are all living longer so if pensions remain payable at 60 they will have to be paid for longer and the Govt has already announced an increase in state retirement age. Raising the age just makes sense. In addition it has proposed the removal of the default retirement age after lobbying from unions so it seems a bit odd that they now complain about having to wait a bit longer for pensions. Secondly, the taxpayers pocket is not bottomless and contributions from scheme members are historically lower than in the private sector. A member would have to find an additional 30% of salary to ‘buy’ an equivalent pension in the private sector. So essentially they are getting a 30% salary increase in pension contributions on a final salary basis. Not bad.

As far as a CARE scheme is concerned it is true that this is likely to produce a lower pension but this is still better than a pure money purchase arrangement which is often what is being put in place in the private sector as FS schemes are closed. The National Association of Pension Funds announced just a day or so ago that the closure of such schemes accelerated by over 17% the past year.

The howls of protest will be as predictable as they are wrong and there may well be marches and protest but I dont hear realistic alternative solutions being suggested. Remember that in London alone, the Local Government Pension Scheme is facing a £14.6 billion deficit. It is no longer the case that public sectors workers earn less based on the promise of a Final Salary pension. But if we are to avoid that ‘race to the bottom’ that Hutton wishes to avoid, we must do better than a Defined Contribution as they currently are. Come 2015 when these changes are due to bite, we may have improved the DC universe, but that’s by no means certain.

Now we all know that pensions are difficult. That’s why my clients pay me very reasonable fees to sort it out for them. The National Employment Savings Trust (NEST) have just published their research paper showing that its target audiences don’t understand many of the terms and phrases used by the pension industry and have produced a ‘phrasebook’ to help raise levels of understanding. I don’t know how much they paid for that piece of research but I (and any one else involved in pensions) could have told them that for free!!

On the whole I’d give it a B for effort. As others have already pointed out (thanks Mike Jones of My Company Pension) here’s just one example of the old and the new. A Pension Commencement Lump Sum becomes A Cash lump sum taken when you purchase a retirement income. Why use 4 words when 11 are so much better…not!! But maybe I’m nit picking here. If this begins to improve member and employer engagement (ooh wait, not sure I’m allowed to say that… just a mo while I check…no that’s fine) then hats off to them. If you want to participate in their Plain English Forum just go onto the NEST website where you can also play their version of Angry Birds…don’t think it will be appearing on an Iphone near you soon though!!

Meanwhile, the Government has confirmed that the Default Retirement Age is to be phased out by October. On the one hand I can see that at 65 many people are more than capable of continuing to work and indeed may economically have to do so. On the other hand, there are also the younger generations to consider and they must be able to access the job market too. (Hold on…may not be able to say ‘access’ – nope, it’s on the banned list…er..) they must be able to get a job too. And for many who might have had hard physical jobs, they may not be able to work beyond 65.

From the pension perspective, most schemes will of course have a Normal Retirement Age at which members of the scheme can take their pension. This gives the scheme some certainty in its funding plans – I’m talking mainly here about DB schemes of course, but equally for DC arrangements, the Employer will have to continue fund contributions on an open ended basis. Arbitrarilly stopping pension contributions at a given age could now perhaps be challenged and scheme rules will have to be carefully analysed to see just what the position is and just what Employers can realistically afford.

I suspect the Law of Unintended Consequences may just have one more clause up it’s sleeve to bite us.

To make up for the dearth of blogs over the past couple of weeks, here’s the second in two days!! Today boys and girls, we are going to talk annuities. The Government, in an effort not to let a day go by without some sort of pension announcement, are expected to call an end to the compulsory purchase of an annuity from pension savings by the age of 75.  What’s all that about then I hear you ask.

Well, as we all know, pension savings are a pretty tax efficient way of building up a fund for our retirement. They are tax free at the point of input (ie saving) but are taxed as income at the other end when we start to draw our pension. In order to ensure that HM Revenue and Customs get their fair share of your hard earned cash, you were required to buy an annuity so that you had some income to tax. An annuity is essentially an insurance policy that promises to pay you an income for life in return for a large chunk of cash when you retire. It’s a bit of a lottery really. If you buy an annuity at age 65 and sadly get run over by a bus the next day, that’s tough, the insurance company is laughing all the way to the bank since they don’t have to pay you anymore, and your family get nothing in return. Of course, if you are lucky to live until you’re 100 it’s the insurance company who may be crying since they’ve probably not gambled on you living so long and have underpriced the annuity. Swings and roundabouts though, and usually the insurers come out on top.

What the Government are now saying is this. They recognise that tying up your pension pot until retirement could be difficult for many who may wish to have access to those savings for good reasons, buying a house for instance before you become too old to enjoy it. They also recognise that many people wish to leave something for their families when they die and annuities would not allow that. However, they still want their tax take and they don’t want people to spend, spend, spend and then become dependant on the State in their old age. So people are going to be able to draw on their pension savings during their working life but there will be strict conditions attached to prevent them blowing it all on wine, women (or men) and song.

But with this flexible approach to retirement savings will come added complexity. And the reality is that for Mr and Mrs Average, an annuity will still be the right way to go. For them, it will guarantee an income in retirement. It is really only the wealthy who have other independent savings who are likely be able to take full advantage of these new rules. Reputable Financial Advisers will I hope steer away from selling unsuitable flexible lifestyle products from those who really should take the annuity option although for heavens sake, remember the Open Market Option for annuity purchase too.

Your favourite pension lawyer spent most of last week snowed in so has been a little remiss in posting but with the thaw comes the need to write so here goes.

This weeks bon mots concern the Government proposals to allow schemes to adopt the Consumer Price Index (CPI) in place of the Retail Price Index (RPI) when calculating the amount by which pensions should increase each year. Now I can already hear the yawns but bear with me because this actually is pretty important. First, some background.

The Government announced earlier in the year that Public sector pension schemes were going to adopt the CPI measure and it was only a matter of time before private sector schemes would come under financial pressure to do the same. What does this mean? Well, each year, pensions in payment and those benefits of members who have left a scheme leaving their pensions behind until they come to retirement age, are uprated. Many schemes will have a rule that says something along the lines of ‘pensions will be increased by RPI’ or ‘by the Index’ or maybe ”by the lesser of x% or RPI’. Now RPI is currently running at about 4.5% while CPI is at 3.2%. A significant difference and one that will grow significantly over time. Clever actuarial types have already crunched the numbers and estimate that this could be as much as a 25% difference over the life of a pension.

Needless to say, the Consultation document which is due to be published today will try to cover these issues and I’ll probably post an update later when we know a bit more. The main thrust of the push seems to be that most pensioners will have paid off their mortgages by the time they come to retire and therefore the index does not need to account for housing costs. RPI is ‘volatile’ according to pensions minister Steve Webb and RPI includes those costs, CPI does not. But to me that is a spurious argument. For one thing, fewer people are and will actually be able to afford a mortgage, they are renting. Renting costs will not diminish and for pensioners, indexation as it is known is a vital part of pension provision.

For sponsoring employers, the temptation to save money in already underfunded schemes will be high, but things are not really that simple and the law may actively prevent reducing RPI if the scheme rules are drafted in a certain way. It will be contraversial and highly unpopular with the workforce.Trustees will need a great deal of advice on whether to agree to an employer’s request to amend the scheme and what the consequencies might be if they do.

Apparently the Government ‘didn’t realise how complicated the change actually was’. Why am I not the least surprised.

Update: The Government has announced that they won’t implement a statutory override permitting schemes to adopt CPI even if their rules would not allow it. So, chaos will rule, no one will win, not the Schemes, nor the members and Steve Webb can sit back and consider it a job well done. It isn’t…not by a long way

Well, the Gods have spoken and we have a slightly better idea (but not by much) on how the Spending Review will impact on pensions. The main point to arise so far concerns the not totally unexpected rise in State Pension Age to 66 by 2020.

This will have a far greater impact on women than men, in that female SPA will rise steeply from 60 to 65 from 2016 to 2018 and then both male and female SPA will rise to 66 by 2020. By the way, there is a highly amusing typo in the Spending Review document at page 69 where the Treasury officials seem unable to spell ‘equalisation’ correctly. Edukashun eh??

Anyway, back to the plot. While the ‘gut’ reaction to this change might seem somewhat negative, let’s just think about this. Women tend to live longer than men on the whole. Any actuary worth his mortality table will tell you that. So why shouldn’t women work longer too? Add to that the fact that it is still a biological fact that women bear children and as a result might have career breaks which would affect their pension build up (putting aside for one minute the Maternity laws). They may therefore welcome the chance to make up those ‘lost’ years.

Ane then there some recent surveys revealing that women are far less likely to save into a pension anyway – a somewhat worrying statistic to be honest – and you have a pretty logical argument for a longer working life for women at least transitionally to bring them into line with men. We wanted equality girls, this is the price we have to pay for it.

In other Spending Review news, we have an indication that auto enrolement and NEST will continue to be funded ‘to encourage high quality pension provision by employers’ Clearly no one has explained to the Treasury that NEST in its current form will never provide that little promise.

Well, what a day it’s been. First, the Government has just annouced the result of its review of the way pension contributions are to be taxed, especially in relation to high earners. The previous administration had proposed an impossibly complicated way of ‘bashing the rich’ which the Coalition immediately on entering office decided to scrap. After the appropriate period of *ahem* consultation they have just announced that the previous £255,000 annual limit on tax relieved contributions is to be reduced to £50,000

In reality, this is rather better than the industry had hoped as initially, an even smaller cap of £30,000 was being mooted which could have potentially caught significantly higher numbers of people and could have had the counter productive effect of reducing the numbers saving into a pension. Before the Daily Wail starts bleating, let’s just be completely clear what this actually means. For Mr and Mrs Average, the thought that they would be able to afford to squirrel £50K a year into their pension scheme is – frankly – laughable. If we take an average annual salary of say £30K a year with a contribution rate of (say) 10% this only equates to £3000 a year. Even if matched by an employer contribution of similar amount you’d have to be going some to hit the cap.

So in fact, the only people likely to be really hit are those very high earners for whom pension saving is only a small part of their overall investment strategy. High net worth individuals will no doubt find this something of an irritation but hardly the end of the world as we know it. All in all, I think this is not a bad compromise.

And on the same day, in the Bonfire of the Quangos, it’s announced with some fanfare that the Pensions Ombudsman and the Pension Protection Fund Ombudsman are to merge. Well, stop the press. Did someone not bother to tell the Government that in reality, these two bodies are already encompassed in one organisation so there will be absolutely no saving whatsoever. What a waste of time. But the good news is that TPAS is saved. Just a pity that NEST was too!!

So, at long last we have Lord Hutton’s interim report on the future of Public Sector Pension Schemes (PSS). We are already hearing the entirely predictable howls from the Unions that they will fight any attempt to take away their cherished (and expensive) Final Salary benefits but maybe, just maybe, we need to have a little reality check here.

What is the Report actually saying. Well, for a start, it recognises that about one in five people in this country are covered in some way or another by a PSS. That’s an awfully large part of the population. Billions of pounds are paid out each year and that figure is likely to double or treble over the next 20 or so years. We are talking here of maybe £60 to 90 BILLION a year. Get real people – WE SIMPLY CANNOT AFFORD THIS IF NOTHING CHANGES.

Next, we are all living longer. When these schemes were established, retiring at age 60 meant we probaly had at best 5 to 10 years of retirement on average in receipt of a pension. Today, we can expect to live into our late 70’s or early 80’s and every year as improvement in health, medical breakthroughs and lifestyle continues, we can expect maybe 20 or 25 years on a pension. Just where to you think that money is going to come from? It doesn’t grow on trees. We have to SAVE for it, and yes, PAY for it while we are able to – in other words during our working lives.

Much has been made in the past of the fact that workers in the public sector have been prepared to sacrifice higher salaries available in the private sector for the fact that they will have a great pension at age 60. Another unpleasant fact for the Unions here – this is simply no longer the case. Many public sector workers are now earning higher salaries than their equivalents in the private sector yet private sector workers have been suffering the reality of closure of Final Salary schemes for many years now and the position shows no sign of changing. So another shibboleth bites the dust. Of course there are hundreds of low paid civil servants out there whose options for jobs outside the civil service may be limited but – and its a big but – ironically these are the very people who benefit least in fact from Final Salary schemes once the sums are done and various means tested benefits are factored into the mix. To quote from the Report

In assessing fairness the Commission also found that the reliance on final salary in the majority of public service pension schemes tends to favour those who receive rapid promotion and those who stay in public service for their whole career. The promotion effect alone could mean that high flyers can receive almost twice as much in pension payments per pound of employee contributions than do low flyers.

What Hutton is saying is essentially this:  Wake up and smell the roses. We are all going to have to make sacrifices and there is really no good rationale why the public sector shouldn’t share the pain. The default retirement age for everyone is gradually going up as we’re living longer. Why shouldn’t PSS normal retirement ages also increase? Contributions will also have to go up. It wasn’t that long ago that some PSS required NO contribution from its members bar a small percentage to cover spouses pension. Granted that has changed in recent times but there is a big black hole to fill. Moving to a ‘career average’ rather than a Final Salary basis and other more innovative risk sharing arrangements is more of a long term aspiration, but it works elsewhere in Europe, why not here? What make us so special? Our pension system – unlike those in Europe and elsewhere where the strategy has always been based on a more holistic approach to pension planning – has instead been incoherent and piecemeal. We have meddled and tinkered around the edges for years, resulting in the most complex, expensive and inefficient system imaginable.

While Hutton is not the complete response to what is an enormous problem, it is a start. If only Steve Webb has the guts to do what he always spoke about in opposition and begin the take that holistic approach, sweeping away years and years of bad law, bad strategy and bad implementation  and give us that New Deal in pensions,  we will be condemned to suffer a poorer old age. The PSS are part of the problem, maybe now they may become part of the answer.