Pensions guidance is not enough

Pitfalls lie in the way of pension savers who need impartial guidance on how best to use their retirement funds following reforms allowing the drawdown of cash lump sums, writes Stephanie Hawthorne

In pubs, clubs and bars, unusually the talk is not of football but pensions. “We’re all in,” is the new refrain, albeit not in the same style as a chant from the terraces. As auto-enrolment reforms gather pace, far more employees and employers see pensions as an important part of the reward package.

Companies use pensions not only to attract and retain staff, but also to make sure each generation of workers can afford to leave and create room for the next talented generation to join. Jonathan Watts-Lay, director of Wealth at Work, points out: “It is still the biggest benefit other than salary.”

And there may be a crock of gold at the end of the rainbow. From April 2015, all remaining tax restrictions on how investors have access to their pension pots will be lifted. Pensioners will have complete freedom to draw down as much or as little of their pension as they want, subject to their marginal rate of income tax, without buying an annuity.

Around half a million people are expected to take advantage of the new options next year, but the area is fraught with risk.

Impartial advice will be crucial. On offer is a free one-off guidance guarantee at the point of retirement. This  is a guarantee to those aged 55 and above with a defined contribution (DC) pension pot that they will have access to either free phone-based, web-based or face-to-face guidance from a centralised service, which will be run partly by the Pensions Advisory Service, Citizens Advice Bureau and the Treasury itself.

What form of pension guidance would you choose

“It is proposed that the only requirement of the new pension rules will be to signpost the guidance service in the wake-up pack four to six months prior to the selected retirement date, just as they do for the open-market option,” says Mr Watts-Lay.

But this is too little too late. Sheer weight of numbers means this service is likely to be basic and will not tell investors how much tax they will actually pay.

TIGHT TIME CONSTRAINTS

The reforms mean a decade’s worth of innovation crammed into the next 12 months.

Will Aitken, senior consultant at Towers Watson, says: “With the best will in the world, 30 minutes of guidance at the point of retirement can’t be enough. The presence of guidance has highlighted that employers will need to communicate more, earlier and better than most have before. Administration will need to become much more member-centric, permitting people to access their money in ways that suit them, not their administrator.

Employers will need to communicate more, earlier and better

“And risk? People need to understand that annuities were a risk-free option and anything else carries risk, not least the risk that you outlive your savings.”

Will employers be ready in time for the new freedoms? Mark Pemberthy, director at JLT Employee Benefits, says: “In theory, all pension schemes can provide all of the retirement flexibility options from April 2015. However, for many schemes, the level of retirement flexibility they can actually provide in April 2015 will be dictated by the functionality of their administration systems. Some administrators will not be able to offer all of the options from April, and some may never be able to offer options such as flexible access drawdown.”

Mr Watts-Lay adds: “Our meetings and discussions with employers have indicated an almost zero appetite or intention to do this.”

The reforms bring with them huge challenges. Mike Spink, DC consultant at Spence & Partners, warns that whatever employers decide to do, it must dovetail with the guidance guarantee or at least not contradict it. “There is a clear risk of having confused plan members if this isn’t addressed at outset,” he says.

The guidance is limited in scope, yet members will be making life-changing decisions. Duncan Buchanan, president of the Society of Pension Professionals, warns: “I can see people making bad choices and then looking for someone to blame.”

Other problems include the risk of defined benefit (DB) members wanting to transfer to DC schemes threatening the DB scheme’s liquidity. Members may pay more tax than they need to and may deplete their retirement savings too quickly. Inappropriate investment strategies are another danger, as is poor communication to members.

So it is vital that employers and trustees plan for all these eventualities. Then the new regime may be a wondrous revolution, rather than a possible train crash.

WRAPS

CORPORATE PLATFORMS ARE STEP UP LADDER

The employee saving for a first home, the new parent wanting to plan for their children’s future, the recent graduate with student debt may all benefit from using corporate platforms.

“These offer a range of saving vehicles that help address a variety of needs, as well as reducing the administration burden on employers,” says Will Aitken, senior consultant at Towers Watson.

Auto-enrolment has dominated pensions for the last three years, while progress with corporate platforms has slowed. But Mark Pemberthy, director at JLT Employee Benefits, expects to see “an increase in prominence as a result of the new retirement freedoms and improved ISA limits”.

Indeed, a good platform can provide tax savings. Jonathan Watts-Lay, director of Wealth at Work, emphasises: “Integrating a Save As You Earn (SAYE) scheme with the workplace ISA will allow employees to transfer SAYE shares into the ISA and mitigate their capital gains tax liability. This is particularly relevant at present as many maturing SAYE schemes have significant profit.”

There are other advantages: linking a share incentive plan (SIP) with a workplace self-invested personal pension (SIPP) lets employees benefit from double tax relief. People also use platforms to hold company stock; this is helpful for those employees who need to hold a certain amount of stock as part of their employment contract. Provision of ISAs and pension wrappers allow for this stock to be held in the most tax-efficient way. Platforms also enable employees to diversify their company shareholding, reducing the risk of having all their eggs in one basket.

Mr Watts-Lay warns: “Failure to do this can have devastating results –  HBOS employees lost not only their wealth, but also their jobs when the company collapsed.”

A good platform should also have an annuity broking tool allowing employees to compare annuity deals at any point in time from the open market.

BEST PRACTICE

DOING THINGS BY THE (PENSIONS) BOOK

Good governance, administration and communications are fundamental to best practice.

New norms regarding pensions flexibility will be set over the coming years. In the meantime, employers should assess their workforce and the capacity of the pensions administrator before deciding on what level of flexibility to offer.  Keep investment strategies constantly under review – are they appropriate for post-April 2015?

In the new flexible world, clear communication will be more important than ever. The best DC schemes give their members access to online information, where they can access real-time fund valuations and an array of interactive tools, such as annuity modellers, as well as key messages. Frequently asked questions lists, e-mail, texts and social media are cost effective and can deliver “punchy calls to action”, says Mark Pemberthy, director at JLT Employee Benefits. Posters and desk drops all have their place.

Kevin Legrand, head of pensions policy, Buck Consultants at Xerox, says providing assistance to employees throughout either employment and into retirement, where the employer is still involved with the employee and their benefits, is a mark of best practice. He adds that this might also include: “providing paid-for access to financial advice at key decision points in a member’s working lifetime”.

Timeliness is essential. Administrators must be ready with all the information their members need to give to the guidance providers so they can make a decision in good time. Ideally, the process at retirement should be seamless.

Finally, there should be a robust governance process in place to review employee-member behaviour and decisions post-April 2015, and continually amend scheme design, investment and communication accordingly.