Company Pensions
- Final Salary Schemes
- Consultants guide hi-tech companies
- Companies need to review their pension arrangements
- A Budget for Pensions?
- SIPP’s Bespoke Investment Choice and Control
- Pension planning is often not top of the agenda
- Company Pensions - under pressure
- Final Salary schemes
- Final Salary Schemes – Would you want one?
- Firms make slow start on stakeholder
- Stakeholder Pensions
Final Salary Schemes
There is currently a dramatic shift away from Final Salary Schemes as companies decide to close or wind up schemes.
Last week frozen Food group Iceland and accountants Ernst & Young both closed their Final Salary Schemes to existing members of staff and it is likely other’s are about to follow. One half of the FTSE 100 index companies no longer have or are closing their Final Salary Schemes.
Final Salary Schemes are now shrinking from what was thought to be their stronghold of the larger companies and Plc’s to government backed employers where ultimately the taxpayers foot the bill. Some of the biggest local authorities will be imposing higher council tax bills because of increasing deficits in their municipal pension funds. It is reported that Consignia’s pension fund could shift from a surplus position to requiring an injection of up to £600 million to fill the black hole produced in part by the company’s dramatic reduction in staff.
The rapid decline of Final Salary Schemes is not simply due to reducing equity returns and falling markets. There has been a gradual imposition of legislation, which, together with demographic changes over the past two decades, has systematically added to the burden on these schemes.
During the late 1980’s and 1990’s, legislation required Final Salary Schemes to provide benefits for early leavers and provide index linked pension benefits. European court rulings designed to ensure sex equality and the Minimum Funding Requirement requiring all schemes to maintain solvency levels based on immediate short term market conditions both added to the complexity and costs of these schemes and risk to the company of maintaining final salary benefits.
The latest nail in the coffin came in the form of a new accountancy rule known as FRS17. This states that pension scheme liabilities must be recognised on the balance sheet on a market value basis. Not only simply increasing the cost by imposing further rules, this will have an immediate impact on the sponsoring companies profits and ability to pay dividends.
The rapid growth of legislation surrounding these schemes together with the increasing life expectancy, cost of purchasing annuities and the second year of falling equity markets (when generally 60 – 80% of final salary funds are invested in equities) combined to form the cancer that may kill defined benefit schemes.
Despite the excellent benefits and member security provided by these schemes it is not surprising that companies are shifting away from providing Final Salary Benefits with the succession of rules and imposition of additional costs in the management of these benefits.
For further information or guidance on Final Salary Schemes, please contact James Bolton of Atkinson Bolton Consulting Limited on 0845 458 1223 or email: james@atkinsonbolton.co.uk
Consultants guide hi-tech companies
Do stakeholder pensions represent yet more onerous legislation or an opportunity to save money and improve your employees' benefits package?
James Bolton a director of Atkinson Bolton Consulting Ltd, corporate benefit consultants, explained, "many companies just take the first product they are offered in order to deal with a perceived problem. What they do not appreciate is that stakeholder is just part of their employee benefit package and the purpose of that package is to reward employees with benefits they value, whilst providing value for money to the company."
Atkinson Bolton Consulting have been working with many clients throughout the region to ensure that they meet the requirements of stakeholder pensions and use the new rules to design bespoke employee benefit packages for the advantage of the clients and their employees.
Take for example Cambridge Display Technology (CDT) who are pioneering the development of light emitting polymers (LEPs) a revolutionary technology based on Nobel Prize winning research that’s about to transform the global display screen market. CDT recently announced a $25 million investment in building a pilot technology development line in Godmanchester, near the company's headquarters in Cambridge.
In the words of CEO of CDT Dr David Fyfe, "We feel a tremendous upsurge in interest in LEPs throughout the display world, our licensees are about to launch commercial products, and the pace of technological progress in the field is amazing. Very exciting times".
CDT’s employee base has grown by 50% over the last year to 100 staff, and will continue to grow by a further 50% over the next year. In order to attract the brightest and the best, it was essential that a competitive benefits package be established. Atkinson Bolton Consulting have undertaken a detailed benefits review on behalf of CDT, covering life assurance, permanent health insurance and medical insurance in addition to implementing a stakeholder pension scheme.
The group stakeholder pension plan now established at CDT offers outstanding benefits to employees, with low charge rates and total flexibility – something that is key in today’s recruitment market. In addition to the advantages offered to individual employees, the introduction of the scheme has reduced the complexity and burden of pension administration for the company, resulting in significant cost savings.
Abcam Ltd a young biotech company based in Cambridge's Science Park, has also recently undertaken a review of its employee benefits package. Founded in1998 by Dr Jonathan Milner, Abcam sells specialist research reagents to biochemists around the world via the Internet.
The company is growing strongly and now has 14 employees and has reached a turnover of £1m a year, it expects to grow a great deal more. Abcam recently turned its thoughts to making sure that it was providing appropriate benefits to its employees so that it attracts and retains the best.
In particular, Abcam believes strongly that companies should provide a good pension scheme as part of employees' remuneration. Consequently it has welcomed the government's initiative on Stakeholder Pensions, seeing it as a straightforward way to introduce a pension scheme.
However Abcam did not feel that it knew how to proceed to implement a scheme and, after attending a seminar by Atkinson Bolton Consulting, met with them to see if they could help. Abcam then asked Atkinson Bolton Consulting to provide the necessary support. In particular they wanted advice on selecting the pension provider and in explaining what it is all about to the Company's staff. Eddie Powell Finance Director at Abcam Ltd stated, “the scheme has now been implemented without any problems and Abcam is extremely pleased with its decision to use Atkinson Bolton Consulting. In fact we will be using them again to advise on further staff benefits, such as life and health insurances."
If these stories inspire you to turn a compliance issue into an opportunity, Atkinson Bolton Consulting are currently offering free reviews of corporate benefit packages. For further information please contact James Bolton on 0845 458 1223 or e-mail him at james@atkinsonbolton.co.uk. Atkinson Bolton Consulting Ltd is regulated by the Personal Investment Authority. To find out more about CDT and Abcam, please visit their respective web sites: www.cdt.ltd.co.uk and www.abcam.com.
Companies need to review their pension arrangements
Companies are starting to get the message that they need to review their pension arrangements to ensure they comply with the new stakeholder rules. Senior employees are often already provided with good quality pension schemes and so the general view has been that stakeholder pensions will not affect these.
Whilst in pure legal terms this may be correct, a typical executive pension scheme will have much higher charges than are allowable for stakeholder pensions. Because contribution levels have often been high, or paid solely by the employer, the level of charges has often been hidden or ignored. Many schemes are run for owner managers where the pension scheme is often a tax planning instrument as much as a means of providing an income in retirement. In these cases too, extremely high charges have often been largely ignored.
Many pension providers justify the high charges by claiming that executive pension schemes are much more complicated than stakeholder schemes. However, money purchase benefits for all employees are achievable within the 1% charge set for stakeholder pensions. As James Bolton, director of employee benefit specialists Atkinson Bolton Consulting, says “For senior employees, we can see no excuse whatsoever for persisting with high charging schemes when much better value products are available, often with the same provider. We believe that many companies will not consider their executive pension plans when reviewing their pensions because of stakeholder. If they fail to do this, they may well be missing an opportunity to provide significant added value to their top employees at no additional cost to their business”.
The government has aimed stakeholder pensions at the lower paid but their appeal goes much further than this. As Simon Gibson says ‘historically, the way for business owners and key employees to maximise pension contributions was to use an executive pension scheme. This may no longer be the case for many people’. One reason for this is that stakeholder rules mean that, if earnings reduce, stakeholder pension contributions can continue to be based on the higher figure for up to five years. For owner managers of small businesses in particular, this enables them to reduce pay significantly (drawing more income in tax efficient dividends) whilst maintaining pension contributions at a very high level.
A Budget for Pensions? More Tax – Sacrifice it
Increases in National Insurance in this week’s Budget will hit businesses hard next year. For Senior Executives and Owner Mangers of business, this is an ideal time to look again at the way their pensions are funded. In particular, a much-ignored pensions planning tool known as “Salary Sacrifice” should be looked at closely.
Salary sacrifice is a perfectly legitimate means by which any employee’s salary is reduced, with their agreement. The employer agrees to make a corresponding payment into their pension scheme.
Of course, the employee is perfectly free to receive their money as pay and then invest it in their pension scheme as a personal contribution. However, by doing so, the employer pays National Insurance contributions (at 12.9% from next year) on any additional salary. Following this week’s announcement employees will also pay an extra 1% tax on the extra earnings.
However, if the employer makes a payment directly into a pension, no National Insurance is due, which can be a significant saving.
The saving can be used to offset the increases in tax or can be used to make increased pension contributions at the same net cost to the company.
Stakeholder Pensions Revisited
Last year, in a blaze of publicity the Government launched Stakeholder Pensions. Stakeholder Pensions were to be the means by which everyone would have access to a low cost, flexible means of savings for their retirement. Underpinning this, virtually all employers, unless they already offered a pension scheme to their staff, would have to offer access to a Stakeholder Pension.
But in the year since, whilst employees have access to stakeholder pensions, most employers do not make any contribution towards their employees stakeholder pension. The Government’s much heralded Stakeholder Pension has done little to really increase the amount of retirement saving in this country.
Perversely, the tax increases announced in this week’s Budget could provide a greater impetus for companies to pay into pension scheme than the launch of Stakeholder Pensions last year. The increase in National Insurance contribution of 1% on employee and employer contributions and the removal of the upper earnings threshold on these additional contributions significantly increases the attraction of a company pension scheme.
Employer pension contributions are fully relievable against National Insurance. Give employees a pay rise, they will have to pay more tax and so will their employer. Make a contribution towards an employee’s pension and they see an increase in their overall remuneration package and a saving in their personal National Insurance bill whilst the company is able to save National Insurance as well.
All companies need to give serious consideration to using pension contributions to reduce the impact of these latest tax increases.
For further information, contact David Thurlow of Atkinson Bolton Consulting Ltd on 0845 4581223 or email david@atkinsonbolton.co.uk. Atkinson Bolton Consulting Ltd is regulated by the Financial Services Authority.
SIPP’s Bespoke Investment Choice and Control
Recently the use of Self-Invested Personal Pension Plans (SIPP’s) has become more common.
As stock markets become more volatile and as industry woes such as those at the Equitable Life bite, probably the major motive for this change is the ability for individual to have greater control.
The investment strategy of an insurance company’s managed fund does not take account of individual time horizons or the differing requirements of say a thirty year old to a person who is approaching retirement.
Another significant change in recent years has been the advent of Income Drawdown. Historically, when a person reached retirement their fund was simply converted to an annuity to provide income for the rest of their lives.
Now at retirement there is a multitude of choices. The traditional annuity can still be purchased and in some cases this is still appropriate, but as annuity rates have fallen people are turning to keeping their pension fund intact and drawing income directly from the fund, known as Phased retirement or Income Drawdown.
On using Drawdown however, there is suddenly a different set of investment matters to consider which is why we advocate the use of Portfolio Managers. Here the portfolio can be designed and managed in line with an individual’s specific investment objectives, income requirements, attitude to risk and time horizon. The last of these being particularly important as under present rules the fund has to buy an annuity by age 75.
The mathematics of Drawdown is complex involving assumptions about the future levels of interest rates, gilt yields, annuity rates, inflation and equity market returns.
In any investment planning exercise it is extremely important to match any given liability with an appropriate asset.
One of the dangers of drawdown can be explained in the term “reverse pound-cost averaging.” Most investors are familiar with the idea of drip-feeding funds into the stockmarket to gain from pound-cost averaging i.e. a lower average cost of purchase as the stockmarket ebbs and flows.
Unfortunately in drawdown this works in reverse.
If an investor has to sell assets periodically to generate income then there is a danger of selling assets at a low point thus depleting the asset base at a low level and, therefore reducing the impact of a recovery in asset prices since some of the assets would have been consumed. Thus, reverse pound-cost averaging results in a lower average sale price if income is drawn from capital.
The SIPP offers greater control and flexibility to all whether you are still young and building up you fund or approaching retirement and planning for income.
For further information contact Simon Gibson of Atkinson Bolton Consulting on 0845 4581223 or email simon@atkinsonbolton.co.uk Atkinson Bolton Consulting Ltd is regulated by the Personal Investment Authority.
Pension planning is often not top of the agenda
For directors of small and medium sized businessed, pension planning is often not top of the agenda. Often, they will regard their business as their pension. However, as Simon Gibson says, ‘if business owners ignore separate pension provision, they are missing a trick.’
There are significant advantages to be gained by not only having your business as your pension, but using your pension for your business as well. There are two types of pension in particular which can appeal to directors of small and medium sized businesses – Small Self Administered Schemes (SSASs) and Self Invested Personal Pensions (SIPPs).
A SSAS is a company pension scheme with a difference. It is a small pension scheme, often consisting solely of a company’s shareholding directors, and the members of the scheme control how the pension fund contributions are invested. Where a company needs to take out a loan for capital purposes, it may be able to borrow the money, on commercial terms, from the SSAS. Rather than the banks benefiting from making the loan, the directors’ pension funds benefit from money that would otherwise have had to be raised externally.
A SIPP is a personal pension scheme where the choice of investment lies in the hands of the individual and his adviser. Unlike a SSAS, it is not possible for a SIPP to make loans to an employer.
Both a SSAS and a SIPP can invest in commercial property. This means that it may well be possible for a SSAS or a SIPP to own a business’s premises, earning rental from the company and boosting the directors’ pensions, whilst avoiding the need for mortgages to third parties.
Funds placed in SSASs and SIPPs can be used in a variety of ways to maximise investment opportunities, but they can also be an extremely efficient way to shelter business profits in a tax efficient environment. For advice on all aspects of SSASs and SIPPs, contact Simon Gibson at Atkinson Bolton Consulting on 0845 458 1223. Atkinson Bolton Consulting is regulated for investment business by the Personal Investment Authority.
Company Pensions - under pressure
The government is forever telling us that pensions are a good thing and we should be saving more for our retirement. It encourages us to do so by a mixture of carrot and stick. On the one hand it gently encourages us with tax concessions for paying into schemes approved by the Inland Revenue. On the other hand, it forces employers to give employees access to a pension scheme (by 8 October), with the threat of fines and even imprisonment if the rules are not met.
Against this backdrop we have the recent announcement by AOL Time Warner that it is scrapping its pension arrangements in favour of the introduction of a share option scheme. The trouble is the costs of running many pension schemes, especially good final salary pension schemes, is increasing all the time and often in danger of spiralling out of control. Government regulation, often intended to protect pension scheme members’ benefits, can potentially lead to companies stepping back from pension provision altogether.
Apart from government regulation and red tape, low interest rates have increased the cost of buying pensions. And the fact is, we are all living longer and are likely to spend more time retired. The combined cost impact of low interest rates and increased longevity is a potentially lethal cocktail for many final salary pension schemes. It is hardly surprising that so many employers are reviewing their pension provision.
There is an increasing awareness amongst employees of the value of a company pension scheme. For a number of years, many employers were able to avoid providing pension schemes altogether, especially in the high tech sector where share options were seen as the ultimate employee benefit. As many have seen, the drawback of share options is that they can be worthless as well as go up. As David Thurlow of Atkinson Bolton says ‘We are increasingly seeing employees wanting tangible employee benefits that are of value regardless of the performance of stock options, and this is especially true of SMEs’.
With the government extolling the virtues of money purchase stakeholder pensions this desire by employees to be provided with a competitive pension scheme is unlikely to diminish. However, with no sign of a reduction in the red tape or costs of occupational pension schemes, the decline of these schemes is set to continue.
Atkinson Bolton Consulting Limited are continuing their workshops on Employee Benefits and Corporate and Individual Financial Planning please call 0845 4581223 for dates and locations.
Final Salary schemes
The problems Final Salary schemes continue to encounter are hitting the headlines. Glaxo Smith Kline last week became one of the latest FTSE 100 companies to reveal a large notional deficit in its final salary scheme based on the new accounting standard FRS17. This news follows similar disclosures from Compass, ICI and BP.
FRS17 requires companies to value the pension fund assets at the end of each year and disclose this in their company accounts. Most final salary schemes have the majority of their investments in equities; these funds have been hit by sharp falls in stock prices. FRS17 follows a stream of other burdens piled upon final salary schemes including new Funding requirements and European Court rulings. Employers are increasingly questioning whether the funding of a final salary pension scheme is in the company’s and shareholders best interests. The eventual losers of the mounting pressure to further protect final salary schemes and benefits could therefore easily be the employees themselves.
If final salary schemes are considering closing and winding up there are a number of vital steps which must be considered and fully understood, these include the following:
Stage 1 – Initial Considerations
The company needs to take detailed advice on the closure and winding up process including the following points:
- Scheme Trust Deed and Rules must be reviewed.
- If a scheme is or has been contracted-out further considerations are required.
- The member records must be audited and up to-date
- The current scheme investments should be reviewed.
Stage 2 – Valuation
A wind up valuation will determine how the scheme can secure all the benefits. This would consider the following:
Securing the benefits on a “cash equivalent or transfer value” basis subject to the Minimum Funding Requirement. This valuation will calculate any potential debt on the employer if the scheme chooses to wind up.
A valuation to investigate the costs of securing benefits by buying immediate and deferred annuities to ensure that each members final salary benefit is secured.
Stage 3 – Review
The company and the trustees need to take advice from their Independent Financial Advisor and the Actuary on the results of the valuation and how the scheme assets including any surplus or deficit, might fairly be apportioned over the membership. Based on this the trustees make a decision of what options are to be given to the scheme members.
Stage 4 – Re-allocation of any surplus/deficit
At this stage the Actuary may undertake further calculations to take into account the trustees decisions for any surplus or deficit within the schemes. It may be necessary to also obtain revised “buy out” quotations.
Stage 5 – Issue of Members Benefit Statement and Option Forms
Statements are issued setting out the estimated level of the members benefits and their options. Members are given up to three months notice to notify the trustees of their choice. The market value of scheme assets will fluctuate during this period so the benefits and cash equivalent values cannot be finalised until they are actually settled and will therefore not be guaranteed at this stage.
Stage 6
Once the notice period has been completed the benefits are settled and secured by purchasing deferred annuity bonds or individual buy out plans by the trustees.
Stage 7
The trustees and the company will then execute a final resolution. This will release the trustees from their responsibilities under the scheme. Further bodies need to be advised that the scheme has wound up and how the benefits have been secured.
The wind up of final salary pension schemes can be complex and may take some time. However, with the periphery of regulation, falling investment returns and increasing annuity costs, it is not surprising that many companies are opting to shut or wind up their final salary schemes replacing them with defined contribution arrangements.
Such a change requires careful consideration and it is vital that regular and clear communication is made to the members of the scheme throughout this process. For further information please contact James Bolton of Atkinson Bolton Consulting Limited. Atkinson Bolton Consulting Limited is regulated by the Financial Services Authority.
Final Salary Schemes – Would you want one?
You are the FD of a new company. What considerations would you take into account when deciding on the most appropriate type of pension provision for your employees?
You know that you need to offer a competitive pension scheme in order to recruit and retain quality employees.
You want the pension cost to be predictable from year to year, without too much volatility. You want to ensure that, in difficult times, the cost of running the pension scheme will not outstrip other business costs and, potentially, place the very existence of the business in jeopardy.. You are not prepared to take on unknown, unquantifiable business costs. In short, you don’t want any surprises.
If certainty of costs is so important for new businesses, why do so many long established firms ignore this when it comes to their own pensions planning? A final salary pension scheme sits very uncomfortably with modern corporate demands. A final salary pension scheme offers no certainty of costs - far from it.
Because the liabilities of the pension scheme are based on past employment as well as future employment, changes to legislation such as the taxation of dividend income create a significant and often retrospective charge on pension funds. Costs within final salary pension schemes are much greater for older employees than newer employees, encouraging ‘downsizing’ companies to offload older, more expensive, employees when often their experience and expertise means they are not the best employees to lose. And all the time, increasing life expectancy, diminishing investment returns and a mass of legislation designed to protect benefits, adds to the costs of these types of pensions.
If you were the FD of a new company, you would not set up a final salary pension scheme for your employees, you might even consider it corporate suicide to do so. Recent research has shown that over a quarter of small to medium companies operating final salary pension schemes are considering closing them down. The fact is that every company operating a final salary pension scheme owes it to itself and to its shareholders to review their current benefit arrangements to ensure they are aware of all the risks they are carrying and to ensure that the pension scheme they are offering continues to be appropriate in today’s business environment.
Firms make slow start on stakeholder
According to figures released by the Association of British Insurers less than a quarter of the 400,000 companies required by law to offer employees Stakeholder Pensions by October have made the necessary preparations.
The ABI have released figures that state that 90,000 employers introduced Stakeholder pensions during the period from April to July. Mary Francis, director-general of the ABI said “stakeholder pensions have made an encouraging start – Employers will play a key role in the autumn in boosting Stakeholder pensions, particularly by people with modest incomes who need to save for their retirement.”
James Bolton of Atkinson Bolton Consulting stated “throughout Cambridge and the region we have seen a good response with many employers ensuring that they will meet and exceed the Stakeholder requirements. In order to attract and retain staff in the highly competitive employment market in Cambridge many companies are also taking this opportunity to review their existing benefits and introducing attractive risk benefit packages and company pension contributions.”
STAKEHOLDER PENSIONS
Stakeholder pensions mark the latest government pensions initiative and are regarded by many as one of the most radical initiatives yet. The purpose of this talk is to give you my thoughts on stakeholder pensions. First I intend looking at why stakeholder came into being, followed by a look at the stakeholder rules themselves and what they will mean to employers. I will then highlight what I see as the main advantages and disadvantages of stakeholder pensions, followed finally by a gaze into the crystal ball to see what impact stakeholder might have on the future pensions landscape. Although I hope my fellow directors at Atkinson Bolton Consulting will agree with much of what I propose to say, the thoughts and opinions I express are all my own and should be taken as such.
Firstly, I would like to look at why stakeholder pensions came into being.
WHY STAKEHOLDER?
1.’Demographic Time bomb’
I am not sure who it was that first coined the term, the demographic time bomb, but it does sum up so well the situation we find ourselves in across the Western world as an increasingly elderly population struggles to find ways of supporting itself in old age.
Much of what follows will be obvious to those of us here, but since it is one of the main motivators for stakeholder, it is undoubtedly worth repeating. As we are aware, the State pension scheme is funded on a pay as you go basis, which means the contributions of those of us working today are paying for today’s pensioners. This is totally the opposite to private pensions which are funded arrangements, whereby we are paying for pensions, which will be paid when we retire, and which therefore have an often significant investment element. The numbers of people working has remained, and is likely to continue to remain, static. However, increasing longevity means that the proportion of retired people to working continues to increase and with it the costs of supporting these people via state pensions. This problem will be exacerbated as the baby boomers reach retirement and increase the numbers of pensioners.
The Government Actuary’s department calculated in 1994 that, whereas there were 4.1 people of working age to each pensioner in 1960 and 3.3 in 1990, there will be just 2.4 in 2030. So, first and foremost, there will be fewer people available to support the retired population. This has happened in the past largely because of a drop in the birth rate meaning that there are fewer people of working age. At the same time, the baby boomers of the late 1940s and 1950s will retire and become pensioners and because of improvements in diet and healthcare, these people are living longer. In 1901, male life expectancy was just 49, though a man who reached age 60 could expect to live another 13 years. By 1991, this had increased to 19 years and, in 2021, this is projected to be 22 years for men. In other words, assuming I retire at 60, I can expect my retirement to be over 10% longer than someone retiring at 60 today. Life expectancy for women has similarly increased and, of course, ladies last longer than we men anyway. The situation is expected to peak around about 2050 when there are projected to be 15m retired, some 36% more than at present.
Average earnings have grown faster than prices in virtually every year since the Second World War, reflecting our growing affluence. The State pension, linked to prices, has been declining relative to average earnings and this is likely to continue. It is clear from the above figures that the working population cannot sustain an increasing retired population without significantly increasing the proportion of government spending paid out in pensions.
So, pension costs could spiral if nothing is done about it, driven by a falling birth rate and increasing numbers of pensioners. At the same time, people’s expectations of their retirement is increasing as they enter what they see as their Third Age. Many people wish to retire earlier, lengthening their retirement still further and reducing their working life.
At the 1999 NAPF Annual Conference, Jeff Rooker, Minister for Pensions, stated ’People who rely on the State Pension will live in abject poverty’. Coming from a Labour politician, I find this statement particularly revealing about the way governments of all political persuasions are likely to think in future.
2. Cost and Complexity of Pensions
If it is accepted that the state alone cannot provide for people’s retirement needs, people have to take responsibility for themselves. The government identified that the main barriers to people failing to take action for themselves was the cost and complexity of existing pension plans – I will return to this subject later. If pensions could be made simpler to understand and cheaper, take up would, in the government’s view, be bound to increase. If it still didn’t increase the government would consider making contributions to a private pension compulsory.
3. Pensions Misselling
Much has been written about the pensions misselling scandal. Much abuse has been justifiably been hurled at advisers and providers alike who have incited employees to opt out of their good occupational schemes and into personal pensions. There really are some horror stories but it is also a fact that there are large numbers of people who were not ‘mis-sold’ pensions in what I would take to be the true meaning of the word. Hindsight can be a wonderful thing. Nevertheless, this does not diminish in any way the mis-selling that did take place and the fact remains that pensions misselling has tarnished our industry badly and has put many people off investing in pensions. I can hardly blame you if your view of pensions companies and financial advisers is that they are after your money for their benefit not yours. Amongst those who hold this view, situations such as the present position of the unfortunate Equitable policyholders, many of whom are being bombarded with advisers offering ‘free’ advice on what to do with their policies, gives the impression of a pack of wolves surrounding their kill, especially when the ‘kill’ is a once proud company that never endeared itself to those same advisers by refusing to pay them their commissions. These events serve to remind us that although most of our industry are professionals in every sense of the word, there are a few rogues out there as well. But, I digress. Back to Pensions mis-selling. Many people have lost faith in the pensions industry - prescribing a pension scheme that can guarantee good value for money in so far as there is a cap on charges is the government’s way of restoring that faith. In many ways, I believe it will succeed.
WHAT IS STAKEHOLDER?
The initial proposals in November 1998 proved to be deeply unpopular and were condemned by just about everyone who read them. Effectively, they created another type of pension scheme – stakeholder – that could not be combined with any of the old schemes and which had a maximum permitted contribution of £ 3600pa. All companies, regardless of size, who had any employees not covered by an occupational pension scheme would have to offer a stakeholder scheme.
The basic legislation governing stakeholder pensions is contained in the Pensions and Welfare Reform Act 1999 and The Stakeholder Pension Schemes Regulations 2000.
The general rule with stakeholder is that every organisation employing more than four people will have to provide access to a pension scheme for its employees.
True, there is one exception to this general rule. If you employ more than four people and every employee earns less than the National Insurance Lower Earnings limit (£ 3484 for 2000/01 - £ 290.33 per month) and has done so for at least three consecutive months, you don’t need to worry about offering a pension scheme – but given that the national minimum wage (£3.70 hour) produces a weekly wage greater than the LEL for just 19 hours work, I think it is going to be difficult to find more than a handful of companies qualifying for this exemption.
So, you have a company employing more than four people. You have to offer a pension scheme and you have until 8 October 2001 to comply with the new rules. What sort of scheme do you have to offer? The simple answer is that you have to offer access to a stakeholder pension scheme unless you already offer a pension scheme, which gives you an exemption from the requirement to offer a stakeholder. Failure to comply with the new rules and companies could face fines of up to £ 50000. For your existing pension scheme to give you an exemption, it has to meet the following criteria:
Occupational pension schemes – must be open to all staff aged 18 or more and over five years from retirement. New employees must be allowed to join the scheme after a maximum of 12 months’ company service, provided they meet the age requirements above.
Group Personal Pensions – must be open to staff aged 18 or over after a maximum of 3 months’ company service. Unlike occupational schemes, a group personal pension can exclude employees whose earnings are consistently below the NI Lower Earnings limit. The employer must contribute at least 3% of basic salary to the scheme but can insist on matching contributions from employees. It must be possible for employee contributions to be deducted from pay and passed by the employer to the scheme. Finally, there can be no charge or penalty imposed when a scheme member ceases contributing to the scheme or transfers his/her funds elsewhere.
If an employer already offers a scheme that meets the criteria above, they are exempt from the need to offer access to a stakeholder scheme. If not, they must introduce a scheme that gives them an exemption, amend their existing scheme so that it does, or offer access to a stakeholder plan.
Recent research by Axa showed that there are 599,000 businesses in the UK with 5 or more employees of which 365,000 currently offer no pension scheme for their employees. Two thirds of those (230,000) did not realise they will have to offer access to a pension scheme for their employees, this despite the fact that Axa’s research was carried out after the DSS issued their ‘guide to employers’ to every business in the country. Incidentally, research by Scottish Equitable, published only last week, indicated that UK employers could well find pensions advice in short supply as companies struggle to comply with the new rules in time for the October deadline. This will not be helped given that worksite presentations can only be carried out by individuals authorised to give investment advice.
As they have evolved, stakeholder schemes are now personal pensions by another name. They will look different to old-style personal pensions in that their charges are much lower, but in practice most personal pensions are already being brought into line with, or close to, the stakeholder charging structure.
Currently, pension providers make a variety of charges, not all of which are obvious to the investor – fund management charges, policy fees, bid/offer spreads and unit allocation rates are common to most schemes, but there may be capital units, installation charges, early surrender penalties, paid up policy fees and so the list goes on.
One of the great strengths of the stakeholder pension is that, in terms of its charging structure, it is far easier to understand than anything that has gone before. The only charge that can be made is a fund based charge and this cannot be more than 1% of the fund per annum, normally deducted from the fund on a daily basis.
Stakeholder pensions must be prepared to accept modest contributions and cannot impose a minimum contribution higher than £ 20. Generally, people paying to stakeholder schemes can change contribution levels at will, but companies deducting contributions from pay can restrict changes to half yearly intervals.
Where a stakeholder pension is set up, it must be made available to all employees aged over 18 after no more than 3 months’ service (though as with GPPs anyone earning less than the NI LEL can be excluded). Unlike group personal pensions, the employer does not have to contribute to a stakeholder pension, they simply have to nominate a provider, publicise their scheme and offer a payroll deduction service for contributions. Companies providing group personal pension schemes that do not offer an exemption (e.g. because the contribution is below 3% or there is a waiting period of longer than 3 months) will have to offer access to a stakeholder pension scheme in addition and offer access to all employees, whether pension plan members or not.
Companies offering occupational pension schemes that do not meet the criteria for exemption also have to offer access to a stakeholder scheme but only to employees not eligible for membership of the occupational scheme.
Initially, the maximum contribution that could be paid to a stakeholder pension was £ 3600 pa, but this amount could be paid irrespective of earnings. This has evolved into the greater of £ 3600 or the normal age related contribution limits applying to personal pensions. And, if your earnings justify a contribution higher than £ 3600, you can use those earnings to base your contributions on for the following 5 years. What is more, these limits have been extended so that they apply to personal pension schemes as well as stakeholder (though to be fair and as mentioned above, under the final rules, a stakeholder is now merely a form of personal pension).
Incidentally, everyone paying to a stakeholder scheme pays contributions net of basic rate tax, regardless of whether or not they are a taxpayer Therefore, a non earner could pay £2,808 from 6 April and have £3,600 invested. These are welcome changes. Had the £3,600 cap remained, anyone earning over £20,000 pa was likely to be able to contribute more to higher charging personal pensions, often much more. The integration of stakeholder and personal pensions has removed these inequalities and ensures that the introduction of stakeholder will be a really meaningful change across the whole of the pensions landscape rather than a limited change affecting only those on below average earnings who had the desire and the ability to save for their retirement. Without these changes, stakeholder would deservedly have withered on the vine.
The stakeholder rules have evolved enormously from when they were first seen. As first drafted, they meant the end of the personal pension. The implication of the originally proposed rules was that all occupational pension schemes were good and all personal pension schemes were bad. This is of course absolute nonsense. I have advised a number of companies to switch from occupational to group personal schemes because of the less onerous responsibilities and the additional flexibility – but in these cases the group personal pensions that have emerged have been every bit as good and often better than the occupational schemes they have replaced. I am pleased and relieved that, gradually, the differences between stakeholder and personal pension schemes have been blurred and it has become clear that there is a future for ‘good’ personal pension schemes as well as occupational schemes.
Concurrency
What we mean by concurrency is that employees earning less than £ 30000 who are not controlling directors can pay into a stakeholder scheme as well as be a member of an occupational scheme.
Concurrency came late to the evolution of the stakeholder. For some time it looked as though employees in personal pension arrangements would be able to pay £ 3600 per year whether or not they had any earnings that would justify it, but occupational scheme members remained subject to the old rules on personal contributions and benefits. Far from encouraging companies to offer good occupational schemes, the likely consequence of this would have been a further drift away from occupational schemes. The advent of concurrency is likely to stem this tide, but also addresses one of the major disadvantages occupational schemes have always had compared to personal pensions. Many personal pensions have been sold because of their flexibility. You join an employer’s pension scheme and when you leave you have to stop paying into the scheme. full stop. But personal pensions could be taken from one employment to another and from employment to self-employment and vice versa. True, in theory, but not in practice. For example, if you had a personal pension and joined an employer with a company pension scheme you had the choice of opting out of the company pension scheme or stopping contributions to the personal pension. In practice, not much of a choice, but many people in this position chose of their own free will not to join the company scheme and many will receive compensation as part of the misselling review, some undeservedly. Similar issues arise with stakeholder, except that if you are earning less than £ 30,000 and not a controlling director, you can pay into the stakeholder as well as the company scheme. Effectively, this treats the stakeholder as an AVC except that it doesn’t count towards maximum benefits, ¼ can be taken as cash at retirement and you don’t have to stop paying in if you leave the employer.
Furthermore, your employer can make the contribution to the stakeholder scheme and, if this is done via a salary sacrifice arrangement, this can have the advantage of an employer NI saving as well as income tax relief.
Free Standing AVCs, by and large an overpriced product already suitable for very few, should be virtually wiped out by the concurrency rules.
Trust based vs. contract based.
Initially, stakeholder schemes were to be set up under trust and, whilst this is still possible, the vast majority of stakeholder schemes will be set up via secure stakeholder managers, which has become known as the contract basis (and is more akin to the way personal pension schemes are operated). When the concept of the contract basis first appeared, it was intended to provide a simpler though probably inferior basis, without the costs of running a trustee board. However, the advantages that a trust based scheme had over a contract scheme have gradually withered away and the last, the fact that trust based schemes could restrict membership to members of a particular company or affinity group, has also been passed on to contract based schemes. This means that the TUC stakeholder, already established on a trust basis, may well prove to be the one and only stakeholder scheme set up on this basis.
THE GOOD THINGS ABOUT STAKEHOLDER
Stakeholder schemes have no fixed charges; just a single fund based charge of up to 1% of the fund. Most old style schemes have fixed charges, usually in the form of a monthly policy fee, typically £ 2-£3 per month. Although not very much, for someone contributing a modest £ 20 per month into a personal pension, this charge alone swallowed up over 10% of each contribution. One of the great advantages of the stakeholder charging structure is its appeal to those with small funds. If someone is in a stakeholder scheme with a very modest fund, provided the fund growth is over 1% pa, the fund will continue to grow. I saw many paid up pension pots that would disappear altogether due to charges unless future growth was 10% pa or more. There are major disincentives for those on low incomes from saving, more of which later, but for those who still wish to contribute to a pension scheme, stakeholder offers significantly greater value than its predecessors do.
For higher funds, the advantages are less clear-cut and a 1% charge on a large fund may well be greater than the charges under the old scheme. However, the 1% is a maximum and a number of companies have already indicated their flexibility in terms of charges for those with larger funds to invest. I have seen charges for pre-stakeholder schemes as low as 0.3%.
The pensions industry has embraced the 1% maximum charge. When it was first announced there were howls of anguish from an industry that protested it could not possibly make a profit from a 1% maximum charge. Yet less than 2 years later, all the major pensions providers and a good many minor ones too have unveiled products falling well within this maximum. Many have discovered they can pay commission to advisers and remain within the 1% ceiling. Barclays has decided it can afford to run a stakeholder scheme without making any charges at all, at least until January 2003 – having said that, they have now outsourced their stakeholder to Legal & General. To my mind, the rush for stakeholder business reminds me of the supermarket wars of a few years ago when everyone was battling to give away tins of beans and no one was making a profit. How long will it be before stakeholder pensions will be given away with our cornflakes? Whether this is good news for the pension providers remains to be seen, and I will come back to that later. It has to be, at least in the short term, good news for the consumer who continues to have a wide choice of pension investments at a fraction of the price of a few years ago.
Flexibility
Not only does stakeholder pensions offer lower charges than old-style personal pensions, it also offers much greater flexibility. The fact that most people can go from employment to self-employment to membership of an occupational pension scheme and continue to pay to their stakeholder is a significant advantage. The fact that there is complete freedom to move funds between providers without penalties is another. A frequent complaint of clients of mine in the past has been the fact that occupational scheme rules and personal pension rules are mutually exclusive. With partial concurrency this is no longer the case. And because people can contribute to a stakeholder based on earnings from up to five years ago, and £ 3600 pa in any event, means that the flexibility to pay higher levels of contributions on a regular basis is much greater than before, even if the introduction of stakeholder coincides with the abolition of carry forward.
Most personal pension schemes today are also completely flexible and I do not believe this would have happened without stakeholder.
Low and no-earners
The vast majority of pensions legislation makes life more complicated for those of us relying on the industry for a living. I mustn’t complain, too much real simplification and maybe my services wouldn’t be needed by quite so many people. I believe – and feel free to disagree – that stakeholder pensions really have made things simpler. OK, not completely, you can have occupational pension schemes under the myriad of old rules and occupational pension schemes under stakeholder rules, but the fact is that a money purchase scheme can operate under stakeholder rules which are the same as a group personal pension which are the same as a stakeholder scheme. This is real progress. The fact that everyone can pay up to £ 3600 per annum without worrying about earnings is major simplification. This also means that people on career breaks can pay up to £ 3600 pa into pensions. The removal of any minimum age means that it is possible for parents and grandchildren to pay into a pension scheme for children/grandchildren. The fact that members of occupational pension schemes earning under £ 30000 can use a stakeholder as an AVC and receive tax free cash from it is a major step forwards, especially as we advisers don’t need to treat one or other as a retained benefit. The fact that people taking out a stakeholder pension scheme will know they are investing in a straightforward, flexible scheme with modest charges has to be a good thing compared to the days when nobody really understood whether the personal pension they had was rear end loaded, front end loaded, level loaded, or even what those expressions mean. The pensions industry has, in the past, often done little to help itself improve its reputation, stakeholder has in part been prompted by this, and if it really does mean the death knell of these old penalty ridden contracts, then I for one embrace it.
Later this year Anna Rogers (PMI Council member and eminent pensions lawyer) will be speaking to our Group updating us on the Pensions & Divorce situation. As you will be aware pension splitting on divorce finally arrived last month. For people who have seen their pension expectation reduced because it has been shared with a former spouse, stakeholder can offer a real opportunity to top up the benefits again.
The good things about stakeholder mean that more customers will be satisfied with their pension funds as far less see that many years after they started their policies, they still have less than they paid in.
I have to ask the question though, why has it taken legislation to force providers to reduce charges to this extent? The fact is that for years, many product providers and advisers have been overcharging an uninformed public and for this reason, I applaud stakeholder.
THE BAD THINGS ABOUT STAKEHOLDER
1. 1% Charge
The 1% charge is not altogether a good thing.
Many providers have taken an aggressive stance in pricing up stakeholder pensions, operating within a 1% charge whilst providing commission levels which can only possibly generate profits if persistency levels (i.e. people carry on paying into the scheme) are at levels never before seen – and remember, before stakeholder most products were designed to put people off from transferring elsewhere. In the stakeholder environment providers are dependant on their profits to investors keeping their money for longer than they have ever done before, at the very time when there is less incentive than ever before for them to do so.
Just how will providers profit within a 1% charge given some of the restrictions placed upon them? For example, the DSS has confirmed that stakeholder schemes will have to accept contributions paid by standing order, cheque, direct debit and direct credit. Clerical Medical have estimated that payments by direct debit cost them 15p per transaction, standing orders £ 2.50, which ignoring all other charges can make a major dent in a 1% charge, especially given the frequency that contributions can be changed. Then there is the cost of providing annual benefit statement, telephone helplines and so on.
And all this ignores the vast costs expended in preparing for stakeholder and revamping product ranges.
Our stakeholder schemes are often compared to that of Australia. Six years ago there were 12 providers of Australian stakeholder schemes. Today, there are two. Already registered with OPRA are 26 stakeholder schemes. OK, our population is bigger than Australia’s but there is no way the UK market can sustain 26 different providers. Maybe this is good news – but continuing major consolidation will lead to a reduction in the choices open to the consumer and that, in my view, is not a good thing.
Who knows what is already suffering as providers tighten their belts to ensure they have the money to run stakeholder at a loss for who knows how many years? Is it not probable that Equitable would have found a ready buyer were it not for the likely candidates buying in stakeholder market share and gearing themselves up for the battles to come. It would be ironic if the demise of the country’s biggest provider of AVCs could well provide a vacuum which stakeholder is well placed to fill.
2. Concurrency
Generally, I regard the rules on concurrency as a good thing. They mean that someone earning less than £ 30000 pa can be in an occupational pension scheme and also contribute to a stakeholder without worrying about ‘headroom checks’ and funding limits. On the face of it, this is a welcome simplification. Until you look at AVCs. Many companies will offer occupational pension schemes that do not quite meet the requirements for stakeholder exemption. They will therefore have to offer access to a stakeholder to employees as well as the occupational scheme for eligible employees. In addition, they will have to offer membership of an AVC scheme. The rules governing AVCs and stakeholder are different so the stakeholder scheme cannot be the nominated AVC scheme, plus there will be employees earning over £ 30000 who cannot pay to the stakeholder. For employees who wish to make additional provision beyond their occupational scheme, should they do this via AVCs or stakeholder? There are many considerations to take into account here. Most AVCs cannot fund for tax free cash, but the employer may subsidise the scheme or match contributions. If the AVC provides added years, the comparison becomes even more difficult. The very real danger is that employees currently paying into a stakeholder will continue to do so, even though an in house scheme offers significant advantages – but who will be there to advise these people?
And what will happen to those people who pay to a stakeholder whilst in an occupational scheme, whose earnings unexpectedly go over £ 30000 during the year? In theory, the excess will have to be refunded, which could become extremely messy – and which the 1% charge would certainly not cover.
3. The Government
Just what is the govt trying to achieve with the introduction of stakeholder. Originally, it was to encourage those on modest incomes –£ 9-18,000 - to provide for their retirement. More recently, the Minister for Pensions Jeff Rooker has confirmed that the reason stakeholder is being introduced is to fill the gap in pension provision for those people who couldn’t afford a private pension and couldn’t get access to an occupational scheme.
If people in this category were going to save for their retirement, stakeholders are a good thing; less of their contributions will be swallowed up in charges. But if the government really wants people to save for their retirement, it has to get rid of the muddled thinking that surrounds the world of pensions. I’m not convinced I could live very happily on £ 66.70 per week but I would be happier with the government’s new Minimum Income Guarantee (MIG) of £ 100 per week. [Incidentally, parts of government clearly do not understand their market – application forms for the minimum income guarantee asked the applicants – all pensioners if they are pregnant] Every pensioner is guaranteed a minimum income in retirement of £ 100 pw. So, if your state pension, plus any private pension, comes to £ 90 pw the govt makes it up to £ 100. Hurrah. But hold on. If I just have my basic state pension of £ 66.70 per week, the govt makes my pension up to £ 100. So for the lower paid, just what is the point of saving for retirement when all that will happen is the govt will take it off my state benefits. For anyone self-employed (because for the employed SERPS complicates matters), a private pension of £ 32.30 per week would be wasted, which would require a fund well in excess of £ 30,000. For many people this would and should make the difference between investing in a pension and stashing your money somewhere else or spending it. If the government wants people to save for their retirement, there has to be a real incentive and 22% tax relief now and 100% tax at retirement is not that.
Fortunately, the govt has recognised this fact and is proposing to introduce a pensions credit from 2003. This will mean that there will be a credit of 60p per week of state benefits for every £ 1 of private pension. Excellent, this means that private pensions up to the level of the MIG are only taxed at 40% - in addition to the normal income tax of course. Thank you Mr Brown, I’m sure millions of pensioners will be delighted with your generosity.
[I was at a company recently talking about stakeholder and what they had to do to comply. Most of their employees were low paid, because of the nature of the jobs they were doing. They had never been provided with a pension scheme before. The company will have to offer access to a stakeholder pension scheme and will have to publicise it to their staff. Some of those low paid employees will join the scheme and a few may have to scrimp and save to be able to afford their pension contribution. After all, the govt wants people to save for their retirement and has therefore made their company provide them with the pension scheme. The likelihood is that, as the law stands at present, these people would have been better off keeping their money or, if they could afford to, putting it in an ISA instead. Take the example of 56 year old Rita who pays £ 100 per month into her stakeholder until she is 65. At 7% growth, she will have a fund of £ 18,100 giving her a pension of £ 1,120, or £ 22 weekly. She will get £ 77 pw pension, topped up by the MIG to £ 100. She will also get a pension credit of 60% of £ 22 which is 3 13.50 per week. Rita will get £ 113 pw whereas if she had not saved she would have got £ 100pw. The govt lets her keep £ 10900 of her £ 18100. She would have been better off not saving; she would have been best off putting the money into an ISA. And how many people on modest earnings will be able to save £ 100 per month? But if she had access to advice, is she really likely to believe the adviser who tells her to ‘opt out’ (and I choose the words carefully) of her company’s scheme and put the money into an ISA instead?
4. Carry Forward
Stakeholder pensions will enable many people to pay more towards their pension than ever before, for the reasons we have already looked at. However, at the same time the ability to carry forward unused tax relief’s for up to 7 years is being removed. Under the current rules, it can be possible to pay the whole of your earnings to a personal pension scheme by using up unused tax relief. This option will be lost after 31 January 2002.
5. Decision Trees
One of the reasons why the charge cap has been set at 1% is because the government believes that stakeholder pensions are inherently simple products, which can be bought without a need for advice. Whilst this will undoubtedly be true for many, there are sufficient complexities involved, as I hope I have demonstrated, to ensure that many will want to seek advice and quite rightly so. The government has introduced the concept of decision trees which people will be able to follow to decide for themselves whether or not to buy a stakeholder. I recall in my days at Norwich Union ‘job cards’ which were being introduced and which laid down the procedures for doing every conceivable piece of work. They were excellent in ensuring that people did standard pieces of work in a standard manner and accurately. Unfortunately, they struggled to cope when ever anyone came up against something slightly out of the ordinary, indeed in these cases people were more likely to get things wrong because as far as they were concerned they had to follow the jobcard, and had not been trained to look more widely. This is the danger with decision trees. Let me know if you would like a copy of the decision trees or, alternatively they can be downloaded from the Financial Services Authority website. Read them and you might even discover if a stakeholder pension is appropriate for you. But be warned, you will have to go through up to 11 pages of decision tree before discovering what is right for you and, if a stakeholder is appropriate, there will be no clues as to which one is best or whether you should use your stakeholder to contract out of the State Second Pension. Isn’t simplicity a wonderful thing?
Face facts, as a recent Cap Gemini report stated ‘ people find pensions boring and complicated’. As things stand at present, there is a very real danger of misbuying of stakeholder pensions and this could yet overshadow what is potentially a great improvement on the money purchase pension schemes that went before.
CRYSTAL BALL GAZING
In many ways, stakeholder needs to be seen for what it really is, part of the evolution of the pensions industry in the UK. It is not the revolution that many have painted it, but it does perhaps mark a quickening of the pace of change. The introduction of personal pensions twelve years ago was a more radical change and, on the whole, was a positive move, bringing pensions to millions of people who were previously provided with nothing. True, there have been hiccoughs along the way, most notably the pensions misselling scandal, but overall many more people have private pension provision than in previous decades. And, for sure, many more people are starting to realise that the state will not full provide for them when they retire and starting to think about this earlier.
As I look into the future, the evolution will continue. Mistakes will be identified within stakeholder, some are obvious already, for example the interaction with the minimum income guarantee. Some of these inconsistencies will be ironed out, some will remain and there may well be scandals along the way.
Government has said stakeholder will be reviewed after 3 years – I expect changes to be made.
Gradually, many companies offering stakeholder pensions will fall by the wayside or become players in niche market. Personal pensions will grow in two directions. One of these will be stakeholder and this will be the equivalent of today’s mass market for personal pensions. Packaged personal pension schemes with charges above the 1% stakeholder cap will, over time, disappear, as it will become increasingly difficult to justify the cost of advice or additional charges. However, the rapid growth in the Self Invested Personal pension will continue and possibly speed up. SIPPs are an ideal route for people who want more control or freedom than packaged products can offer them – if you want a packaged product, buy a stakeholder, if not buy a SIPP.
As mentioned above, I believe that many players in today’s market will have to pull out of the stakeholder market. Many of those entering today are dependent for their profitability on people remaining invested with them, they are taking huge risks in terms of their investment in stakeholder pensions today and sacrifices of future profitability. This will make them vulnerable to predators from outside the UK, who will be subject to no such constraints on their profitability. There is a very real danger in my view that the UK pensions industry will be wholly controlled by overseas firms by the time stakeholder starts to generate very real returns. New entrants from the US and elsewhere will be able to establish an immediate footing in the stakeholder market, undercutting UK firms charges, once the value of funds under management in stakeholder schemes starts to look interesting. What protection is there for the companies making the sacrifices now? The life and pensions industry has seen much consolidation over the past ten years. This could be nothing compared to what will happen as a result of stakeholder.
Then there are people in occupational schemes. Sad though I believe it is, I have seen little evidence that the decline in final salary schemes will continue, especially amongst companies employing less than 500 people. Regulation continues to make final salary schemes increasingly difficult to justify except for the largest companies. Perhaps we will come full circle and final salary schemes will come back into vogue, the money purchase boom has been going for twelve years and large numbers of people are starting to retire from these schemes. However, the modest benefits people are receiving from these schemes has not, as many expected, led to a clamour for the return of the final salary scheme. Rather, it has led to a clamour for changes to the rules on purchasing annuities.
However, what will change for occupational schemes is the role of the AVC. As I have mentioned above, this is a difficult area. There are many very good AVC schemes, which are far better than stakeholder schemes. It is vital that trustees and pension managers publicise the strengths of these schemes or people will pick stakeholders in preference. For many companies, the stakeholder will and should, become the AVC of choice. I hope, but am not confident, that the future will see the bringing together of the stakeholder and AVC rules. Simplification, which is vital in my view but which, the Revenue does not seem receptive too at present. Perhaps when the system has been running for a few years their view will change.
FSAVCs will, and quite rightly in my view, become even more of a niche product than at present. If concurrency works, it may well be extended and this could well be the death knell of the FSAVC. A recent study, I’m sorry but I can’t remember whom by, indicated that 14% of occupational scheme members had contributed to FSAVCs. I can well believe these figures, especially given the selling tactics of some of the direct sales forces and hope that the FSAVC sales review will flush out some of the worst practices. Given the advantages of a FSAVC over conventional AVCs, I believe this represents gross overselling of these contracts. Whilst I accept there are circumstances where FSAVCs are right for some people, I for one will shed no tears at their passing.
Generally, though, people will have more faith in stakeholder pensions than in many of their predecessors, and rightly so. Jeff Rooker was right when he said that stakeholder would be ‘secure, flexible and good value for money’. There are likely to be fewer complaints about stakeholder misselling but it is difficult to see the millions of extra pension contributors that many have predicted joining the fray. Just where are these extra investors going to come from?
The govt thinks that it wants people to save for their retirement and thinks, by giving them tax relief on contributions, that it is doing so. Then for the lower paid in particular, their private pensions are used to offset state benefits.
At the same time, the govt simply must encourage private provision. It cannot, in the long term, afford the ever increasing cost of old age pensions. The more people are able to provide for themselves, the easier this burden is on the state.
Employers are forced to offer stakeholder pensions but do not have to pay anything into them. How high do we seriously expect take up to be amongst people who are not currently paying into a pension scheme?
There has to be an end to the muddled thinking within government circles. At present, investors wanting to benefit from tax relief have two main choices, pensions or ISAs. At present the tax benefit is in favour of pension schemes but is not significant and anyone forced to buy an annuity might well have got better value for money by investing in an ISA from outset. Annuity rates can change but the government could help by increasing the options available to people at retirement.
The government has said that compulsion will be introduced if stakeholders are not a huge success.
A survey by datamonitor last year estimated that Stakeholder would generate about 2.2bn in contributions by 2005, about 19% of total pension premiums. Will the government see this as a success – it might do, but should not, the same report indicated that the vast majority of this money will represent contributions that would otherwise have been paid to personal pensions. Stakeholder does not deserve to be a success amongst the lower paid. Compulsion will have to happen and, let’s face it; the prospect of compulsion in the (not too distant) future is the reason why so many insurers have thrown their hats into the stakeholder ring. The trouble with compulsion is that it could rebound on any government that introduces it – opposition would see it as an additional tax, which lets face it, it would be. I am certain compulsion would already be here if the govt had not felt it was just too big a step to take.
And finally –
In the May 2000 issue of PMI news there was an article written by the PMI’s Vice President focussing on the implications of stakeholder for insurers. The author identified the characteristics required of a provider to succeed in the world of stakeholder pensions as follows:
- Strong brand
- Administration systems capable of handling very high volume
- Sustainable low costs
- Flexible imaginative management
- Access to appropriate distribution channel(s)
- He then suggested an exercise which, if you didn’t do it then, would be well worth doing now. Jot down a list of providers who you believe can meet those criteria.
Keep your note safe and check in five years time and see which companies have been successful. As the Vice President said at the time, be prepared for a shock.
As well as being PMI Vice President, Neil Crichton was also Senior manager Group pension development at Equitable. I suspect that if we had jotted down those names last April, Equitable Life would have been on many lists, but we have already seen, in my opinion, the first victim of stakeholder.