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Is a final salary promise still the Gold Standard?

Final Salary (Defined Benefit) pension arrangements have always been seen as the “Gold Standard” of pensions when compared with the Money Purchase (Defined Contribution) alternative. However, I would suggest that employees’ perception of this is changing. John Reeve, Senior Consultant, Premier Pensions Management.

Final salary arrangements will commonly offer just one form of benefit; a pension, increasing in retirement and with a dependent’s pension payable when the employee dies. It is a one-size fits all solution in an increasingly diverse world. In addition, legislative changes have been aimed at levelling the playing field. Confusion amongst employees alongside a widespread lack of confidence in the Financial Services industry generally has added to a swing of opinion against final salary arrangements.

Final Salary PromiseOver the past few years the popular press has been full of articles that have demonised annuities going as far as to call them robbery. To counter this (and to earn additional revenue) the Treasury has announced that, from April 2015, retirees will not need to buy an annuity; they can take their benefits in cash. Whilst those of us working in the industry realise that these new “freedoms” only apply to money purchase arrangements, most employees makes no such distinction. Those retiring from final salary arrangements, rather than thanking their employers for the “Gold Plated” benefit, are asking why they cannot have the cash. Indeed employees who have been told that they “must” take a pension often feel that they are being forced into one of those demonised annuities.

Most importantly I would suggest that both Trustees and Employers must recognise the issue. The “one-size fits all” nature of final salary arrangements is no longer appropriate. Final salary members can take advantage of the flexibility offered by the new rules by transferring into a personal pension plan. Transfers from final salary schemes have been discouraged in the past but we now need to recognise that, for some employees, a transfer is appropriate. The challenge is to ensure that only those for whom a transfer is appropriate go ahead and not those who are badly advised or have a knee-jerk reaction to poor press coverage.

Many retirees in the UK now will have a combination of final salary and money purchase benefits and hence the retirement process and the decisions that need to be take are very complex, Whilst the Government’s promised “Guidance” will help, employers are increasingly offering full IFA advice; not just at retirement but also in the run-up to finishing work. Some employers and trustees have resisted introducing members to an IFA fearing that, by recommending an advisor, they are exposing themselves to criticism. I would suggest that this is flawed thinking. By ensuring that the member has access to a qualified advisor who is appropriately remunerated and can give professional advice, the trustees and employer are safeguarding the member. It would be far worse to let them deal with these complex, long term decisions with poor quality advice.

The benefit to the employee of good advice is obvious. However, providing IFA advice can also make financial sense for the employer. Recently one Finance Director told me that the person who could influence his financial results the most was the actuary who calculated the pension costs! Whilst I think this exaggerates the role of the actuary, the point is well made. Pension costs and the volatility of those costs is an issue to most UK companies. Anything that can be done to reduce the quantum or volatility is to be welcomed. Employees who decide that they want to take their benefits in a different form (maybe with different increases in payment or with a different level of protection for dependents) will transfer from the final salary arrangement. For reasons too complex to go into here the Transfer Value paid to a member will generally be less than the reserve held in the Scheme to pay that benefit. Even where the two values are broadly equal, the employer is no longer exposed to the risk of increased longevity or investment volatility on that benefit. Any transfer reduces the employer’s costs and risks. Thus both the employer and employee can benefit from the process.

I suggest that the days when final salary arrangements were put on a pedestal above criticism are gone. However, with this comes greater engagement and an opportunity to help employees to get more appropriate benefits from their savings. There is a “win-win” solution here if employers are willing to embrace the challenge.

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