It’s your pension… get a grip
Taking responsibility for our retirement
savings is one of the biggest personal financial challenges confronting us in
the 21st Century, yet the vast majority of the UK’s adult population
has no idea how to face this challenge.
The government has come up with a solution to this
problem, which is to throw everybody into their employer’s pension scheme and
let them sort it out from there. The problem with this strategy is that whereas
ten years ago this would have meant that most people would have ended up in a
well-funded final salary pension scheme – so no need for the employee to worry
too much about the details – that just isn’t the case any more. By the time we get round to 2012, the launch
of Personal Accounts and the imposition of auto-enrolment on existing pension
schemes, the vast majority of employees will be looking at a money purchase
There are several problem areas here. Firstly, not enough is being paid
into money purchase pensions. The average contribution rate is currently around
the 10% mark, including employer contributions; with the introduction of
Personal Accounts and their benchmark eight percent funding rate, there may
well be some further levelling down of overall contribution rates. This is not
enough to buy you a decent pension; not unless you start in kindergarten, and
don’t retire until you are 70.
Secondly there is the extremely vexatious issue of investment strategy.
Are you going to take responsibility for this, or are you going to thrust it
all on to the employees? What about a default fund? We know that Lifestyling
(automatic pre-retirement switching from equities to bonds and cash) is a far
from perfect solution. More often than not it will cost investors money and
even when it does protect them from the worst of the market falls, the benefits
tend to be marginal.
The final big challenge comes when the employee reaches retirement and
is confronted with a whole new set of decisions to make about decumulation –
getting the money back out again. There are myriad different annuity types
available now, as well as Drawdown, phased retirement and Alternative Secured
Along the way employees may also have questions about their other
pension benefits and how they will interact with their current employer’s
There are external sources of information, such as the FSA’s Money Made
Clear, Citizen’s Advice Bureaux and the Pensions Advisory Service. None of them
though, is currently geared up to handle the six million or more people who are
going to get rolled into Personal Accounts when they launch in 2012, let alone
the millions of other occupational scheme non-joiners who are suddenly going to
find themselves in a pension for the first time and who may be wondering what
this means for them.
Just to further complicate the picture, there is the question of Salary
Sacrifice. Salary sacrifice is an obvious tool for employers to use to squeeze
greater efficiency out of their pensions budget, yet a significant number still
don’t take advantage of it. By reducing employees’ salaries and using the
savings to fund an increased employer pension contribution, the employer and
the employee can benefit from the reduced National Insurance liability (because
NI is payable on salary but not on pension contributions). Perhaps one of the
problems with this excellent tax saving dodge is that employees have an
understandable reluctance to give up some salary. The way to over come this
reluctance is through communication and education. The employer is saving 12.8
percent of the salary sacrifice and the employee is saving at least 1%, more if
they earn less than £40,040. This saving can help to cover the cost of improved
communication. I anticipate that Salary Sacrifice will become increasingly
popular as the economic downturn takes its course and employers find their
profits coming under increasing pressure.
So, the upshot of all of this is that employee education on pensions is
going to become something of a necessity over the next few years. There is a
wide range of tools available to meet his challenge. Some of the information
and decision making, such as contribution calculators, asset allocation analysis,
annuity purchase decision trees, can be automated. This automation though, is
no substitute for human contact, seminars, help-lines and one to one meetings.
My expectation is that many schemes are going to have to revisit their
employee education and communication over the next few years, possibly as part
of a wider revision to the overall benefit structure. I am absolutely convinced
that the most realistic hope of achieving employee engagement with their
retirement savings lies through workplace communication and education.