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Promised land, a pension nirvana

In 2013 the auto-enrolment initiative will not just be measured on how many people stay opted in, but importantly, what outcomes auto-enrolment will deliver for members in retirement. Jamie Jenkins, Head of Workplace Strategy, Standard Life looks forward to a critical year ahead, and beyond.

Beginning with the UK’s largest employers, by 2018, all things being equal, every employer will have a workplace pension scheme. To put that into perspective, that’s over 1 million employers and anything up to ten million employees who will be automatically enrolled. It’s easy to look at auto-enrolment as simply a function of fiscal policy. Despite the more immediate economic difficulties, there’s a recognition that the future burden on the State Pension system needs to be alleviated, and also that those who do retire in the future need to be financially secure and still able to contribute to society. Or you could look at it as a regulatory burden; just one more thing imposed on HR departments to comply with. Another expense for the FD. But in reality, it’s widely considered a social policy which is for the greater good of society as it encourages a good savings habit through the workplace. The launch of auto-enrolment is a huge step in helping people to save regularly for their retirement, yet it’s just the first part of the story. The next big challenge is ensuring people engage with their workplace saving and have a good experience.

Over the course of 2011/12, the Pensions Regulator helped pension providers, industry groups and consumer groups reach a consenus and agree six key ‘enablers to good member outcomes’ for pension scheme members: Appropriate contribution decisions; Appropriate investment decisions; Efficient and effective administration; Protection of assets; Value for money and; Appropriate decumulation decisions. In other words, that means helping pension scheme members to decide how much to pay, where to invest, making sure they get good service and clear communications, reassuring them that the assets in which their scheme invests are protected, , ensuring they get a good deal and then make the right choices at retirement with what they’ve saved. Employers will play a pivotal role in supporting people through these decisions. It is employers, after all, who will be making many of the big decision, or contributing to decisions on scheme design, contribution rates, investment defaults, communications and retirement options.

So let’s look at these drivers that will help us achieve good member outcomes in more detail and also at where some of the challenges lie: Paying the right amount into a pension is arguably the most important element of all and in most cases will have the greatest impact on the level of the pot at retirement. So how much is the right amount? There are some well-quoted rules of thumb that do not offer any guarantees but provide a starting point, let’s look at these. First, there is the rule of thumb that people should save 15 percent of salary throughout their working life. Sounds good, but for many people in their 20s already wrestling with student debt or trying to get onto the housing ladder, this is a big ask. And for people in their 50s, starting to save for the first time, this level of savings almost certainly isn’t going to provide them with the level of retirement income they really need. That brings me onto the second rule of thumb, that people should save a percentage of salary equivalent to half their age. That means paying ten percent from age 20, 15 percent from age 30 or 20 percent from age 40, which I think is a reasonable proxy for aiming at an overall retirement income of 2/3rds of final salary. Again, though, affordability will always be a significant factor. In fact, few people will have sufficient free cash to save at these levels, which is why the employer contribution and the tax relief are so important to the end result. Even the three percent employer minimum that has been introduced with auto-enrolment will make a difference, plus the additional tax relief on the employees contribution of 20 percent (or 40 percent for Higher Rate Taxpayers) has a major impact.

Few people consider themselves investment professionals or even feel they have a good understanding of where to invest. And we shouldn’t expect them to. That’s why many risk based-funds have been developed, to make the investment selection process so much easier for scheme members. It is also why having the right default fund is such an important decision for employers and their scheme members. With the launch of auto-enrolment, workplace pension schemes now need a default investment fund that is suitable for the majority of employees who will be automatically invested in it. For most, this will be something which gives employees some exposure to stock markets in the earlier years, when risk is more tolerable, but with a ‘de-risking strategy’ in the later years, in order to avoid stock market volatility and investment returns being wiped out in the run up to retirement.

Most providers already offer a range of default investment funds that can be tailored to suit the needs of different workforces and demographics. Some go even further and offer flexible periods of de-risking, switchable component funds and investment strategies that are future-proofed. There has always been a need for companies to review their default funds regularly, to ensure they remain fit for purpose and are capitalising on the latest thinking in investment fund offerings. But it’s even more important to carry out a review ahead of introducing auto-enrolment and it makes sense to seek advice on this. It’s one thing when people are joining a scheme proactively and defaulting their investment decision. It’s a very different situation when they are being automatically enrolled by their employer. Pensions administration has improved substantially over the years. These days, most administration is straight-through processing. And both employers and employees now tend to have online access, allowing them to view details of their pension accounts and make certain changes online. But processing is only one part of the administration story. Arguably a more important element is effective communications to employees. With auto-enrolment in place, employees are more likely to remain enrolled and to value the pension scheme their employer is providing for them if they receive communications that resonate and help them engage with the whole process. So establishing the right communications both in advance of being automatically enrolled and on an ongoing basis is paramount. Whether trust or contract-based pension schemes are used, workplace advisers or providers can usually help in providing communication programmes that are tailored to the needs of the workforce and to maximise engagement.

There are many protections in place for members of workplace pensions; not least of which the Financial Services Compensation Scheme (FSCS). But not every type of investment is covered by the FSCS, even within a registered pension scheme. Some external fund links with other investment firms are set up in such a way that they rely on the financial strength of the providers, in the event of the fund provider not being able to meet its liablities. Providers should highlight where these risks exist and employers/trustees and their advisers should ensure that there are adequate protections in place for the default funds selected. Charges are important, but it doesn’t simply mean cheapest is best. For both employees and employers, it’s a question of being able to ensure value for money. While employers will aim to negotiate a reduction for their scheme members, price always needs to be considered in the round. Getting the cheapest price at the expense of an appropriate investment default seldom makes sense. Equally, not investing in good communications or guidance on contributions could be a mistake. The charges made to members always need to be considered with other factors – like those above, in mind. If you have the lowest charges, but the poorest communications, it’s likely fewer people will remain in your scheme and thus fail to benefit from the charges negotiated anyway. But overall, the key to charges is that they are transparent and simple to understand, so that the right decisions around value can be made. The same applies to any investment fund that an employee is choosing, where charges need to be weighed up against the potential for investment return.

When employees come to retire, the decisions they make about their retirement income are crucial. If they are buying an annuity, for example, then that decision is generally irreversible. Given that an annuity often forms the bulk of someone’s income for the rest of their life, it’s imperative the right annuity is bought. Buying an annuity is not just about getting the best price – that should be the very final part of the purchase decision, once people have decided if they should buy a level annuity that remains the same each year, or one that increases over time. Or if they should buy a single life annuity, or a joint life one that will continue to provide an income to their spouse when they die, or if they want some additional guarantees, before focusing on getting the best price for what they need. Seeking advice can make real sense, but not all employees will be willing or able to pay for advice. That’s why it’s good to know that many employers are now offering pre-retirement workshops, or retirement-based advice from advisers, to help employees with such decisions. These can provide invaluable support to people who are nearing retirement. These are just some of the things we need to consider if we are to achieve good outcomes for those in workplace pension schemes. And a good member outcome has to be the ultimate achievement. The main thing is that no matter what type of scheme is in place, even if it is some kind of defined ambition scheme of the future – the six enablers to good member outcomes will still hold true. That in itself provides those offering workplace pensions with clear focus and consistency, making it easier to show employees a clear road ahead.

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