Automatic Enrolment and the New Regulatory Landscape for Pensions in the UK
By Robert Young
Posted: 15th July 2015 09:38There is no doubt that this is an interesting time for pensions with yet another period of major change.
Firstly we have the challenges of Automatic Enrolment. Although this started back in October 2012, at that stage it was the largest employers and it is now moving into a phase where smaller employers are reaching their staging dates until eventually reaching the micro employers. Many of these employers have not established a pension scheme before. In theory this should be straightforward but the Pensions Regulator has managed to write 418 pages of guidance so perhaps not so simple after all.
The key to delivering this efficiently and at reasonable cost is in the word “automatic” and linking the payroll systems through to the pension provider systems with little or no manual intervention. This aids accuracy and keeps the need for internal resourcing as low as possible. The Pensions Regulator suggests a planning period of 12 to 18 months but as long as a budget is created for the company contributions then the actual period can be much shorter.
The issue for the pensions industry is capacity as we move forward to periods where in excess of 100,000 employers stage in a single month. The selection of the pension provider is only one part of the process but an important one. There is a lot of focus on charges and we agree that charges must be reasonable, but net investment return (i.e., return after charges) is also important if good retirement outcomes are to be achieved.
We can help employers prepare a suitable plan and guide them through the process and select a suitable provider and generally help ensure everything runs smoothly, as well as giving guidance on issues that may arise. As we work alongside a law firm we can also provide guidance on any employment contract issues that may arise. For owner managed and family businesses we can look to integrate self-invested personal pension arrangements for the directors and family members with the automatic enrolment solution for any staff thus keeping administration to a minimum with everything effectively being provided through one arrangement while still maintaining investment flexibility for the directors.
As mentioned above, obtaining a good investment return on funds invested in defined contribution pension arrangements is an important element in achieving good retirement outcomes. Most members of these schemes simply leave their funds in the default investment fund which is why every qualifying workplace pension arrangement for automatic enrolment must have a default fund with charges no more than the current charge cap of 0.75% pa. Indeed this issue is of such importance that the Department of Work and Pensions has published criteria on default fund design.
Until recently many default funds were based around some form of “lifestyle” design whereby funds were gradually moved into less risky assets over the 10 years or five years to retirement. Most aimed to be 25% in cash and 75% in bonds at the point of retirement as 25% of a fund could be taken in cash and the remainder was used to purchase an annuity. The issue with these funds generally was that the switches were automatic and took no account of investment markets at the time of the switch. Some have added a level of governance to this so that investment experts regularly review the asset allocation of the fund and adjust the allocations should market conditions dictate. However now that there is no longer a need for annuities to be purchased at retirement and increasingly retirement is phased rather than at a single date the design of these funds needs to be reviewed.
A newer alternative are the funds known as Target Date funds. As the name implies these target a retirement year with risk being taken out as the retirement year approaches. Over time the allocation between return seeking, diversifying and capital preserving assets is adjusted. The funds follow a glide path which goes through several stages.
At the beginning is the growth phase when the focus is on long term growth with regular contributions smoothing gains and losses this essentially being the period up to age 40. Then comes a transition phase from around age 40 to age 55 where a balance is struck between growth and stability. Next comes a consolidation phase from age 55 to age 65, the key preretirement period. The focus in this phase switches to short term stability. Finally comes the stability phase or at retirement phase when the focus is on preserving the capital that has been accumulated but with a modest allocation to asset classes that offer a hedge against inflation and to insure against longevity risk.
Throughout this glidepath is managed both strategically and tactically to reflect the economic and market conditions by experienced investment professionals. Funds are now available that deliver all of this at an economical price. They are designed so that if scheme members have no wish to personally engage in the investment process, they are in a fund that is managed in an appropriate way along the journey to retirement with risks appropriately managed.
As noted above until recently funds accumulated in pension arrangements were generally used to purchase an annuity but in an environment of low yields on gilts these were increasingly considered as poor value and inflexible. From April 2015, however, we moved into the era of Pension Freedoms. From age 55 the whole fund accumulated in the pension fund may be taken out as a cash sum although doing this is inefficient from a tax perspective. The fear that there would be mass withdrawals has not happened so far as most realise that these funds are necessary to facilitate their lifestyle throughout their retirement.
For many there are several stages of retirement, the first phase where there may be a desire to travel or take up a new hobby, a second phase when perhaps life slows a little and travel and other activities are reduced and possibly a final phase when care and support may be required. There are many options available and the government has introduced the Pension Wise service to help guide retirees through the maze. This service will not however recommend any products or tell retirees what to do with their money so it will simply give some pointers. Given the range of options now available we would argue that the need for full advice at retirement has never been greater, particularly to ensure that any solution is tax efficient as well as meeting income requirements. We are increasingly using cash flow modelling tools to help retirees plan their retirement income. No one knows how long we will live in retirement but this time period is getting longer with increased longevity generally. The future is not certain but by constructing suitable models and showing a range of potential solutions, and by including all retirement and investment funds, a holistic retirement plan can be created, monitored and adjusted over time.
There have also been changes with regard to the distribution of benefits on death, with funds now being available to pass to any beneficiary and with no tax charge if death is before age 75. As sums accumulated in pension arrangements generally fall outside of the individual’s estate for inheritance tax planning, this opens up a range of planning opportunities. Again suitable professional advice should be taken.
Overall we are going through another significant period of change within UK pensions and it will be interesting to see as we go forward, the development of new products to meet some of the new challenges. One thing that is certain, however, is the need for advice on all of these issues has never been greater.
Robert Young is a Consulting Actuary and heads the firm’s employee benefit division. He qualified as an actuary over 20 years ago and has specialised in pensions and employee benefits throughout his career. He is also regulated by the FCA to provide financial advice. He strives to present complex technical and financial issues in terms that Trustees, Sponsoring Employers and Individuals can easily understand, enabling them to consider the issues they face and ensuring they have the knowledge to be able to make informed decisions. He has worked for companies across the spectrum, ranging from large quoted companies to smaller owner and family run businesses providing advice in respect of benefits for staff and to the owners themselves regarding their own arrangements