Death & Taxes - Undefined Benefits
If you’re a typical Master Investor reader there’s every chance that at some stage you’ve been a member of a Final Salary Pension Scheme with a former employer. Or maybe you’re still in the job. Whatever the case may be, it’s likely the scheme doesn’t take any payments from staff anymore or allows new employees to join. So what? I hear you ask.
Well unless you’ve been living in a cave for the last few years, you will have noticed that these “antique” group savings schemes are allegedly in trouble, thanks to a long history of poorly thought-out law changes and years of mismanagement. And that’s just for starters.
As if that was not bad enough, the previous Chancellor of the Exchequer, George Osborne, faced with a shortage of tax revenues decided folks sitting in pension plans worried about retirement income were an easy target. So he enticed them out of their “straightjacket” pension plans and/or their final salary schemes by allowing them to cash up their lifetime pension rights and deposit their “winnings” in standalone plans where you don’t have to buy a “useless” annuity. And he attracted the attention of you and me by calling it “Pensions Freedom.” Sounds good eh?
Now you might have stumbled across all this in the news if you recognise the terms DB and DC. Ring any bells? Have you noticed the financial services industry has a penchant for confusing us by using jargon words and odd acronyms? Which other industry would try to entice you with a “Section 32 Buy Out,” a “SSAS,” “SIPP” or “Phased Annuity?” How do you fancy a Without Profit Endowment or a Collective? Err, no thanks.
Well DB stands for Defined Benefit. DC for Defined Contribution. Any the wiser? DB is shorthand for a Final Salary Group Pension Scheme. Remember how that used to be “Gold Plated” and “the Envy of Europe”? Well not anymore, judging by the fact that so many schemes are deep in debt, and that 80,000 folk have already left them in only two years, dumping their guaranteed pension rights in exchange for one-off huge cash sums then put under their own “control.” Gulp.
Why is it that policyholders think they’ve won the lottery while scheme trustees and employers are high fiving each other having got shot of their onerous liabilities?
DB or not DB?
If Shakespeare’s Hamlet were alive today he’d no doubt be pondering….
“DB or not DB? That is the question. Whether it is nobler in the mind to suffer
The slings and arrows of outrageous fortune, or keep my pension rights where they are?”
But to understand why we are now in this confused pension mess, it’s worth looking back at the halcyon days of “Gold Plated” Final Salary Group Schemes. Was it really all so perfect?
I started working in 1969 after leaving University hoping to become an actuary. Fortunately I didn’t make it thanks to having a personality. But the work gave me a good grounding enabling me to understand the nuances of financial products and translate industry jargon into meaningful explanations. In 1972 I was given the Herculean task of improving the productivity of the pension department in a mutual assurance office. I surrendered after only a few days. It was all too bewildering for mere mortals like me.
Fortunately my boss had previously wandered up and down the UK convincing employers to provide benefits to their employees via “Gold Plated” DB Schemes. So he understood the jargon and complexities. Sitting down with a sheet of paper he drew a water tank shape with an inflow pipe above and a tap at the bottom. Let’s call this a DB scheme he said.
The inflow pipe pours money into the tank and the idea is that enough money is in there to pour out sufficient to buy benefits (income and some tax free cash) when the oldest member of the scheme retires. So how do they know how much money to pour in every year I wondered? Easy he replied…….
You do an analysis of all those joining at the start - dates of birth, salaries, marital status, male/female mix, then assume rates of yearly salary increase, rates of inflation, rates of return on investments, mix in mortality statistics, work on assumptions the scheme lasts for infinity, throw all that into a computer and out pops a funding rate. A what? That’s the percentage of staff salaries that’s needed to be paid in by employer and employees to keep the scheme on track. And that’s easy?
I looked at him in astonishment. That can’t possibly work I said. Shh he replied, don’t tell anyone!
And that was the best it got. But over the following thirty-odd years all that changed. New legislation meant that all pensions now had to be revalued in real terms, all past employees needed to be protected, and scheme asset surpluses were frowned upon by Governments (tax evasion they said) so contribution holidays were encouraged. Legal changes were accelerated by successive governments, especially during Gordon Brown’s vindictive tax onslaught from 1997.
There used to be something called “Legitimate Expectation of Benefit” under Law of Contract. Applied to pensions it was upheld religiously throughout all the restrictive changes introduced from 1988 onwards. You could rely on there being no restrictive legislation reducing your rights. Then in 2006 Brown tore it all up, applying caps to benefits retrospectively. It was all illegal but few cared. Our Judges did and threatened to resign en masse, so were exempted. As was the Prime Minister, Chancellor of the Exchequer, and Leader of the House of Commons. Surprise surprise.
I’ll not bore you with all the details but we now have umpteen regimes of lifetime caps retrospectively applied creating tax traps on income and capital for the unwary. As for the damage already caused, the CA magazine calculate that the unfair retrospective imposition of capped benefits has already led to a sixth of GPs between age 55 and 59 leaving their profession thanks to it. And in turn that led to 265,000 patients having their GP practice closed. And that’s probably just the tip of the iceberg.
And now thanks to the political situation in the UK right now, thousands are in limbo wondering whether they can contribute to their plans or not, and whether it’s worth it or not. And remarkably, despite the obvious benefit in having your pension position checked out by folk who really can guide you through this mess, only 10% of those asked in a survey saw the value. Doh!
Think it over. Think it under.
But to those tempted to join the lemming-like rush out of their secure and guaranteed lifetime income plan (DB Schemes) alongside the 80,000 who feel confident to manage their income and asset value perhaps for the next 40 years (assuming longevity experts are right), maybe ask yourselves a few questions first….. such as…..
If this transfer had been available to you 10 yrs ago, at the age you are now, with a similar transfer value of up to 40 times your DB pension level, and you’d invested in a UK Stockmarket about to fall by as much as 50% over the following year thanks to the financial crisis, how would you have felt, and what would you have done next ? Is that something you’d be able to handle?
If you transfer out to your own plan do you know whether you’re going to increase your liability to taxes given you’re leaving a benign tax area to a more highly taxed one?
Why do you think you’ve won the lottery with the transferred amount while the trustees and employer left behind are high fiving each other? Any idea how much it costs on the open market to buy a £20,000 guaranteed indexed pension plus two thirds pension for life guaranteed for a surviving partner? It’s probably 50% more than your “lottery win.”
And are you convinced the adviser who helped you transfer and select investments for your income for life is best placed to guide you through all the complexities and fears over your retirement?
Why is it that in surveys 80% of those heading into retirement say they want guaranteed income for themselves and their partner, yet the same percentage say they don’t want to buy annuities or something similar?
This all sounds very confusing to me. Don’t make a decision like this without pondering questions like this without pondering questions like these.
As Winnie the Pooh said “Think it Over. Think it Under”………… In other words due diligence has never been so important. Take time. Lots of it.