Financial incentives to save for retirement DWP research

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1 12th February 2009 Issue No: 6 Pensions Bulletin Financial incentives to save for retirement DWP research The Department for Work and Pensions (DWP) has published a research report which looks at the financial incentives to save for retirement in the context of the Government s pension reforms (in particular Personal Accounts and auto-enrolment). The report is intended in particular to address concerns about the disincentive effect of the withdrawal of means-tested benefits as low earners build up savings in Personal Accounts. To this end it models, via a measure called payback, the impact on individuals making savings into a defined contribution pension arrangement after 2012 to which their employer also contributes. Payback compares the value of the net additional retirement income obtained by saving with the employee contributions made, and the modelling under it shows that: over 99% are better off in retirement by saving in other words they have more money available to them in retirement than if they hadn t saved; for over 95%, the expected improvement is greater than the cost of their contributions, even after taking inflation into account; and over 70% of savers can expect to get back more than twice what they put in, even after taking inflation into account. Moreover, it demonstrates that there is no readily identifiable group in the working age population whose members cannot, on average, expect to gain back more than they put in to a pension. The report goes on to examine various proposals to amend the tax and benefits system to minimise the disincentive effect of the withdrawal of means-tested benefits, but does not find favour with any of them. The results of this report have been hailed by the Government and by the Trades Union Congress (TUC), which welcomed the conclusions as alleviating the concerns of some that pensions savings will be detrimental to those receiving means-tested benefits. However, the NAPF warned that if personal accounts and auto-enrolment are to be successful, the Government needs to rebuild confidence in retirement saving, as well as identifying those who will not benefit from the new measures, and ensuring appropriate advice is made available to them. This research needs careful interpretation. For many who will see means-tested benefits withdrawn as a result of Personal Accounts saving, it is the employer contribution that is doing the work. But that contribution might have come from depressing wage rates. Payback also appears to assume that the alternative to Personal Accounts saving is immediate spending, on which it places no utility. Furthermore, the modeling appears to have been run on one set of assumptions. The possibility of investments going down as well as up does not seem to have been considered.

2 GMP Conversion Government response The Department for Work and Pensions has published its response to the consultation on draft regulations intended to enable contracted-out salary-related pension schemes to convert guaranteed minimum pensions (GMPs) into ordinary scheme benefits (see Pensions Bulletin 2008/37). The response clarifies a few issues that were causing confusion for instance making it clear that the trustees will need to decide the conversion date and that since actuarial equivalence will need to be demonstrated on this date, that these assumptions must be determined in advance of that date (but potentially revisited if conditions change significantly). But it does not bend to pressure for some relaxation in the requirements for survivor benefits after conversion. It is also disappointing that there is no expectation that the Pensions Regulator will issue any guidance to trustees in this area or identify a stop date after which schemes will no longer be required to unpick a conversion. At this stage, it is not clear whether any material changes will be made to the draft regulations, but they are due to be laid shortly and are expected to come into force in April or May While in theory the ability to convert GMPs into ordinary scheme benefits could be useful, in particular to those who wish to embark on radical simplification of an existing scheme, there are still many concerns about the practicalities of how this process will actually work In particular, there is no guidance on how schemes should allow for unequal GMPs when complying with the requirement to provide equal benefits overall to men and women in respect of pensions accrued from 17th May At this stage, there has to be a danger that this issue along with many of the other difficulties that were raised by respondents, could result in GMP conversion becoming impractical, even for those schemes that might otherwise have considered it. Reductions to pensions in payment in deflationary times Tax law block The Joint Working Group Technical Liaison Group recently asked HM Revenue and Customs (HMRC) as to whether current tax law might permit reductions to pensions in payment (the question being asked in the context of deflation potentially becoming a reality). HMRC has replied that its interpretation of the legislation quoted is that, in most cases general reduction will not be possible without triggering unauthorised payment charges. HMRC has advised that the specific provision of the Finance Act 2004 to which JWG referred does (since 6th April 2006) allow a scheme to reduce scheme pensions so long as the same reduction is applied to every scheme pension in the whole scheme; but that this provision is not available to a scheme if any pension in the whole scheme (or any part of a pension) is reduced by a different rate. : In practice, most schemes will have pensions payable to some members that cannot reduce due to other legislation (for example post-97 pensions subject to statutory LPI increases or post-88 GMPs). So it is likely that tax law would block general reductions to pensions in payment for the majority of occupational pension schemes (as indeed was the case before A- day). Page 2

3 Pension Protection Fund Trustee Good Practice Guide The Pension Protection Fund (PPF) has published an interactive web-based version of its Trustee Good Practice Guide, following feedback received from the pensions industry since it was initially published last spring (see Pensions Bulletin 2008/20). The guide is also available to download from the website or request in hard copy. The guide is intended to help trustees understand what is needed to complete an assessment period in a timely and effective way, particularly: the journey a scheme must make to complete its assessment period and the key activities it needs to undertake; the roles and responsibilities of the trustees during the assessment period; what the PPF will expect from the trustees; and how the PPF will support the trustees. Pension Protection Fund Notional levy ceiling 2009/10 The Occupational Pension Schemes (Levy Ceiling Earnings Percentage Increase) Order 2009 (SI 2009/200) has been laid before Parliament. The Order specifies as 3.6%, the increase in the general level of earnings for the twelve months ending on 31st July 2008 by which the pension protection levy ceiling for the 2009/10 financial year should be set. Accordingly, the Department for Work and Pensions has published the draft Occupational Pension Schemes (Levy Ceiling) Order 2009 which sets the levy ceiling for the 2009/10 financial year at million, up from million in 2008/09. The purpose of the ceiling is to limit the total amount of the pension protection levy that can be raised by the Pension Protection Fund. As last year, this ceiling is notional given that in 2009/10 the PPF intends to raise 700m. Financial Assistance Scheme Extension to ill-health provisions Following consultation last November, the Department for Work and Pensions has published draft regulations (see also the draft explanatory memorandum) that will extend the ill-health provisions of the Financial Assistance Scheme (FAS). These regulations are little changed from those published for consultation (see Pensions Bulletin 2008/47) and allow qualifying members of the FAS who are aged over 55, whether within five years of their normal retirement age or not, to access FAS assistance early, without actuarial reduction, where they have a serious illness that significantly reduces their life expectancy. The regulations are due to be laid before Parliament shortly and are expected to come into force before the Easter recess. Page 3

4 Financial Assistance Scheme Trustee Update The Department for Work and Pensions (DWP) has published a trustee update intended to inform pension scheme trustees about amendments to existing Financial Assistance Scheme (FAS) rules that came into force late last year, as well as progress on legislative and operational changes. The update includes discussion of the following: Amending regulations published in December enabling schemes that underwent an insolvency event prior to 6th April 2005, but only began to wind up between 6th April 2005 and 22nd December 2008, to qualify for the FAS. The intention to commence consultation on a further set of draft regulations shortly, which will cover further changes in line with the proposals made in December 2007 to introduce post-5th April 1997 indexation and other related changes to the calculation of FAS payments (see Pensions Bulletin 2007/52). The DWP hopes to bring these regulations into force in the summer of The intention to conduct preliminary consultation on proposals for the transfer of residual assets to the PPF, the delivery of the resulting asset-backed payments (including lump sums) and the formal discharge of trustees of qualifying schemes. The expectation is that a further set of draft regulations will go out for consultation in the summer, with a view to bringing them into force in the winter of The Update also raises the issue of equalising benefits for unequal GMPs. It states that trustees should ensure that the information provided by schemes to FAS for qualifying members reflects benefits calculated on an equalised basis. Furthermore, where schemes are in future transferring remaining scheme assets to the FAS, part of the pre-transfer process will be ensuring that equalisation has been dealt with. Annuities DWP research The Department for Work and Pensions (DWP) has published a research report which examines pension annuity rates in the UK from 1994 to 2007 and thereby computes the money's worth of annuities, which is defined as the expected present value of the annuity payments divided by the actual price paid. On average, the report found that the money's worth for 65 year old males has been 90%, and for females 91%. The report s authors suggest that, taking into account providers administrative expenses and normal profit requirements and in comparison with other financial and insurance products, this implies that annuities are fairly priced. However, there is evidence that the money s worth has fallen since 2002 and this could be in part due to providers pricing more cautiously against a backdrop of a greater risk in forecasting life expectancy. Page 4

5 This Pensions Bulletin should not be relied upon for detailed advice or taken as an authoritative statement of the law. For further help, please contact David Everett at our London office or the partner who normally advises you. Page 5