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The BBC today reported that the top 100 UK firms have a combined shortfall on their Final Salary pension funds of £96Billion (yes Billion!). This represents a deterioration from a combined deficit of £41Billion at the same time last year. Most of the fall in value has been attributed to falls in share prices but changes in the assumptions, which are used to determine the level of funding needed to meet promised benefits, have also had a significant bearing. In some cases the value of the underfunding actually exceeds the value of the company.
The BBC article goes on to suggest that this will lead to more schemes being closed to new members. Of the top 100 companies, only three still offer Final Salary Pensions to new members. If you are interested, they are Cadbury, Diageo and Tesco.
What the article does not mention is that there are many more Final Salary pensions, mostly held on behalf of small to medium sized employers (and most people in Britain work for one of these rather than a top 100 firm). These will also be suffering from substantial deficits. The difference between a lot of the smaller firms and the top 100 firms is that they are often privately owned and therefore do not have the same access to additional capital as companies that are quoted on the Stock Exchange.
The issue with the smaller companies, who will be feeling the pinch every bit as badly at the moment is that, they are more likely to go bust and therefore be unable to make up the under-funding on their pension funds. Where this occurs the benefits will come under the auspices of the Pension Protection Fund, about which I have blogged before Protection for Final Salary Scheme Benefits could be under threat.
To cut a long story short, the PPF provides limited protection which, over time, can fall substantially short of what was originally promised. Furthermore, due to potential difficulties with funding the protection (based on levies charges to the remaining schemes which are already in financial difficulties) PPF benefits could need to be reduced in future.
So what should you do if you have final salary benefits either with your current or a previous employer? Well, for certain you should obtain details of the Transfer Value and the benefits to which you are entitled. These should be reviewed on your behalf by a pensions specialist (who will also take a whole range of other factors into account such as the state of funding of the scheme and the financial health of the sponsoring employer, amongst others). From this you will be able to form a realistic assessment of the safety of your benefits and whether you ought to move them to an arrangement that provides you with greater personal control.
If you are a financial adviser reading this article and you are not qualified to provide Pension Transfer Advice, consider referring your clients to an adviser who will work with you to ensure that your client’s needs are met in this regard.
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New guidance has been issued by the Solicitors’ Regulation Authority (SRA) stating that Solicitors must not refer clients to tied or multi-tied advisers; i.e. advisers who are not truly independent.
The SRA has stated that it is aware that some law firms have been approached by multi-tied and tied advisers seeking to enter into restrictive arrangements to provide financial services to the law firms’ clients. It reiterated that firms must always act in the best interests of their clients. This means that they must refer clients to independent financial advisers for investment advice.’
According to Sifa (the body representing independent financial advisers who specialising in working with law firms), there is confusion among solicitors about the status of financial advisers and this has resulted in widespread breached of the Solicitors’ Code of Conduct. Sifa said it had received numerous calls from IFAs reporting instances of solicitors referring clients to St James’ Place.
So, if you are a Solicitor or indeed anyone seeking financial planning advice make sure that you ask the adviser whether they are genuinely independent. Solicitors can be sanctioned for failing to do so and individuals are likely to suffer from a restricted choice and, in all probability, high charges
The Telegraph on 17th July published a list of tips for investing in a recession, which included a contribution by me!
For top investment tips click here
In summary, my view is to be systematic and disciplined … and keep costs down.
In an earlier blog I commented on the inadequacy of the Pension Protection Fund (PPF), which provides benefits to members of final salary pension schemes where the employers have gone bust. To summarise, the maximum benefits for employees who have not yet reached retirement age, are subject to a cap and are likely to increase both before and after retirement by less than the original scheme. In addition, options such as early retirement are not available under the PPF.
The PPF is funded by a levy on other pension schemes. Unsurprisingly, in these times of recession, an increasing number of schemes are having to call on the PPF because their employers have ceased to trade. In June of this year the PPF announced that levies will remain at the current level, which increases in line with wages. However, the Chief Executive of the PPF, Alan Rubenstein, also indicated that, whilst they are aiming to avoid increases above the level of wage inflation, further rises above this level cannot be ruled out in future, in order to maintain the benefit levels.
Whilst the PPF can demand more from schemes, the question is, can they actually raise the money? Recently a major firm of actuarial consultants has pointed out that, unless the recession ends fairly soon, it may not be possible for the PPF to simply impose increased levies on schemes attached to employers that are already suffering from the economic down turn. If this occurs, the PPF will have little option but to reduce the level of protection it offers to members of final salary pension schemes. Such cuts can be applied not only to the benefits which are not yet in payment but also to benefits already being paid to pensioners.
So what should you do if you have final salary benefits with a current of past employer? (For the avoidance of doubt these are benefits in which your pension is based on your years of service and final salary and are not normally related to investment returns or annuity rates.)
– Order a transfer value and statement of deferred benefits. These will tell you how much the scheme would provide you with were you to transfer elsewhere and also the value of the benefits which you have in the scheme.
– Provide these details to an independent financial adviser, who specialises in pensions, to carry out an initial review (they may need further information, which they can obtain from you or directly from the scheme).
– Obtain a copy of the employer’s accounts to get a view on how solvent they are.
If you are worried about the financial security of an ex-employer, depending on the state of funding of the scheme, there may be a case for moving the transfer value to a scheme under your own control. This is a complex matter requiring specialist professional advice, which I will cover in more detail in a separate post.
There are essentially two main sources of financial advice in the UK; Independent Financial Advisers and Tied Agents. The key difference between the two is that Independent Financial Advisers are required to act as the agent of the client and to select products from the whole of the market, whereas Tied Agents represent a single financial institution, or at best a limited number of companies. Independent Financial Advisers are also required to offer the option of being paid by a fee instead of taking commission when they arrange transactions on your behalf.
So, what does this matter? After all, both types of adviser put themselves forward as providing comprehensive financial planning, wealth management, tax and estate planning. Some Tied Agents even promote their fund management service as offering a ‘Best of Breed’ – take a look at this Google Search result page for a few examples.
Well, the chances are that you already own products from a variety of companies. Once the financial planning advice has been provided you are probably going to need to acquire some products in order to provide the security that you require and deliver your long term financial goals. With a Tied Agent you immediately encounter a couple of problems. They are not allowed to advise you on the products which you hold with other companies. Just as importantly, when it comes to putting the financial plan into action what choice do you get from a Tied Agent? If you have been following this so far, it will come as no surprise to learn that what you get are products from the companies that they represent.
Suppose you have gone ahead and bought a number of products from a Tied Agent and after a while you decide that their investment performance has not been up to scratch. You go to the Tied Agent and ask him what your options are. He can only offer other fund choices from the provider that he represents.
Independent Financial Advisers, in contrast, can advise on all products that you already hold. If you need to buy new products, they are required to search the whole of the market and recommend the most suitable one for your needs. They are strictly answerable to you and act as your agent and not that of a product provider.
Clearly it is a matter of personal choice. The following table may help you to decide which type of advice is best for you:
If you do decide that Independent Financial Advice is best for you make sure that you check that is in fact what you are getting. Due to the obvious advantages Independence confers on consumers Tied Agents working for ‘Wealth Management’ companies will go to considerable lengths to fudge the issue. Ask them out right whether they are an Independent Financial Adviser. If in doubt check the Unbiased Register to see if their details are included.
Take a look at this 5 min video about Dollar Cost Averaging by Professor Kenneth French.
Dollar (UK investors should read Pound) Cost Averaging, in this case refers to lump sums available for investment which, instead of immediately being fully invested in the markets, are allocated over a series of months. The objective is to avoid being caught out by sudden market falls shortly after making the investment. In the UK we call this ‘Phased Investment’.
Interestingly, Prof French reinforces the academically accepted view that Dollar Cost Averaging does not optimise returns, given the level of risk that an investor wishes to take. When considered purely from a finance perspective, if the right thing to do, in order to deliver a set of goals, is to invest in an equity portfolio, then it should be implemented in full, immediately. Market timing has been shown to contribute very little to returns and as a consequence there is no good reason to delay.
But, is this always right? Well ,Prof French observed that, from a behavioural finance point of view, it may be a good thing. People apparently feel worse about the negative outcomes from acts of comission (things they did) than they do about acts of ommission (things they didn’t do). Hence an investor feels a lot worse about the fact that his portfolio plummeted shortly after investing the money that he does about the returns which he failed to make because he didn’t invest the money.
On balance, Prof French concludes that, even with his finance professor’s hat on, the damage to prospective returns caused by Dollar Cost Averaging is very little, so it makes little difference whether investors use it or not. However, he observed that it may give them an experience that they feel better about.
Ultimately as investment professionals and, especially as financial planners, we do need to step outside of the theoretical world of optimised portfolios and look at things more closely from our client’s point of view. If doing things that are theoretically sub-optimal but not actually damaging makes our clients feel better about what they are doing then there is no good reason not to facilitate this. After all we are not on some kind of Evangelical mission to convert the pagan unwashed. Oh, and it is their money…. not ours.
Final Salary Scheme Closures
In a recent survey nearly a third of employers indicated that they intend to freeze their final salary schemes to existing members and over 80% had already closed the schemes to new members. In addition, the Pension Protection Fund (PPF) recently indicated that collectively the UK’s final salary schemes have a shortfall against the amount needed to provide members benefits of £179.3Billion.
What is this article about?
This piece looks at the reality of the protection provided by the Pension Protection Fund. If you want to be spared my verbiage and cut to the Conclusions
Final salary schemes have traditionally been described as guaranteed on the grounds that the benefits provided by them are ‘guaranteed’ by the employer. In any case, if the employer went bust, benefits would be protected by the PPF. Correct?
Well, not quite. Whilst those who had already retired and reached their scheme’s normal pension age when their employer went bust will receive 100%of their entitlement, others will receive 90% of a their entitlement subject to maximum pension of £28,742.68. This equates to the maximum pension an individual earning £43,115 would receive after 40 years service assuming that their entitlement builds up at 1/60th per year of service (which is commonly the case with this type of scheme). Individuals with a greater pension entitlement than this will have their benefits reduced to £28,742.68.
Many readers who are not lucky enough to be on high earnings or who don’t have a large pension entitlement may conclude that they are pretty well protected by the scheme since it provides 90% of their pension entitlement. Unfortunately, especially for those with some time to go, before they are due to retire, there are a couple of other catches with the ‘protection.’ One of these is that the option of early retirement is lost. PPF Benefits are only payable at the original scheme’s normal retirement age, typically 65. Forget heading to Spain at age 55!
The other catch, which is more subtle but, in the long run highly damaging to the level of benefits actually paid out, relates to the level at which the pension entitlement increases in the time before retirement. Since the Social Security Act 1990 came into effect all benefits must be increased between leaving service and retirement by RPI, subject to a 5% pa cap. This means that deferred pensions are substantially inflation proofed. However if the scheme comes under the auspices of the PPF the rate at which deferred pensions increase is capped at 2.5% per annum.
In common with many financial calculations, the effect of a 1-2% reduction to pension increases in deferment may be difficult to see. However, this is perhaps best illustrated by the rate of return (commonly called the ‘Critical Yield’) required to match final salary scheme benefits given up in the event of a transfer. Without going into the full details of final salary pension transfers, returns of 6-7%pa are usually required to match scheme benefits in the event of a transfer. However, in a number of cases I have recently looked at, returns of around 3-4% are required to match PPF benefits. This means that the PPF benefits, which need to be targetted, are substantially lower than the original entitlement. In addition, whilst it may be borderline to transfer for the purpose of beating original benefits, even for relatively risk averse individuals the chances are fairly good that PPF benefits would be exceeded.
It would be remiss of me not to point out there there is a great deal more to final salary pension scheme transfers than this and it is essential that professional advice from an appropriately qualified pension specialist be sought before making any changes to pension benefits.
The Pension Protection Fund provides limited protection at best in the event that an employer with a final salary pension scheme goes bust. Benefits are capped and higher earning employees could stand to lose a substantial amount. Early retirement is not available and benefit increases, before and after payment, are subject to a low cap. PPF benefits are funded by way of levies from other pension funds and if there is a shortfall benefits could be reduced.
Anyone with final salary benefits should arrange for these to be reviewed by a specialist pension consultant, especially if they are fearful of the financial strength of their ex-employer. Once an employer goes bust it is too late.