Last week, I noted the possible or probable abolition of the upper age
limit at which an annuity must be drawn and the certain abolition of the
upper age limit at which employees willbe required to retire.
Both these developments (or likely developments) have been prompted by a
European Union directive issued last year which requires member states to
outlaw compulsory retirement ages by no later than 2006.
In my last article, I briefly noted the effect this would have on
pensions. I would like to examine more closely the impact of this directive
on financial planning for clients.
This impact should be considered by financial advisers to be immediate as
although the directive might not come into force in this country until the
2006 – although there is speculation that we might comply some time before
that date – it is already certain it will affect all employed clients who
are due to reach retirement age at any time from that date onwards.
First, a look at pension planning. Many advisers now recommend to clients
contribution levels derived from the target benefits required by each
client at an assumed retirement age.
Where these clients are employees who are not due to reach the scheme's
normal retirement age before 2006, the next discussion with the client
should include the likelihood that the client will want to, and be
financially able to, retire at the current accepted retirement age
(typically 65, of course).
Many clients might express a burning desire to retire as soon as possible
but others might prefer the increased flexibility of retirement age which
will soon be accorded to them. Only physical or mental incapacity to
perform jobs can justify compulsory retirement and many people will
continue to work well in to their 70s, 80s or even beyond.
As for retirement income options, possibly the most exciting development
would occur if the age 75 limit is removed. This would potentially remove
the requirement ever to move funds out of a pension fund or, indeed, out of
a pension drawdown arrangement.
Combine this with increasing life expectancy and it can be easily seen the
whole environment for retirement income options is destined to go through a
period of huge change.
This change should result in greater flexibility for almost everyone due
to reach what is currently set as a normal retirement age.
Perhaps the most obvious and far-reaching change on pension planning may
be forced upon final-salary schemes. The European directive on its own may
be sufficient to require schemes to continue granting accrual of pension
rights after what is currently the scheme's normal retirement age. If Joe
Singer wins, this likelihood will turn into a certainty.
This would increase the funding rate for final-salary schemes massively
unless they reduce the accrual rate. Such a move would be very unpopular
with existing scheme members.
These schemes will be watching developments very closely indeed but if
accrual is not granted for employees beyond, say, 65 then this will,
without doubt, as far as I can see, constitute discrimination against older
people which contravenes the European directive and, more important, is
ill-egal under the provisions of the Human Rights Act.
Money-purchase scheme contributions by employers will also have to
continue as long as the employee is employed.
For many bigger employers, the pension scheme will not be the only
employee benefit which may need to be reviewed. Group risk schemes are set
for an even bigger shake-up.
As many employees will continue to work beyond the current normal
retirement age, any benefits granted to employees generally must also
continue. The most obvious benefits are life insurance and private medical
insurance, though, of course, it includes group PHI and group
Again, as with pension contributions and benefits, the removal of such
benefits from employees over, say, 65 is illegal and so employers must
brace themselves for huge extra costs if they wish to maintain these group
risk schemes. The cost of providing cover to this ageing sector of the
workforce will be much greater than for younger employees.
It is hard to see how employers can get round this soon to be introduced
requirement and I strongly believe that, unfortunately, most of these group
risk schemes will become a relic of the past as the cost commitment by the
employer becomes unmanageable. If I am right, then this is once again an
example of legislation which is designed to help employees achieving
exactly the opposite.
What about the financial planning needs of individual clients? As we can
assume many people will work to a much greater age, I suggest advisers
should be starting to consider writing PHI contracts to, say, 70 or 75 as
opposed to the current normal retirement age.
I would hope PHI providers will quickly recognise this need and permit
these longer-dated contracts without question.
Advisers should be aware that this need to anticipate the removal of the
compulsory retirement age must be addressed now. PHI contracts written now
to the earlier age are likely to be difficult, if not impossible, to amend
when the European directive takes effect – insurers may fear selection
against the office. This could leave the client with a deficient PHI
contract if he or she anticipates working until a later age.
Similar considerations should be taken into account in age-restricted
critical-illness cover policies.
Finally, a small but amusing political prediction. State pensions are not
caught by the directive and so may still be paid from 65 or (as is
currently allowed) deferred until a later age, with an increase for each
year of deferral. This could lead to the payment of state pensions for many
years while an employee continues to work.
Can you hear the politicians suggest this “double payment” is unnecessary
and unwarranted? Perhaps the state pension should not be paid while the
individual is working as this would represent an embarrassment of riches.
So, defer the state pension until he or she needs it, perhaps.
But then, this would represent a shift towards making the state pension
means-tested, wouldn't it? And that could never happen, could it?
Crystal ball gazing – election after this one 2005, European directive
introduced 2006 with deferred state pension payments at the same time.
Three or four years to the next election plenty of time to forget.
More immediate and certain – next week we move on to the fundamental use
and misuse of trusts in financial planning.