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Come rain or shine

This week, I will continue my series of articles on recent and imminent developments in the field of pensions. As in previous articles, I will not only identify and describe the developments but will discuss the implications and opportunities for pension advisers and their clients.

Specifically, I want to look at the fairly recent introduction of pension forecasts. I will categorise my thoughts in two sections – state pensions and non-state pensions. The former will be further divided between the basic state pension and the state second pension while the latter will be divided between defined-benefit occupational schemes and money-purchase schemes.

As regards state pensions, I hope that the vast majority of pension advisers are not only familiar with but also regularly use benefit request forms BR19 and BR20 with clients. To briefly remind ourselves, BR19 requests a forecast expressed in terms of a regular payment of benefit from the basic state pension and S2P.

The lesser-used BR20 provides a statement of the client’s accrued bene- fit within S2P as a capitali- sed amount.

BR20 is mostly of interest (unless I have missed some other point, in which case I would be grateful for correspondence from any readers) to divorce lawyers considering attacking a spouse’s entitlement to S2P in some way or at least taking its value into account in an agreed settlement.

Thus, I will concentrate for the purposes of this article on the nature and implications of the penson forecast resulting from a BR19.

The main purpose of BR19 is for clients to be able to more accurately assess the value of their likely future entitlement to state pension benefits so that a forecast can be made of any likely shortfall in their required income in retirement.

This can then be used to calculate the required regular contribution to a private pension arrange- ment or some other form of investment to provide future retirement income.

But I would particularly like to suggest in this article that BR19 has an important use for financial advisers in assessing a client’s lik- ely future entitlement to means-tested social secur- ity benefits.

I discussed this issue in a different context in a rec- ent article but held back at that time from a consideration of the important use of BR19.

Fundamentally, it is widely appreciated that saving through pension schemes or other investments might be a futile sacrifice – albeit, arguably, an honourable one – where the individual could be expected to qualify for means-tested social security benefits after retirement.

To use a fairly extreme although not uncommon example, if an individual can expect little or no entit- lement to state pension benefits or any other form of accrued pension bene- fits or investment funds, the first chunk of any money that he or she now starts to accumulate will do little more than reduce their entitlement to means-tested state benefits of various descriptions.

Thus, it could be argued that it might be negligent for a financial adviser to recommend any form of regular savings unless the likely eventual fund is expected to produce an income significantly higher than the level of projected means-tested state benefits.

I believe that BR19 should be completed for each and every client as part of the usual financial planning process. But I strongly suggest that it should be an integral part of the planning process where the adviser has reason to believe that the client has few other investments and might be entitled to a significant level of means-tested state benefits.

In my experience, an individual who has worked all his or her life and is likely to continue in work until state retirement age should be expected to accrue state pension benefits at such a level as to make possible entitlement to means-tested state benefits relatively. For employees with no accrued entitlement to S2P, my comments remain valid as, of course, the lack of entitlement to S2P indicates entitlement to private pension provision of some description.

On, then, to non-state pension forecasts, starting with entitlement to accrued benefits within a final-salary pension scheme.

Here, I suggest that projections should be considered separately for early leavers (that is, preserved pension benefits for clients who have left their employer’s scheme before retirement age) and for those still in employment and active members of the employer’s final-salary scheme.

As regards early leavers, I have in previous articles already discussed the enhanced protection for final-salary pension scheme members from recent developments including the Pension Protection Fund.

But, even putting aside the possibility of scheme default, I cannot understand how advisers can purport to have completed a full financial planning assessment unless they have completed all due enquiries as regards accrued benefits from previous final-salary pension schemes.

By this, I am not talking about an assessment of the merits or otherwise of a transfer from the final-salary scheme to an alternative private pension arrangement, I am simply looking at an assessment of the client’s potential need for additional provision for retirement income.

Thus, as far as this arti- cle goes, we can now add the client’s entitlement to state pension benefits to his or her entitlement to accrued final-salary sch- eme benefits.

It is important to understand that all these projections rely on cer- tain assumptions which may prove to be wildly incorrect by the time that the client actually starts to draw benefits.

It should be remem- bered that BR19 produces a pension projection in real terms (that is, net of inflation) which should not then be added to any other statement of future bene- fits, for example, entitle- ment to benefits from a final-salary pension sch- eme, which might be expressed in monetary terms without any allow- ance for inflation.

The adviser must either convert the state benefit entitlement by escalating the projection forwards at an assumed rate of inflation or convert the final-salary benefit entitlement to real terms by reducing the projection by an assumed rate of inflation.

Either way, it has to be acknowledged that the eventual result has been calculated without the use of precise science. The inflation rate assumed in the calculation may well prove very wide of the mark.

Moreover, BR19 assumes that the client will continue to accrue future entitlement to at least the basic state pension until retirement age, while this might not, in fact, apply.

It also assumes further entitlement to S2P when, in fact, it might not curr- ently arise or might cease at some stage in the future. The possibility of the cli- ent’s circumstances changing should also be borne in mind.

In conclusion, this all contributes to a require- ment for these elements of client research to be completed at regular intervals to continue to reassess the client’s needs in the light of changing circumstances and assumptions.

Perhaps, in the absence of any significant changes, performing this exercise on an annual basis might be impractical for many or most clients.

However, no less frequently than every three or five years as a minimum would be appropriate.

In my next article, I will move on to money-purchase illustrations to complete the whole picture.

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