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Grey areas in planning

In my last few articles, I have identified, summarised and discussed the implications of some recent and upcoming pension developments. This week, I am moving on to a very recent bit of legislation which will not only have a massive impact on pensions but also on most other aspects of financial planning.

The Government has recently confirmed that from December 2006 it will be illegal for employers to force an employee to retire on the grounds of age. The vast majority of employers currently impose a mandatory retirement age of somewhere between 60 and 65 but from the end of 2006 they will no longer be able to do so. If an employee wants to keep on working and is physically and mentally capable of continuing to work, the employer will not be able to enforce retirement.

Before discussing some of the implications of this new legislation, I feel it is important to confirm why this issue is so crucial to financial planners now, rather than just in three years time when this legislation comes formally into effect. It means that every employee who is not due to reach his or her normal retirement age before December 2006 has already, in effect, not got a normal retirement age. Financial planning, let alone the financial balance of the country, is about to go through a revolution.

Where has this legislation come from? If you believe the Government&#39s ministers, this legislation is being introduced because the Government cares about the elderly and wants them to be able to continue working and earning for as long as they feel willing and able to be financially valuable to society. In fact, as I reported over two years ago, this development has been forced on the UK – as well as every other EU member state – as a result of a simple interpretation of the European Human Rights Act.

That act prevents discrimination between individuals on the grounds of race, sex and age. A European directive requires the abolition of an enforced retirement age for employees by no later than December 2006. The UK is pushing this implementation to the limit.

What is this going to mean for the UK&#39s working population? Well, life expectancy in this country is increasing rapidly, by about three years every decade for males and two years every decade for females.

Longer life expectancy means that annuity rates are coming down for pension scheme members and everyone has to accumulate a bigger pot of money while working to subsidise the increasing number of post-retirement years without earnings.

Add to these financial considerations the growing acknowledgment that retirement often accelerates mental and physical decline and it can rightly be anticipated that many employees will either want to or financially need to continue working well beyond the traditionally accepted normal retirement ages of 60 or 65.

In my experience, the vast majority of clients state firmly that they want to retire at 55 or 60. Even when prompted to consider whether they will be financially able to retire at such an early age, they have little or no cognisance of the amount of savings they would need to be able to finance their wishes.

Predictive life expectancy indicates that people under 40 can expect to live on average beyond 100. If this case, we would be at school for 20 years, work for 40 years and sponge off the rest of the country for 40 years. The numbers do not stack up. So, more people will be working longer and accumulating more wealth. It is becoming easy to see why financial advisers should concentrate their marketing and development efforts on the elderly.

If we assume that there are only a certain number of jobs in this country, if elderly people increasingly become so inconsiderate as to live longer and keep working longer, then we can assume that our younger brethren will find it increasingly difficult to find jobs.

Anyhow, back to financial services. Think back to the European Human Rights Act. You – the younger employer – offer, say, one-sixtieth pension accrual to your employees, assuming that they are going to draw the benefits at age 65. The nature of final-salary scheme funding means that younger employees are very cheap to fund but older ones are very expensive. Add to this a few 70 to 80-year-olds and your final-salary funding is well and truly stuffed. As if all the other pension developments (see my last few articles) were not enough, goodbye final-salary schemes.

We are continuing to move inexorably towards moneypurchase pensions and working more years to make up for lower annuity rates, brought about not least because we are living longer.

But it is not only pensions which will be affected by open-ended retirement ages. I believe that group risk schemes are largely doomed. Take, as a first example, group private medical insurance rates. PMI is much more expensive for older people than for youngsters. Try getting PMI cover for a 75 or 80-year-old.

But, as an employer, if you provide PMI for a 25, 35 or 45-year-old employee, you must also provide it for a 65,75 or 85-year-old. Remember, the European Human Rights Act means you cannot discriminate between older and younger employees. The fact that employers will not be able to secure PMI for older employees will not excuse them. If they cannot get insurance, employers will simply have to pay the cast of private medical treatment directly. Of course, no employer will be prepared to meet these potentially huge costs, so I firmly predict that employers will simply scrap the entire scheme. Then there is no discrimination.

Perhaps the same will happen to death-in-service benefit. What about group PHI? To what retirement age should this be written after December 2006? Remember, with no compulsory retirement age, if an employer agrees to pay salary or provide salary cover during prolonged illness, the liability could be potentially limitless. Perhaps this class of group risk business will also disappear.

I am sure you can think of many more implications of this imminent development. In summary, my crystal ball seems to suggest that many or most employers will start to favour renewable fixed-term contracts for employees rather than permanent appointments, perhaps similar to the deals with professional footballers.

We must ensure that our financial planning projections and advice take full account of the effects of this legislation.

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