The National Association of Pension Funds conducts a yearly survey to ascertain various aspects of the establishment, running and membership of occupational pension schemes. I have commented in previous years about the importance to financial advisers of many of the results and this year's publication continues to highlight a number of interesting trends and developments.
Probably the most important trend reported is the continuing closure of many finalsalary schemes. Three years ago, for the first time, we saw 10 per cent of remaining final-salary schemes close to new members and by 2003 this figure had escalated to 25 per cent.
There appears to be little possibility of any reversal in the trend towards money purchase. With average employer contributions to final-salary schemes, as measured by the long-term funding rate, running at around 20 per cent, while money-purchase funding levels average less than half this figure, there is little wonder that around three-quarters of final-salary schemes closing in 2003 cited cost savings as the main reason for switching to money purchase.
The message to employees and their financial advisers should be obvious – a halving of contributions to pension schemes means a halving of future retirement benefits. It also means that employees must now take responsibility for the performance of their chosen investment strategy and run the risk of falling annuity rates brought about more by increasing life expectancy than by falling interest rates.
Employees should be made acutely aware of the deficit they are almost certain to face in their desired income levels after retirement, putting much more emphasis on the need for regular savings than has been the case in previous years when significant final-salary benefits were being provided.
Financial advisers must also be aware of the differences in scheme membership depending on whether new employees are automatically included in the employer's scheme or whether they have to proactively complete a membership application.
Incredibly, of all employees who automatically join a scheme on entering service, around 10 per cent subsequently opt out – many from non-contributory schemes. It is accepted that few of these opt-outs are prompted by financial advisers, as it appears that we have well and truly learnt our lesson from the pension review, and there are no obvious explanations as to why so many people should voluntarily forgo between 10 and 20 per cent of their earnings contributed to a pension scheme by their employer.
Even more worrying, where employers do not automatically include new employees in the pension scheme, 27 per cent of potential final-salary members and an incredible 50 per cent of potential money-purchase members fail to join. Remember, these figures include schemes which do not require employee contributions.
The figures for opt-outs and non-joiners have been increasing steadily for some years since the outlawing of compulsory scheme membership and I would like to offer the following advice to financial advisers. When conducting a client fact-find or review, just the client believes he or she is a member of a pension scheme, do not take that belief at face value. In my experience – supported by successive NAPF surveys – many of these people will have accidentally forgone membership while believing they are part of the scheme.
If left uncorrected, it appears that millions of employees are destined to reach retirement in the mistaken belief that they will be entitled to benefits from their employer's pension scheme. Always ask employed clients for a recent benefit statement from their employer's scheme. You will encounter many instances of clients who have not the first clue what you are talking about, which is a fairly sure indicator that they are not a member of the scheme.
Having ascertained this, you will have drawn the client's attention to an exceptionally valuable financial planning benefit which will typically require relatively little or even no personal contribution.
Before leaving this particular issue, it is perhaps worth noting that the NAPF survey reveals that only 40 per cent of private-sector schemes and 72 per cent of public-sector schemes operate automatic scheme entry for new employees. This continues to be the main reason for reducing scheme membership. Bearing in mind the fact that opters-out and non-joiners save the employer a significant amount of funding, a cynic might suggest that the principle of automatic entry might continue to fall into disrepair.
On to other issues. Regular readers of this column and attendees at my seminars will be aware that one of my favourite pension topics in recent years has been the death entitlement or otherwise of common-law and same-sex partners.
Historically, only legally married spouses were entitled to a surviving spouse's pension but, over the last couple of decades, common-law partners and, more recently, same-sex partners have increasingly been considered for death benefits by a number of pension schemes.
This trend continued in 2003 when only 9 per cent of private-sector schemes but 53 per cent of public-sector schemes said they would not pay a survivor's pension to a common-law partner under any circumstances. The remaining schemes stated in roughly equal numbers either that payment would be made at the discretion of the trustees or if the survivor was financially dependant or interdependant on the deceased at the date of the member's death.
On a technical point, schemes would be well-advised toremind themselves of the Inland Revenue requirement that a survivor's pension can only be paid to an unmarried claimant who was financially dependant or interdependant on the deceased. Trustees should not even consider paying anyone not fulfilling this condition.
It is important for financial advisers to understand the implications of these statistics and bring them to the attention of relevant clients. In my experience, many people in long-term common-law partner relationships believe that a survivor's pension will be payable automatically from the scheme to the most appropriate claimant.
This belief is particularly rife where the employee has made a nomination for lump-sum death benefits in favour of their partner. In fact, the nomination only applies to the lump-sum death benefits and has little or no influence on the survivor's pension benefit.
A little-known statistic from the NAPF survey reveals that 10 per cent of private-sector schemes and 25 per cent of public-sector schemes will not pay the lump-sum death benefit to anyone other than a dependant child or legally married spouse, regardless of the member's nomination in favour of someone else.
If a financial adviser truly wants to ensure that the best interests and intentions of his clients are being served, then I suggest that confirmation of the rules of the pension scheme in respect of both lump-sum and survivor's pension benefits be sought. Mere evidence that the client has made a nomination will clearly be insufficient in many cases. Where it becomes evident that death benefits will not be payable from the scheme to a common-law partner, the need for life cover will be increased.
As regards same-sex partners, the NAPF survey reveals that around 50 per cent of all scheme treat these relationships in the same way as common-law partnerships. This figure is broadly the same figure within the private and public sectors. This means that many schemes refuse benefits altogether unless the claimant was legally married.
The other half of schemes tend to treat same-sex partners much less favourably, typically refusing to consider benefits altogether or placing an increased reliance on the discretion of the trustees. For advisers with homosexual clients, the messages relating to common-law partners are therefore even more important.
In my next article, I will consider more messages from the NAPF survey, including minimum and maximum retirement ages.