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On target for a comfortable retirement

When an employer switches from defined benefit to money purchase, why do the employees rarely seem to object to the usual reduction in employer commitment that accompanies the change?

There are several possible reasons. Perhaps the most obvious one is that often the existing employees are unaffected by the change. It is only new employees who go into the money-purchase arrangement and it was part of their joining package.

Even where existing employees have to join the new money-purchase arrangement for future accrual they may well feel that the alternative would be a financially weak or uncompetitive employer, and less valuable pension accrual is the better option.

In other cases it may be that the employees simply do not understand that their pension prospects have been seriously damaged by the change. After all, it is hardly in the employer&#39s interests to emphasise any downsides of the new pension arrangements.

The blissful ignorance of employees is more likely to be preserved if they are given a point-of-sale projection on the FSA-regulated basis, than if instead they are given projections on a bespoke actuarial advice basis.

Consulting actuaries are obliged to obey actuarial guidance note GN34, which lays down some general rules to ensure that employees get a fair picture about money-purchase prospects for the future.

But whatever the reason for employee acceptance of the situation, the fact remains that the vast majority of moneypurchase employees are not on target for a comfortable old age. Whether through ignorance, fudge or wishing away the problem, most are not acting to correct the shortfall.

However, from next April they are going to get a wake-up call. And this alarm clock is one of those annoying ones which keeps going off at regular intervals – in this case annually. Because what we are talking about here is the statutory illustration of money purchase, or Simp, which will become part of the annual benefit statement process from April 2003.

Simp is very different from current FSA point-of-sale projections. Its object is to demonstrate the approximate buying power of the money-purchase pot throughout retirement.

Simp is a single pension figure – not middle, upper or lower. It will give an answer expressed in today&#39s money and it will assume an RPI-linked annuity is bought (even though that may not be what people will do with the pot at retirement).

The combined effect of these changes, plus the adoption of up to date mortality assumptions, will often lead to quite dramatic reductions when compared to the FSA middle point-of-sale projection.

It will be very common for the new basis pension figure to be less than half of the oldfigure. People are going to need help to understand what is happening and – crucially – what to do about it. If handled properly, this can play a big part in overcoming the apathy and ignorance which leads to systematic under-provision in money-purchase pensions.

Once the employee understands the need to save more for retirement, various means of achieving this can be explored. The employer might be willing to match, or otherwise add to, additional contributions by the employee. Salary sacrifice might be worth considering. Isas might also be considered, as well as the explicitly pension options (though Isas are in general less tax-efficient than pensions).

This is a classic win-win situation. The individuals get back on track for a comfortable old age and the advisers and providers get an average contribution income per head which gives adequate reward for the costs of sales, advice and administration of the business. Simp is a challenge. If it is met in the right way it can be the making of money purchase.

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